Financial ratio analysis explained for investors
A company's stock price tells you what the market thinks right now. Financial ratios tell you whether the market is right.
Financial ratio analysis is the process of pulling numbers from a company's financial statements — the income statement, balance sheet, and cash flow statement — and comparing them to reveal how profitable, stable, and fairly valued a business actually is.
Think of it like a health check-up for a company. Just as a doctor checks blood pressure, cholesterol, and heart rate to assess your health, financial ratios check a company's earnings quality, debt levels, and operational efficiency to assess its investment potential.
For Indian investors looking at US stocks, ratios are especially useful because they let you compare companies across borders on a level playing field. Whether you're evaluating Apple against Microsoft or comparing a tech stock with a consumer goods company, ratios strip away the noise and give you comparable metrics.
There are 5 main categories of financial ratios, each answering a different question about a company:
| Category | What it tells you | Key ratios |
|---|---|---|
| Valuation ratios | Is the stock fairly priced? | P/E, P/B, P/S, PEG, EV/EBITDA |
| Profitability ratios | How efficiently does it make money? | ROE, ROA, gross margin, net margin, EPS |
| Liquidity ratios | Can it pay short-term bills? | Current ratio, quick ratio, cash ratio |
| Leverage ratios | How much debt is it carrying? | Debt-to-equity, interest coverage, debt ratio |
| Efficiency ratios | How well does it use its assets? | Inventory turnover, asset turnover, receivables turnover |
Let's break each one down with real numbers.
Valuation ratios: Is the stock worth its price?
Valuation ratios help you answer the most fundamental investing question: Am I paying too much for this stock?
Price-to-earnings ratio (P/E)
The P/E ratio compares a company's stock price to its earnings per share. It tells you how many rupees (or dollars) investors are willing to pay for every ₹1 or $1 of earnings.
Formula: P/E ratio = share price ÷ earnings per share (EPS)
As of February 2026, the S&P 500's trailing P/E ratio sits at roughly 27–29, which is above its 25-year average of about 16.3. That context matters — a P/E of 25 might look expensive in isolation, but could be reasonable for a high-growth tech company.
How to use it: Compare a stock's P/E to its industry average, not the broader market. A tech company with a P/E of 35 might be fairly valued when the tech sector average is 32, while a utility stock with the same P/E would be significantly overpriced relative to its 15–18 sector norm.
A few things P/E won't tell you: it doesn't account for growth rates, it can be distorted by one-off earnings events, and it's useless for companies that aren't yet profitable.
Price-to-book ratio (P/B)
P/B compares a stock's market price to the value of its assets minus liabilities (its book value).
Formula: P/B ratio = market price per share ÷ book value per share
A P/B below 1.0 can signal that the market values a company at less than its net assets — potentially a bargain. This ratio works best for asset-heavy industries like banking, real estate, and manufacturing. It's less meaningful for tech companies, where the real value lies in intellectual property and brand equity, which don't appear on the balance sheet.
Price-to-earnings growth ratio (PEG)
The PEG ratio adjusts the P/E ratio for expected earnings growth, giving you a more complete picture.
Formula: PEG ratio = P/E ratio ÷ expected annual EPS growth rate
A PEG below 1.0 generally suggests the stock may be undervalued relative to its growth. A PEG above 2.0 could mean you're overpaying for the growth on offer.
Enterprise value to EBITDA (EV/EBITDA)
This ratio compares a company's total value (including debt) to its operating earnings before accounting adjustments.
Formula: EV/EBITDA = enterprise value ÷ EBITDA
It's particularly useful when comparing companies with different capital structures. An EV/EBITDA below 10 is generally considered attractive, though this varies significantly by sector. The S&P 500's average EV/EBITDA has hovered around 15–16 in recent years.
Price-to-sales ratio (P/S)
For companies that aren't profitable yet — think early-stage growth stocks or biotech firms — P/S lets you assess value based on revenue.
Formula: P/S ratio = market cap ÷ annual revenue
This is most useful when comparing companies in the same industry. A SaaS company with a P/S of 8 might be reasonable if peers trade at 10–12, but the same ratio would be unusually high for a retailer.
Profitability ratios: How well does the company make money?
Earnings per share (EPS)
EPS is arguably the most fundamental profitability metric. It shows how much profit a company generates for each outstanding share.
