Why this matters
Financial ratios are the language of stock analysis. When an analyst says "Reliance trades at 28x earnings with 15% ROE," they are communicating an entire investment thesis in a single sentence. Without understanding ratios, you are reading balance sheets without comprehension — like staring at sheet music without knowing how to play. Every serious investor in India, from mutual fund managers to retail traders on Zerodha, uses these ratios daily to make buy, hold, and sell decisions.
Section 1: Valuation Ratios — Is the Stock Cheap or Expensive?
Valuation ratios answer the most fundamental question in investing: is this stock priced fairly relative to what the company actually earns, owns, or generates? A great company at the wrong price is still a bad investment. These ratios help you avoid overpaying.
Price-to-Earnings (P/E) Ratio
The P/E ratio is the single most quoted valuation metric in Indian markets. It tells you how much investors are willing to pay for every rupee of earnings. A P/E of 25x means the market values the company at 25 times its annual profit — or equivalently, if earnings stayed flat, it would take 25 years to "earn back" your investment.
Formula: P/E = Current Market Price / Earnings Per Share (EPS)
There are two types: Trailing P/E (based on last 12 months actual earnings) and Forward P/E (based on estimated future earnings). Forward P/E is more useful because stocks are priced on future expectations, not past results. Screener.in shows trailing P/E; analyst reports on Trendlyne or Tickertape show forward P/E.
Indian Sector Average P/E Ratios
FMCG commands the highest P/E due to earnings predictability. Metals trade at lowest due to cyclicality.
Why does FMCG trade at 40x while Banking trades at 15x? Because FMCG companies like HUL and Nestle have extremely predictable, recurring revenue. People buy soap and noodles in every economic cycle. Banks, on the other hand, carry credit risk — a recession can spike NPAs and wipe out profits. The market pays a premium for certainty.
Key Insight: Never compare P/E ratios across sectors. A P/E of 30x for an IT company may be cheap, while 30x for a steel company is absurdly expensive. Always compare a stock's P/E to its own sector average and its own historical P/E range.
Price-to-Book (P/B) Ratio
P/B ratio compares the market price to the book value (net assets) of the company. It answers: how much are you paying for each rupee of actual net assets the company owns?
Formula: P/B = Market Price / Book Value Per Share
P/B is especially important for banks and NBFCs in India. Since a bank's primary asset is its loan book (a financial asset), book value closely approximates actual value. HDFC Bank trades at ~3x P/B because the market trusts its asset quality. PSU banks often trade at 0.8-1.2x P/B because of higher NPA risk. A P/B below 1.0 means the market values the company at less than its liquidation value — either a deep value opportunity or a sign of serious underlying problems.
EV/EBITDA — The Professional's Choice
Enterprise Value to EBITDA is the ratio institutional investors prefer over P/E. Why? Because it accounts for debt. Two companies may have the same P/E, but if one is loaded with debt and the other is debt-free, EV/EBITDA will correctly show the leveraged company as more expensive.
Formula: EV = Market Cap + Total Debt - Cash. EV/EBITDA = Enterprise Value / EBITDA.
In India, EV/EBITDA is particularly useful for comparing Reliance Industries (which has massive debt from its Jio capex) with asset-light IT companies like TCS. On a P/E basis they might look similar, but EV/EBITDA reveals the true capital structure difference. A typical healthy range for Indian large-caps is 12-18x EV/EBITDA.
PEG Ratio — Growth-Adjusted Valuation
The PEG ratio solves P/E's biggest flaw: it does not account for growth. A company growing at 40% per year deserves a higher P/E than one growing at 5%. PEG adjusts for this.
Formula: PEG = P/E Ratio / Earnings Growth Rate (%)
A PEG of 1.0 means the stock is fairly valued relative to its growth. Below 1.0 suggests undervaluation, above 2.0 suggests overvaluation. In the Indian context, companies like Bajaj Finance historically traded at high P/E (50-60x) but had PEG ratios near 1.0 because they were growing earnings at 40-50% annually. Meanwhile, ITC often shows a low P/E (20-22x) but a PEG above 2.0 because its earnings growth has been sluggish at 8-10%.
Section 2: Profitability Ratios — How Efficiently Does the Company Make Money?
A company can have high revenue but terrible profitability. Profitability ratios reveal how effectively management converts sales into actual profit for shareholders. These ratios separate truly great businesses from mediocre ones disguised by top-line growth.
Return on Equity (ROE)
Net Profit / Shareholders' Equity x 100
ROE measures how much profit a company generates from shareholders' money. An ROE above 15% is good; above 20% is excellent. TCS consistently delivers 40%+ ROE because it needs minimal capital to generate profits — asset-light IT model. Tata Steel's ROE swings wildly (5-25%) because capital-intensive businesses are cyclical.
Return on Capital Employed (ROCE)
EBIT / Capital Employed x 100
ROCE includes debt in the equation, making it more comprehensive than ROE. A company can boost ROE by taking on debt, but ROCE catches this trick. In India, HDFC Bank maintains 15%+ ROCEwhile efficiently deploying both equity and borrowed capital. A ROCE consistently above the cost of capital (typically 10-12% in India) means the business creates genuine economic value.
Return on Assets (ROA)
Net Profit / Total Assets x 100
ROA shows how efficiently a company uses all its assets to generate profit. It is most comparable within the same industry. Indian banks: 1.0%+ ROA is excellent (HDFC Bank ~1.8%), below 0.5% signals problems. For FMCG, ROA of 15-20% is common because they need few physical assets. For capital-heavy sectors like power and metals, 3-5% ROA is acceptable.
