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Here are general guidelines for interpreting financial ratios. While the ranges can vary by industry, these benchmarks give a broad sense of what constitutes a good, very good, or bad position for each type of ratio.
1. Profitability Ratios
Gross Profit Margin
- Very Good: >50%
- Good: 20%–50%
- Bad: <20%
Net Profit Margin
- Very Good: >20%
- Good: 10%–20%
- Bad: <10%
Return on Equity (ROE)
- Very Good: >20%
- Good: 10%–20%
- Bad: <10%
Return on Assets (ROA)
- Very Good: >10%
- Good: 5%–10%
- Bad: <5%
2. Liquidity Ratios
Current Ratio
- Very Good: 1.5–2.5
- Good: 1.0–1.5
- Bad: <1.0 (indicates liquidity issues)
Quick Ratio
- Very Good: >1.5
- Good: 1.0–1.5
- Bad: <1.0
3. Leverage (Solvency) Ratios
Debt-to-Equity Ratio
- Very Good: <0.5
- Good: 0.5–1.0
- Bad: >1.0 (indicates heavy reliance on debt)
Interest Coverage Ratio
- Very Good: >5
- Good: 3–5
- Bad: <2
4. Valuation Ratios
Price-to-Earnings (P/E) Ratio
- Very Good: 10–20 (reasonable valuation with growth potential)
- Good: 20–25 (higher growth expectations)
- Bad: >30 (overvaluation) or <10 (potential distress)
Price-to-Book (P/B) Ratio
- Very Good: 1–2
- Good: 2–3
- Bad: >3 (overvalued) or <1 (undervalued or poor growth prospects)
Dividend Yield
- Very Good: >4%
- Good: 2%–4%
- Bad: <2% (low income returns)
5. Efficiency Ratios
Asset Turnover Ratio
- Very Good: >1.5
- Good: 1.0–1.5
- Bad: <1.0
Inventory Turnover Ratio
- Very Good: >10 (depending on the industry, such as retail or FMCG)
- Good: 5–10
- Bad: <5
Receivables Turnover Ratio
- Very Good: >10
- Good: 6–10
- Bad: <6
PEG Ratio (Price/Earnings to Growth Ratio)
The PEG ratio is a valuation metric that adjusts the P/E ratio (Price-to-Earnings Ratio) by considering a company’s growth rate. It helps investors assess whether a stock is fairly valued, overvalued, or undervalued based on its earnings growth.
Formula:
Interpretation:
- PEG < 1: Indicates the stock might be undervalued relative to its growth (good opportunity).
- PEG = 1: The stock is fairly valued.
- PEG > 1: The stock might be overvalued relative to its growth.
Example:
- P/E Ratio: 20
- Earnings Growth Rate: 15%
Here, the PEG > 1 suggests the stock may be overvalued.
Book Value
The Book Value represents the net asset value of a company, calculated as total assets minus total liabilities. It reflects the intrinsic value of a company's assets on its balance sheet.
Formula:
Per Share Calculation:
Interpretation:
- Book Value > Market Value: The stock may be undervalued or in financial trouble.
- Book Value < Market Value: Investors expect growth or intangible value not captured in the balance sheet.
Importance in Valuation:
Price-to-Book (P/B) Ratio
- P/B < 1: Indicates undervaluation (good for value investors).
- P/B = 1-3: Considered fair value in most industries.
- P/B > 3: Indicates overvaluation or high growth expectations.
Intrinsic Value Measurement: Useful in industries with significant tangible assets (e.g., banking, manufacturing).
Price-to-Book (P/B) Ratio
- P/B < 1: Indicates undervaluation (good for value investors).
- P/B = 1-3: Considered fair value in most industries.
- P/B > 3: Indicates overvaluation or high growth expectations.
Intrinsic Value Measurement: Useful in industries with significant tangible assets (e.g., banking, manufacturing).
Comparison: PEG vs. Book Value
- PEG Ratio: Focuses on growth and earnings potential. Ideal for evaluating growth stocks.
- Book Value: Focuses on the company's asset value. Suitable for asset-heavy industries and value investing.
Book Value and Intrinsic Value
1. Book Value
The Book Value (BV) indicates the net worth of a company based on its balance sheet. To assess whether the Book Value per Share is favorable, compare it to the Market Price per Share using the Price-to-Book (P/B) Ratio.
Price-to-Book (P/B) Ratio Ranges
- Very Good: P/B < 1
The stock is trading below its book value, indicating undervaluation (common for value stocks). - Good: P/B = 1–3
The stock price is aligned with its asset value, considered fair value for most industries. - Bad: P/B > 3
The stock is overvalued unless justified by high growth or intangible assets (e.g., tech companies).
Caution:
- A low P/B ratio (e.g., < 1) might also indicate potential risks like poor profitability or asset quality.
- A high P/B ratio (e.g., > 3) could reflect strong intangible assets like brand value or future growth expectations.
2. Intrinsic Value
The Intrinsic Value reflects the "true" or "fair" value of a stock based on fundamental analysis, including future cash flows, growth, and risk factors. Comparing Intrinsic Value to the Market Price helps determine if a stock is overvalued, fairly valued, or undervalued.
Ranges for Market Price vs. Intrinsic Value
Very Good: Market Price < Intrinsic Value (by 20% or more)
The stock is undervalued, offering a margin of safety.
Example: Intrinsic Value = ₹120, Market Price = ₹90.Good: Market Price ≈ Intrinsic Value (±10%)
The stock is fairly valued.
Example: Intrinsic Value = ₹100, Market Price = ₹95–₹105.Bad: Market Price > Intrinsic Value (by 20% or more)
The stock is overvalued, posing higher risk.
Example: Intrinsic Value = ₹100, Market Price = ₹125.
Key Factors in Intrinsic Value Analysis
- Discounted Cash Flow (DCF) Method: Projects future cash flows and discounts them to present value.
- Growth Adjustments: Factor in expected earnings or revenue growth.
- Risk Premium: Incorporate risks (e.g., economic, industry-specific) to adjust the valuation.
Practical Application
- Book Value: Focuses on tangible assets and is more relevant for industries like banking, real estate, or manufacturing.
- Intrinsic Value: Emphasizes potential future earnings and growth, making it critical for tech or high-growth sectors.
Key Notes:
- Industry-Specific Differences: Always compare ratios within the same industry for meaningful analysis. For instance, a high debt-to-equity ratio might be normal in utilities but risky in tech companies.
- Historical Trends: Look for improvements or deteriorations in ratios over time, as consistency is often more critical than a single value.
- Combination of Ratios: No single ratio provides a complete picture; use multiple ratios to assess financial health.
