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Imagine trying to buy a car without looking under the hood or checking its mileage. You might end up with a lemon that looks great but performs terribly. The same principle applies to investing—without examining the right numbers, you risk putting your money into companies that appear promising but have serious hidden flaws.

For value investors—those seeking companies trading below their intrinsic worth—financial ratios serve as the diagnostic tools that reveal a company's true health and value. These simple calculations can help you separate genuinely undervalued opportunities from dangerous value traps.

Let's explore the essential financial ratios that will empower you to invest with confidence, even if you're just getting started.

The P/E ratio is the most commonly used financial ratio among investors. It tells you how much you're paying for each dollar of a company's earnings.

Formula: Market Price per Share ÷ Earnings per Share

Think of it like buying a rental property. If a house costs $200,000 and generates $10,000 in annual profit, its "P/E ratio" would be 20. This means it would take 20 years of earnings to recoup your investment.

A lower P/E suggests you might be getting more earnings for your investment dollar. However, as DrWealth points out, "PE is not a fixed number, it is ever-changing" due to fluctuating prices and earnings.

The P/B ratio compares a company's market value to its book value (the net value of its assets).

Formula: Market Price per Share ÷ Book Value per Share

This ratio is particularly useful for evaluating asset-heavy businesses like banks or manufacturing companies. A P/B ratio below 1 might indicate an undervalued company—you're essentially buying assets for less than their accounting value.

When a company isn't profitable yet but generates substantial revenue, the P/S ratio becomes valuable.

Formula: Market Price per Share ÷ Revenue per Share

This ratio helps you compare companies in the same industry, particularly young or cyclical businesses that might temporarily show low or negative earnings.

ROE measures how efficiently a company uses shareholders' investments to generate profits.

Formula: Net Income ÷ Shareholders' Equity

Value investors should seek companies with consistently high ROE compared to industry peers. According to research on LQ45 Index stocks, ROE has "a significant positive effect on stock return."

This ratio reveals what percentage of revenue remains after covering operating expenses but before interest and taxes.

Formula: Operating Income ÷ Revenue

A strong operating margin suggests the company has pricing power and cost control—qualities that often translate into sustainable competitive advantages.

While not mentioned in many basic lists, Free Cash Flow per Share to Price (PFCF) is highly significant for value investors.

Formula: Free Cash Flow per Share ÷ Share Price

Research recommends that "retail investors prioritize the PFCF ratio when evaluating potential stock investments," as it focuses on actual cash generation rather than accounting profits.

This ratio measures a company's financial leverage—how much it relies on debt versus equity financing.

Formula: Total Debt ÷ Total Equity

High debt levels increase risk during economic downturns. As LinkedIn notes, "A high D/E ratio may indicate higher risk, as the company relies more on debt than equity for financing."

This tells you how easily a company can pay the interest on its outstanding debt.

Formula: Operating Income ÷ Interest Expense

A higher ratio means the company generates enough operating income to cover its interest payments multiple times over—a sign of financial strength.

The current ratio assesses whether a company can pay its short-term liabilities with its short-term assets.

Formula: Current Assets ÷ Current Liabilities

A ratio above 1 generally indicates sufficient liquidity, though extremely high ratios might suggest inefficient use of assets.

Also called the "acid-test ratio," this provides a more stringent test of short-term liquidity by excluding inventory.

Formula: (Current Assets - Inventory) ÷ Current Liabilities

This ratio is particularly important for companies with inventory that might be difficult to sell quickly.

Financial ratios vary widely across industries. A "high" P/E ratio in utilities might be "low" for a tech company. Always compare companies within the same sector.

A single ratio snapshot might mislead you. Track ratios over several years to spot deterioration or improvement in a company's fundamentals.

No single ratio tells the complete story. For example, a company might show a low P/E (seemingly attractive) but also have a high debt-to-equity ratio (indicating risk).

Quantitative ratios should complement qualitative analysis. Even the best ratios can't capture factors like management quality, competitive advantages, or industry disruption.

Understanding these financial ratios is just the first step. The real skill comes in applying them to actual investment decisions and knowing which ones matter most in different situations.

Want to see these ratios in action, applied to real companies? Join our upcoming "Step-By-Step Company Analysis of a Good Growth Us-Listed Company" webinar, where we'll walk through:

• A deep dive into a fast-growth company case study.
• What are the key financial metrics when evaluating whether a stock has strong growth potential.
• Step-by-step guide on how to apply value investing methodology on real-world companies.
• Learn the exact criteria that successful investors use to evaluate a company.
• How to determine the intrinsic value of a stock so you'll know exactly when to enter or exit the market.
• How ViA Atlas Intrinsic Value (IV) Directory can get you started on building your own portfolio of superhero stocks, even for busy professionals without much time to spare