Formula: EPS = (net income − preferred dividends) ÷ weighted average shares outstanding
What matters more than the absolute EPS number is its trajectory. A company whose EPS grew from $3.50 to $4.20 to $5.10 over 3 years is showing a healthy upward trend. Declining or erratic EPS is a red flag.
Trailing EPS uses actual past earnings. Forward EPS uses analyst estimates for the next 12 months. Both are useful — trailing for what actually happened, forward for what the market expects.
Return on equity (ROE)
ROE measures how effectively a company turns shareholder money into profit.
Formula: ROE = net income ÷ shareholders' equity
An ROE above 15% is generally considered strong. Apple's ROE has consistently exceeded 100% in recent years — but that's partly because the company has bought back so much stock that its equity base is unusually small. Always check whether high ROE is driven by genuine profitability or financial engineering.
Return on assets (ROA)
ROA shows how efficiently a company uses everything it owns to generate profit.
Formula: ROA = net income ÷ total assets
A higher ROA means the company wrings more profit from fewer assets. This ratio is especially useful for comparing companies within the same industry, since asset intensity varies wildly across sectors.
Profit margins
There are 3 profit margins worth tracking:
Gross profit margin = (revenue − cost of goods sold) ÷ revenue. This shows how much money is left after production costs are deducted. Software companies routinely see gross margins above 70%, while retailers might operate at 25–35%.
Operating profit margin = operating income ÷ revenue. These factors in all operating expenses (salaries, rent, marketing) reveal how efficiently the core business runs.
Net profit margin = net income ÷ revenue. The bottom line — what's left after every single expense, including taxes and interest. A net margin above 20% is considered strong for most industries.
Liquidity ratios: Can the company pay its bills?
Liquidity ratios tell you whether a company has enough short-term assets to cover its short-term debts. A profitable company can still go bankrupt if it runs out of cash at the wrong moment.
Current ratio
Formula: Current ratio = current assets ÷ current liabilities
A current ratio above 1.0 indicates that the company has more current assets than current liabilities. Most healthy companies maintain a current ratio between 1.5 and 3.0. Below 1.0 is a warning sign. Significantly above 3.0 might suggest the company is sitting on too much idle cash rather than investing it.
Quick ratio (acid-test ratio)
Formula: Quick ratio = (cash + accounts receivables + marketable securities) ÷ current liabilities
The quick ratio is a stricter version of the current ratio. It strips out inventory, which can't always be converted to cash quickly. A quick ratio above 1.0 suggests solid short-term financial health.
Cash ratio
Formula: Cash ratio = (cash + marketable securities) ÷ current liabilities
The most conservative liquidity measure. It only counts actual cash and near-cash holdings. While a cash ratio of 1.0 or above is ideal, many healthy companies operate with ratios below 1.0 because they don't need to hold much inliquid cash.
Leverage ratios: How much debt is the company carrying?
Debt isn't inherently bad — many companies use it strategically to fuel growth. But too much debt becomes dangerous, especially when revenue dips.
Debt-to-equity ratio (D/E)
Formula: D/E ratio = total liabilities ÷ shareholders' equity
A D/E of 1.0 means the company has equal amounts of debt and equity. What counts as "healthy" varies dramatically by industry:
| Industry | Typical D/E range |
|---|---|
| Technology | 0.1 – 0.5 |
| Utilities | 1.0 – 2.0 |
| Banking/Financial | 2.0 – 10.0+ |
| Consumer goods | 0.5 – 1.5 |
| Real estate | 1.0 – 3.0 |
A tech company with a D/E of 2.0 would raise eyebrows. A utility company with the same ratio would be perfectly normal.
Interest coverage ratio
Formula: Interest coverage = EBIT ÷ interest expense
This shows how many times over a company can pay its interest obligations from operating earnings. An interest coverage ratio of 3.0 or above is generally considered safe. A score below 1.5 indicates the company is struggling to service its debt.
Debt ratio
Formula: Debt ratio = total liabilities ÷ total assets
A debt ratio above 0.5 means more than half of a company's assets are financed by debt. Again, context matters — compare within the same industry.
Efficiency ratios: How well does the company use its resources?
Efficiency ratios (also called activity ratios) reveal how well a company manages its internal operations.
Inventory turnover
Formula: Inventory turnover = cost of goods sold ÷ average inventory
A high turnover means the company sells through its stock quickly — good for cash flow. A low turnover might signal weak demand or overstocking. A retailer like Walmart might turn over inventory 8–10 times a year, while a luxury goods maker might turn it 2–3 times.
