ITC, Reliance, Hindustan Unilever,
Axis Bank, TCS. Which stock is right to invest? There are more than 5000 listed companies
in India. And this question might often
come to your mind that out of these so many companies,
in which should I invest? Let’s make this decision of yours easy. Financial Ratios, which is also
the subject of our today’s video. Financial Ratios are used to measure
the health of any company. You can also use them to compare
any two companies. Let’s start today’s video on
Financial ratios. Hello friends,
my name is Abhishek and I work in the
investment products team at Smallcase. Let’s start today and understand the first
point, what are the Financial ratios. Like you have your blood report,
where it has your cholesterol level, it has your platlet count,
it has your sugar level. Similarly, there are other parameters,
but these are such parameters, which tell you how your overall health
is doing. Similarly, Financial ratios tell us about
the health of any company, how that company is doing. Here, you can judge a company by using
the parameters of Financial ratios. Similarly in a blood report, from cholesterol level you can
know how your overall health is. Now the important thing here is, that to measure the health of any company,
to judge how good or how bad it is It is always benchmarked
with relevant benchmark. For example, to measure the overall health of India there are two indexes Nifty 50
and Sensex 30. These two indexes measure and track
the largest Blue chip stocks of India. And they overall measure the health,
how Indian Economy is behaving. So here if you compare financial ratios
of any company with Nifty or BSE sensex then you will know, how the health of that company is,compared
to the overall health of the economy. Next we will talk about that… by using those financial ratios you can
compare any company with its industry. For example, if we talk about banks,
Axis Bank, HDFC Bank, Federal Bank, State Bank of India. For all these companies, NPA which is called Non-performing assets,
is an important financial parameter. So if you see that NPA
for Axis Bank is 10% to take the decision on this basis
only if Axis Bank is a good company or a bad company, will be wrong. You have to check NPAs
for other banks as well. And if NPA of Axis Bank is the least, this means that, that company is
the best company in its industry. And the second important thing
here is Financial ratios, which we will discuss today. On their basis only, we should not judge if
I should invest in this company or not. Other financial ratios are there, just
like your blood report has many parameters. Cholesterol level is just one of them. Similarly the financial ratios
we will talk about today, those are few important financial
ratios among many Financial ratios. You can check them before
taking any investment decision. But you should not invest on the
basis of only these ratios. Like I have told you now, there are a lot of financial
ratios available in the market. We can divide all these financial
ratios into five broad categories. We will take them one by one. The first category is liquidity ratio. Liquidity financial ratios are
those ratios which help you and tell you how capable the company is to
meet its liabilities in short-term. It also tells how effective
is company’s management to manage its working capital. Let’s talk about second ratio.
They are called turnover ratio. Turnover ratios of those
ratio usually which tell you how any company is capable of
converting its assets or accounts quickly or effectively to
sales or to free cash flow. Third kind of financial ratios are
Profitability ratios. Profitability ratios help you to know how much is the profit generating
capacity of any company. This ratio will also help you if you want to know if any company
is loss making or profit making. This ratio helps you there as well. Fourth kind of ratios are solvency ratios. These ratios tell you how capable the company is to
meet its long-term debt obligations. Usually, long-term is more than one year. So if the company has taken any loans and
its interests are due after 1 or 2-3 years. These ratios will help you to know, how
able that company is to clear those dues. Fifth and the last kind of ratios are
Valuation ratios. Valuation ratios tell about any company
how attractive that company is as an investment opportunity right now. Friends, this way we have categorised
all the ratios into five categories. Now, among those five categories,
we will talk about top financial ratios, using which you can measure
the health of any company. Let’s talk about the first ratio. Debt to equity ratio. It is a solvency ratio. And this ratio tells you the ratio of
the company’s total debt to its equity. Let’s take an example here. Total assets of a company are Rs. 100.
Out of it, 50 are debt and 50 are equity. Company has financed its total
business operations in debt and equity in equal weight. Here the debt to equity ratio will be
50 divided by 50, means 1. Similarly, there may be few companies
whose ratio maybe debt is 80 and equity is 20,
then it will be 80 by 20, which is 4. This way you can measure debt to equity
ratio by dividing debt to equity. Now let’s talk about implications.
How you can use this ratio? When you calculate debt to
equity ratio of any company, generally the lower debt to equity
ratio is considered better. Because it means that the company’s debt
repayment capacity is much better. And since the debt is low on its book, interest to be paid by it
will also be comparatively less. So, here, financially it is pretty secure. The second thing we should know that the creditors have faith in the
company. Since its debt level is low, So… that it can follow
its debt capacity better and it can repay it easily
in case of any calamity. Whereas for those companies
whose debt level is high, it may happen that if economy is not
doing good or it’s in cyclical business, then it may not repay its debt
and it may default. You might have seen many default cases
occurring in Indian markets nowadays. For example IL&FS defaulted
in last September. This means that it cannot repay
its interest. Recent, very recent example is
Altico Capital. They missed their interest payment
of Rs. 20 crores. So if there are companies which
cannot repay their interest payment, then these companies
are not considered good. And there are many such companies where
we have to see their debt to equity ratio. Important thing here is to compare
this ratio within the industry. For example, D/E ratio of textile,
cement, manufacturing companies is high because they need more debt financing
as compared to equity. Whereas the debt to equity ratio
of food or IT companies is generally less. Because there is not much
industry specific need of debt financing. Let’s understand through an example. For example debt to equity ratio
of Reliance Industries is 40% versus industry average
which is around 65 to 70%. Reliance has used less debt
as compared to equity, in its own industry as compared to
its benchmark, as compared to its peers. So, here, as you can see
Reliance has financed its business and its growth operations using less debt. And hence Reliance is less risky
because whenever it’s debt is due, it is better capable of repayment
of its interest payments. Let’s take the second example
of Hindustan Unilever. Hindustan Unilever works in FMCG and
its debt to equity ratio is almost zero as compared to industry
which is around 20%. Friends, it is very important to know here
that debt can be zero. And if debt is zero means all of its
operations are financed by equity. As you have seen from the examples here, both Reliance and HUL are pretty good stocks. They’ve performed
very good over the past five years. But Reliance has debt
and HUL doesn’t have debt. So, it’s not necessary that the company
with high debt to equity ratio is always bad or it will perform badly. This ratio is more industry specific
and hence use it as a benchmark. Like we have compared Reliance’s
with industry benchmark and HUL’s with its industry benchmark. And we saw that for both of them, ratio
is lower than their industry benchmark. and how both companies
have performed better in the past 5 years. But it’s better not to compare
Reliance and HAL with each other. Because their industries are different,
their industry dynamics are different. Hence, their debt requirements
are different and hence the debt to equity ratio
comes out differently. Friends, in this video we spoke about
debt to equity ratio. In the next video of this video series
of financial ratios we will cover four more ratios, which are, Return on Equity ratio,
Dividend yield ratio, PE ratio and free cash flow to Sales ratio. Make sure to subscribe to this channel. And press the bell icon to get the notification
as soon as our next video is published.