A NOTE ON FINANCIAL RATIO ANALYSIS
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VALUATION RATIOS
Valuation ratios indicate the
performance of the equity stock of a company in the stock market. Since the
market value of equity reflects the combined influence of risk and return,
valuation ratios play an important role in assessing a company's performance in
the stock market. The important valuation ratios are the Price-Earnings Ratio
and the Market Value to Book Value Ratio.
Price-Earnings (P/E) Ratio :
The P/E ratio is the ratio between the market price of the shares of a firm
and the firm's earnings per share. The formula for calculating the P/E ratio
is:
P/E ratio = Market Price of Share / Earnings per Share
The price-earnings ratio indicates the growth prospects, risk characteristics,
degree of liquidity, shareholder orientation, and corporate image of a
company.
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Market Value to Book Value Ratio :
This is the ratio between the market price per share (MPS) and actual book
value per share. It can be calculated as follows:
Market Value to Book Value Ratio = Market Price per Share / Book Value per
Share
This ratio reflects the contribution of a company to the wealth of its
shareholders. When this ratio exceeds 1, it means that the company has
contributed to the creation of wealth of its shareholders.
DUPONT ANALYSIS
Dupont Analysis is a technique that breaks ROA and ROE measures down into three
basic components that determine a firm's profit efficacy, asset efficiency and
leverage. The analysis attempts to isolate the factors that contribute to the
strengths and weaknesses in a company's financial performance. Poor asset
management, expenses getting out of control, production or marketing
inefficiency could be potential weaknesses within a company. Expressing these
individual components rather than interpreting ROE, may help the company
identify these weaknesses in a better way. This model was developed by the US
based DuPont company. The model breaks down return on networth (RONW) into three
basic components, reflecting the quality of earnings along with possible risk
levels.
RONW = PAT / NW
Where,
PAT = Profit after Tax
NW = Networth
The above formula can be further broken down into:
RONW = PAT / Sales * Sales / CE * CE / NW
Where, CE = Capital Employed.
COMMON SIZE STATEMENTS
TA common size statement is an extension of ratio analysis. In a common size
statement, each individual asset and liability is shown as a percentage of total
assets and liabilities respectively. Such a statement prepared for a firm over a
number of years would give insights into the relative changes in expenses,
assets and liabilities. In a common size income statement gross sales/net sales
are taken as 100 per cent and each expense item is shown as a percentage of
gross sales/net sales.
CALCULATING FINANCIAL RATIOS OF HLL
COMMON SIZE INCOME STATEMENT OF HLL
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