Receivables turnover
Formula: Receivables turnover = net credit sales ÷ average accounts receivable
This shows how quickly a company collects money owed by customers. A higher ratio means faster collection, which improves cash flow.
Asset turnover
Formula: Total asset turnover = net revenue ÷ average total assets
This measures how efficiently a company uses all its assets to generate sales. Capital-light businesses (like software firms) tend to have higher asset turnover than capital-heavy ones (like manufacturers).
How to actually use financial ratios: A practical framework
Knowing the formulas is step one. Using them effectively is what separates informed investors from everyone else.
Step 1: Never use a single ratio. A low P/E might look attractive until you see that the company's debt-to-equity ratio is 5.0 and EPS is declining. Always look at ratios in combination.
Step 2: Compare within the same industry. A P/E of 30 is expensive for a bank but might be cheap for a high-growth cloud software company. Industry context is everything.
Step 3: Look at trends, not snapshots. A company whose ROE improved from 12% to 18% over 3 years tells a better story than one sitting at a flat 15%. Check 3–5 years of ratio data.
Step 4: Cross-check with qualitative factors. Strong ratios paired with poor management, regulatory risks, or a shrinking market won't end well. Ratios tell you the "what" — you still need to understand the "why."
Step 5: Watch for manipulation. Companies can temporarily boost EPS through share buybacks, inflate revenue through aggressive accounting, or hide debt off-balance sheet. If a ratio looks too good to be true, dig deeper.
If you're new to this and want a structured approach, the fundamental analysis checklist for stock picking provides a step-by-step framework that puts these ratios into a decision-making process.
Key takeaways
Financial ratio analysis lets you compare companies on a level playing field, regardless of size or geography. The 5 core categories — valuation, profitability, liquidity, leverage, and efficiency — each answer a different question about a company's health. Always compare ratios within the same industry, track trends over 3–5 years rather than looking at single snapshots, and use multiple ratios together rather than relying on any one metric. For Indian investors analysing US stocks, ratios are the most reliable way to cut through market noise and evaluate whether a stock deserves a place in your portfolio.
Disclaimer: The views and recommendations made above are those of individual analysts or brokerage companies, and not of Winvesta. We advise investors to check with certified experts before making any investment decisions.
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Table of Contents
A company's stock price tells you what the market thinks right now. Financial ratios tell you whether the market is right.
Financial ratio analysis is the process of pulling numbers from a company's financial statements — the income statement, balance sheet, and cash flow statement — and comparing them to reveal how profitable, stable, and fairly valued a business actually is.
Think of it like a health check-up for a company. Just as a doctor checks blood pressure, cholesterol, and heart rate to assess your health, financial ratios check a company's earnings quality, debt levels, and operational efficiency to assess its investment potential.
For Indian investors looking at US stocks, ratios are especially useful because they let you compare companies across borders on a level playing field. Whether you're evaluating Apple against Microsoft or comparing a tech stock with a consumer goods company, ratios strip away the noise and give you comparable metrics.
There are 5 main categories of financial ratios, each answering a different question about a company:
| Category | What it tells you | Key ratios |
|---|---|---|
| Valuation ratios | Is the stock fairly priced? | P/E, P/B, P/S, PEG, EV/EBITDA |
| Profitability ratios | How efficiently does it make money? | ROE, ROA, gross margin, net margin, EPS |
| Liquidity ratios | Can it pay short-term bills? | Current ratio, quick ratio, cash ratio |
| Leverage ratios | How much debt is it carrying? | Debt-to-equity, interest coverage, debt ratio |
| Efficiency ratios | How well does it use its assets? | Inventory turnover, asset turnover, receivables turnover |
Let's break each one down with real numbers.
Valuation ratios: Is the stock worth its price?
Valuation ratios help you answer the most fundamental investing question: Am I paying too much for this stock?
Price-to-earnings ratio (P/E)
The P/E ratio compares a company's stock price to its earnings per share. It tells you how many rupees (or dollars) investors are willing to pay for every ₹1 or $1 of earnings.
Formula: P/E ratio = share price ÷ earnings per share (EPS)
As of February 2026, the S&P 500's trailing P/E ratio sits at roughly 27–29, which is above its 25-year average of about 16.3. That context matters — a P/E of 25 might look expensive in isolation, but could be reasonable for a high-growth tech company.
How to use it: Compare a stock's P/E to its industry average, not the broader market. A tech company with a P/E of 35 might be fairly valued when the tech sector average is 32, while a utility stock with the same P/E would be significantly overpriced relative to its 15–18 sector norm.
