How should you analyse a company before you INVEST IN ?

There are many ways an Investor invests in a company’s shares globally, The method that is followed depends on how long they want to stay invested in them. If someone is interested in an ultra short term such as less than a month, this kind of investor uses technical analysis. Technical analysis is more statistical and has no fundamental reasoning in it.

Historically we have seen people who stay invested for long term are the people who have made the most return in the stock market. We have heard many such stories about investing in TATAs and Reliance.

In this blog lets understand How should you analyse a company if you want to invest in the share for a very long term ?

The basic Analysis an Investor should do is a RATIO ANALYSIS.

What is a RATIO ANALYSIS ?

Ratio Analysis or Financial Analysis which helps to determine the profitability , operating efficiency and the Liquidity by comparing the financial statements such as Balance sheet and the profit and loss statement.

Ratio Analysis can be categorized into five broad categories of ratios like liquidity ratios, solvency ratios, profitability ratios, efficiency ratio and the coverage ratio. There are many sub-ratios under each of these categories.

We shall see only the most important ratios which an Investor should consider before investing.

1.Working Capital Ratio: This ratio helps us to understand how strong the company is to repay the current liabilities using the current assets. This is an important ratio that determines the ability to repay the Creditors of the company.

Working capital is calculated by dividing the Current Assets by Current Liabilities.

WC = CA / CL

2.Quick Ratio: In this ration we consider only cash and cash equivalent such as bank balance and divide it with current liabilities. Inventories and stock in hand is not considered in this ratio.

This Ratio is a very important ratio as it helps us to understand how efficiently the liabilities are managed. This Ratio is also called the ACID RATIO.

QR = CA less inventories and stock in hand / CL

3.Earning per share: As the name suggests, Earning per share is nothing but the profit or loss per equity share. Here you simply divide the profits or losses by the number of equity shares. It is also called EPS. The higher the EPS the better the company is. If the company is making losses then the EPS could be negative.

4.Price to Earning Ratio: This is a very important ratio that every Investor should consider before investing. This ratio helps the investor to analyze how the company could perform in future. Here you divide the company’s latest traded price per share by the EPS.

For example if the last traded price (LTP) is Rs80 and the EPS is 8, then the PE is 10. Which means you will have to pay Rs 10 for every earnings. The normal rule is lower the PE the better the share is.

5.Return on Equity: It is also called ROE. As an Investor you always want to know how much the return that your company is giving you back. Here you should consider net profit less any dividends paid during that period divided by the number of equity shares.

The bottom line here is that ratios help us to understand the health of the company. They are completely scientific and a strong reasoning by dividing one component with another component of the balance sheet. As everyone knows a good balance sheet is when your assets and liabilities are equal.

One should also need to have average ratios within the industry and compare the individual stocks with the industry averages before you invest in them.