When someone first told me about financial ratios, I honestly zoned out. PE? ROE? Debt-to-equity? It felt like I needed a finance degree to make sense of it all. But as I started investing, I realized these ratios are less about math and more about common sense. Think of them as tools to measure how “healthy” a company is, just like you’d check a car’s mileage or engine condition before buying it.
These three—PE (Price-to-Earnings), ROE (Return on Equity), and Debt-to-Equity—are my go-to ratios. They don’t tell the whole story, but they’re a great place to start. Let me walk you through them, minus the jargon.
What Is the PE Ratio, and Why Does Everyone Talk About It?
The PE ratio is like the popularity score of the stock market. It tells you how much investors are willing to pay for every rupee the company earns. The formula is:
PE Ratio = Current Stock Price ÷ Earnings Per Share (EPS)
So, if a company’s stock price is ₹100 and its EPS is ₹10, the PE ratio is 10. Simple, right? A high PE ratio might mean investors expect big things from the company in the future, while a low one could mean it’s undervalued—or that people don’t have much faith in it.
When I started out, I thought a low PE was a steal. Once, I bought into a company with a PE of 8, thinking, “What a bargain!” A few months later, the stock tanked. Turns out, the low PE wasn’t a discount—it was a warning. Lesson? Context matters.
ROE: The “How Hard Is Your Money Working?” Ratio
ROE, or Return on Equity, measures how well a company uses the money you’ve invested to make profits. Think of it as a productivity score for your money. The formula is:
ROE = Net Income ÷ Shareholders’ Equity
Let’s say you invest ₹100 in a company, and it earns ₹20. That’s a 20% ROE, meaning the company is making ₹0.20 for every ₹1 of your money. Sounds efficient, right?
But here’s the thing: a high ROE isn’t always great. Sometimes, it’s boosted by excessive debt, which brings us to the next ratio.
I once got excited about a company with a 25% ROE. It looked amazing until I realized most of that return came from borrowed money. When earnings dropped, the debt became a huge problem. Now, I always check ROE alongside debt-to-equity.
Debt-to-Equity: The Stability Check
Debt-to-equity shows how much of a company’s operations are funded by debt versus shareholder money. The formula is:
Debt-to-Equity Ratio = Total Debt ÷ Shareholders’ Equity
If a company has ₹50 crore in debt and ₹100 crore in equity, the ratio is 0.5. This means it’s using ₹0.50 of debt for every ₹1 of equity.
High debt-to-equity can be a red flag, especially in industries prone to downturns. Imagine running a household on maxed-out credit cards—it works fine until something goes wrong. That’s what too much debt looks like for a company.
I remember buying a stock from a capital-intensive industry without checking this ratio. Everything looked great—profits, revenue growth—but the debt-to-equity was over 3. A year later, the company struggled to pay its loans, and the stock price plummeted. Never again.
How These Ratios Work Together
Here’s how I use these three ratios. First, I look at the PE ratio to see if the stock is fairly priced. Next, I check the ROE to see if the company is making good use of its resources. Finally, I review the debt-to-equity ratio to make sure the company isn’t overleveraged.
These numbers aren’t perfect. They’re just pieces of the puzzle. But together, they paint a clearer picture.
My Approach to Financial Ratios
Let me be real: when I started, I didn’t even know where to find these ratios. I relied on random blogs and YouTube videos that oversimplified everything. Over time, I learned to dig deeper. Now, I cross-check ratios with industry standards and look at trends over multiple years. One bad year doesn’t scare me, but a declining pattern? That’s when I start asking questions.
If you’re just starting out, don’t overcomplicate it. Stick to the basics. Look up these ratios on financial websites—they calculate them for you. Focus on understanding what they mean instead of memorizing formulas.
Final Thoughts
PE, ROE, and debt-to-equity ratios might seem like dry numbers, but they’re incredibly useful. They don’t guarantee success, but they can help you avoid bad decisions. Think of them as road signs on your investing journey—they won’t drive the car for you, but they’ll point you in the right direction.
When I look at a stock now, these ratios are the first things I check. They’ve saved me from some bad calls and helped me spot a few hidden gems. The key is to stay curious and keep learning. Every time you use these ratios, you’ll get a little better at understanding what they’re telling you. And in the world of investing, a little extra knowledge can go a long way.