A few things P/E won't tell you: it doesn't account for growth rates, it can be distorted by one-off earnings events, and it's useless for companies that aren't yet profitable.
Price-to-book ratio (P/B)
P/B compares a stock's market price to the value of its assets minus liabilities (its book value).
Formula: P/B ratio = market price per share ÷ book value per share
A P/B below 1.0 can signal that the market values a company at less than its net assets — potentially a bargain. This ratio works best for asset-heavy industries like banking, real estate, and manufacturing. It's less meaningful for tech companies, where the real value lies in intellectual property and brand equity, which don't appear on the balance sheet.
Price-to-earnings growth ratio (PEG)
The PEG ratio adjusts the P/E ratio for expected earnings growth, giving you a more complete picture.
Formula: PEG ratio = P/E ratio ÷ expected annual EPS growth rate
A PEG below 1.0 generally suggests the stock may be undervalued relative to its growth. A PEG above 2.0 could mean you're overpaying for the growth on offer.
Enterprise value to EBITDA (EV/EBITDA)
This ratio compares a company's total value (including debt) to its operating earnings before accounting adjustments.
Formula: EV/EBITDA = enterprise value ÷ EBITDA
It's particularly useful when comparing companies with different capital structures. An EV/EBITDA below 10 is generally considered attractive, though this varies significantly by sector. The S&P 500's average EV/EBITDA has hovered around 15–16 in recent years.
Price-to-sales ratio (P/S)
For companies that aren't profitable yet — think early-stage growth stocks or biotech firms — P/S lets you assess value based on revenue.
Formula: P/S ratio = market cap ÷ annual revenue
This is most useful when comparing companies in the same industry. A SaaS company with a P/S of 8 might be reasonable if peers trade at 10–12, but the same ratio would be unusually high for a retailer.
Profitability ratios: How well does the company make money?
Earnings per share (EPS)
EPS is arguably the most fundamental profitability metric. It shows how much profit a company generates for each outstanding share.
Formula: EPS = (net income − preferred dividends) ÷ weighted average shares outstanding
What matters more than the absolute EPS number is its trajectory. A company whose EPS grew from $3.50 to $4.20 to $5.10 over 3 years is showing a healthy upward trend. Declining or erratic EPS is a red flag.
Trailing EPS uses actual past earnings. Forward EPS uses analyst estimates for the next 12 months. Both are useful — trailing for what actually happened, forward for what the market expects.
Return on equity (ROE)
ROE measures how effectively a company turns shareholder money into profit.
Formula: ROE = net income ÷ shareholders' equity
An ROE above 15% is generally considered strong. Apple's ROE has consistently exceeded 100% in recent years — but that's partly because the company has bought back so much stock that its equity base is unusually small. Always check whether high ROE is driven by genuine profitability or financial engineering.
Return on assets (ROA)
ROA shows how efficiently a company uses everything it owns to generate profit.
Formula: ROA = net income ÷ total assets
A higher ROA means the company wrings more profit from fewer assets. This ratio is especially useful for comparing companies within the same industry, since asset intensity varies wildly across sectors.
Profit margins
There are 3 profit margins worth tracking:
Gross profit margin = (revenue − cost of goods sold) ÷ revenue. This shows how much money is left after production costs are deducted. Software companies routinely see gross margins above 70%, while retailers might operate at 25–35%.
Operating profit margin = operating income ÷ revenue. These factors in all operating expenses (salaries, rent, marketing) reveal how efficiently the core business runs.
Net profit margin = net income ÷ revenue. The bottom line — what's left after every single expense, including taxes and interest. A net margin above 20% is considered strong for most industries.
Liquidity ratios: Can the company pay its bills?
Liquidity ratios tell you whether a company has enough short-term assets to cover its short-term debts. A profitable company can still go bankrupt if it runs out of cash at the wrong moment.
Current ratio
Formula: Current ratio = current assets ÷ current liabilities
A current ratio above 1.0 indicates that the company has more current assets than current liabilities. Most healthy companies maintain a current ratio between 1.5 and 3.0. Below 1.0 is a warning sign. Significantly above 3.0 might suggest the company is sitting on too much idle cash rather than investing it.
Quick ratio (acid-test ratio)
Formula: Quick ratio = (cash + accounts receivables + marketable securities) ÷ current liabilities
The quick ratio is a stricter version of the current ratio. It strips out inventory, which can't always be converted to cash quickly. A quick ratio above 1.0 suggests solid short-term financial health.