DuPont Analysis
ROE = Net Margin x Asset Turnover x Equity Multiplier
DuPont breaks ROE into three drivers: profitability (margin), efficiency (asset turnover), and leverage (equity multiplier). This reveals whether high ROE comes from genuine operational excellence or simply from piling on debt. Infosys gets high ROE from high margins. D-Mart gets it from high asset turnover. Some NBFCs get it from high leverage — a riskier source.
Section 3: Liquidity Ratios — Can the Company Pay Its Bills?
A profitable company can still go bankrupt if it runs out of cash. Liquidity ratios measure a company's ability to meet its short-term obligations. These are early warning systems for financial distress.
Current Ratio
Current Assets / Current Liabilities
A current ratio above 1.5 is generally healthy. Below 1.0 means the company cannot cover its short-term debts — a red flag. However, some Indian companies like D-Mart operate with a current ratio near 1.0 by design because they convert inventory to cash so quickly. Context matters.
Quick Ratio (Acid Test)
(Current Assets - Inventory) / Current Liabilities
The quick ratio strips out inventory because it may not be easily convertible to cash. For manufacturing companies with large raw material stocks, the quick ratio gives a more realistic picture. A quick ratio above 1.0 is considered safe. IT companies like TCS have very high quick ratios (2.0+) because their "inventory" is essentially zero.
Section 4: Debt Ratios — How Much Risk Is the Company Taking?
Debt amplifies both returns and risk. These ratios tell you whether a company's leverage is manageable or a ticking time bomb. In the Indian context, many mid-cap companies have destroyed shareholder wealth through excessive borrowing — Suzlon, JP Associates, and Vodafone Idea are cautionary tales.
Debt-to-Equity (D/E) Ratio
Total Debt / Shareholders' Equity
D/E below 1.0 is generally safe. Between 1.0-2.0 is acceptable for capital-intensive sectors (power, infrastructure). Above 2.0 is dangerous for most industries. IT companies like TCS and Infosys are nearly debt-free (D/E near 0). Infrastructure companies like Adani Ports operate at D/E of 1.0-1.5. NBFCs are a special case — D/E of 5-7x is normal because leverage IS their business model.
Interest Coverage Ratio
EBIT / Interest Expense
This tells you how easily a company can pay interest on its debt from operating profits. Above 3x is comfortable. Below 1.5x is a warning. Below 1.0x means the company cannot cover interest payments from operations — it is either borrowing more or selling assets to survive. During the 2020 COVID lockdown, many Indian real estate and hospitality companies saw interest coverage drop below 1x.
Section 5: Key Ratios for Top Indian Stocks
Here is a snapshot of key financial ratios for some of India's most-tracked large-cap stocks. Use these as benchmarks when you analyze other companies in the same sectors.
| Company | Sector | P/E | P/B | ROE | D/E | ROCE |
|---|---|---|---|---|---|---|
| Reliance Industries | Conglomerate | 28x | 2.5x | 9% | 0.4 | 12% |
| TCS | IT Services | 30x | 14x | 45% | 0.0 | 55% |
| HDFC Bank | Banking | 19x | 3.0x | 16% | N/A* | — |
| Infosys | IT Services | 27x | 9x | 33% | 0.0 | 42% |
| ITC | FMCG | 25x | 7x | 28% | 0.0 | 36% |
*D/E is not meaningful for banks as deposits are liabilities. Use P/B and ROA instead. Ratios are approximate and change quarterly.
Section 6: Red Flags in Financial Ratios
Financial ratios do not just help you find good stocks — they help you avoid disasters. Here are the warning signs that experienced Indian market investors always watch for.
Consistently declining ROE
If ROE drops for 3+ consecutive years, the company is becoming less efficient at generating returns. Check if management is diluting equity or if margins are compressing.
D/E rising quarter after quarter
A company that keeps borrowing more without proportionally growing profits is heading for trouble. This pattern preceded the collapse of companies like Jaypee Infratech and Suzlon.
Interest coverage below 2x
The company is barely covering its interest payments. One bad quarter could push it into debt default territory. Especially dangerous for Indian mid-caps with promoter pledging.
P/E much higher than sector average
A stock trading at 3x the sector P/E better have a very strong growth story. Otherwise, it is priced for perfection — any earnings miss will cause a sharp correction.
Current ratio below 1.0
The company cannot meet its short-term obligations from current assets. Unless it has a special business model (like quick inventory turnover), this signals liquidity stress.
Negative free cash flow for years
Profits on paper but no actual cash generation suggests aggressive accounting or a business that constantly requires capital infusion. Watch for companies that report growing profits but never generate FCF.
Pro Tip: Use Screener.in's "Peer Comparison" feature to instantly see how a stock's ratios compare to its competitors. On Trendlyne, use the "DVM Score" which combines durability, valuation, and momentum ratios into a single score. Never analyze ratios in isolation — always compare against sector peers and the company's own historical range.
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Now that you understand financial ratios, dive deeper into the financial statements they are derived from. Start with the balance sheet — the foundation of all fundamental analysis.
- Balance Sheet Analysis — Learn to read assets, liabilities, and equity like a professional analyst
- Income Statement Analysis — Understand the revenue-to-profit waterfall
- Cash Flow Analysis — Why profits on paper do not always mean real cash
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