Cash ratio
Formula: Cash ratio = (cash + marketable securities) ÷ current liabilities
The most conservative liquidity measure. It only counts actual cash and near-cash holdings. While a cash ratio of 1.0 or above is ideal, many healthy companies operate with ratios below 1.0 because they don't need to hold much inliquid cash.
Leverage ratios: How much debt is the company carrying?
Debt isn't inherently bad — many companies use it strategically to fuel growth. But too much debt becomes dangerous, especially when revenue dips.
Debt-to-equity ratio (D/E)
Formula: D/E ratio = total liabilities ÷ shareholders' equity
A D/E of 1.0 means the company has equal amounts of debt and equity. What counts as "healthy" varies dramatically by industry:
| Industry | Typical D/E range |
|---|---|
| Technology | 0.1 – 0.5 |
| Utilities | 1.0 – 2.0 |
| Banking/Financial | 2.0 – 10.0+ |
| Consumer goods | 0.5 – 1.5 |
| Real estate | 1.0 – 3.0 |
A tech company with a D/E of 2.0 would raise eyebrows. A utility company with the same ratio would be perfectly normal.
Interest coverage ratio
Formula: Interest coverage = EBIT ÷ interest expense
This shows how many times over a company can pay its interest obligations from operating earnings. An interest coverage ratio of 3.0 or above is generally considered safe. A score below 1.5 indicates the company is struggling to service its debt.
Debt ratio
Formula: Debt ratio = total liabilities ÷ total assets
A debt ratio above 0.5 means more than half of a company's assets are financed by debt. Again, context matters — compare within the same industry.
Efficiency ratios: How well does the company use its resources?
Efficiency ratios (also called activity ratios) reveal how well a company manages its internal operations.
Inventory turnover
Formula: Inventory turnover = cost of goods sold ÷ average inventory
A high turnover means the company sells through its stock quickly — good for cash flow. A low turnover might signal weak demand or overstocking. A retailer like Walmart might turn over inventory 8–10 times a year, while a luxury goods maker might turn it 2–3 times.
Receivables turnover
Formula: Receivables turnover = net credit sales ÷ average accounts receivable
This shows how quickly a company collects money owed by customers. A higher ratio means faster collection, which improves cash flow.
Asset turnover
Formula: Total asset turnover = net revenue ÷ average total assets
This measures how efficiently a company uses all its assets to generate sales. Capital-light businesses (like software firms) tend to have higher asset turnover than capital-heavy ones (like manufacturers).
How to actually use financial ratios: A practical framework
Knowing the formulas is step one. Using them effectively is what separates informed investors from everyone else.
Step 1: Never use a single ratio. A low P/E might look attractive until you see that the company's debt-to-equity ratio is 5.0 and EPS is declining. Always look at ratios in combination.
Step 2: Compare within the same industry. A P/E of 30 is expensive for a bank but might be cheap for a high-growth cloud software company. Industry context is everything.
Step 3: Look at trends, not snapshots. A company whose ROE improved from 12% to 18% over 3 years tells a better story than one sitting at a flat 15%. Check 3–5 years of ratio data.
Step 4: Cross-check with qualitative factors. Strong ratios paired with poor management, regulatory risks, or a shrinking market won't end well. Ratios tell you the "what" — you still need to understand the "why."
Step 5: Watch for manipulation. Companies can temporarily boost EPS through share buybacks, inflate revenue through aggressive accounting, or hide debt off-balance sheet. If a ratio looks too good to be true, dig deeper.
If you're new to this and want a structured approach, the fundamental analysis checklist for stock picking provides a step-by-step framework that puts these ratios into a decision-making process.
Key takeaways
Financial ratio analysis lets you compare companies on a level playing field, regardless of size or geography. The 5 core categories — valuation, profitability, liquidity, leverage, and efficiency — each answer a different question about a company's health. Always compare ratios within the same industry, track trends over 3–5 years rather than looking at single snapshots, and use multiple ratios together rather than relying on any one metric. For Indian investors analysing US stocks, ratios are the most reliable way to cut through market noise and evaluate whether a stock deserves a place in your portfolio.
Disclaimer: The views and recommendations made above are those of individual analysts or brokerage companies, and not of Winvesta. We advise investors to check with certified experts before making any investment decisions.
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Invest in 11,000+ US stocks & ETFs
