Fundamental analysis is the method of evaluating the financial health of a company by analyzing its financial statements and financial ratios. fundamental analysis includes leverage ratios, profitability ratios, operational ratios and valuation ratios. One of the key components of fundamental analysis is profitability ratios. Profitability ratios help investors to determine the financial strength of a company and its ability to generate profits. The theory of financial ratio’s was made popular by ‘Benjamin graham, who is known as the father of fundamental analysis.
Profitability ratios
Profitability ratios are ratio’s that helps to understand the profitability of a company. It helps to analyze the company just by looking into some ratio’s helping the investors to study about the company without much complexity.
Most prominent financial ratios are
1) PAT MARGIN AND PAT GROWTH
The profit after tax margin (PAT) interprets us about how profitable the company is at an overall level, it accounts for not just operational expense but also it accounts for tax , interest depreciation etc.
PAT MARGIN can be found by (PAT / TOTAL REVENUE)
If PAT MARGIN of a company is 10%, that represents that the company spent 90% of its revenue towards expense and retained 10% for profit.
That means Rs 10 profit when total of 100 Rs total revenue is generated.
2) EBITDA AND EBITDA MARGIN
Earnings before interest tax depreciation and amortization (EBITDA) tells us about the how efficient the company’s operating model is performing. EBITDA MARGIN interprets us about how profitable the company is at an operating level.
EBITDA can be found by (OPERATING REVENUE – OPERATING EXPENSE)
OPERATING REVENUE can be found by (TOTAL REVENUE – OTHER INCOME)
OPERATING EXPENSE can be found by (TOTAL EXPENSE – FINANCE COST – DEPRECIATION – AMORTISATION.)
EBITDA MARGIN can be found by (EBITDA / TOTAL OPERATING REVENUE)
EBITDA of 500crore means that company has retained 500crore from its operating revenue.
EBITDA MARGIN shows us how much profit percentage has been retained.
3) RETURN ON EQUITY (ROE)
RETURN ON EQUITY (ROE) is a ratio that helps to provide investors with insights into how efficiently the company is handling the money that shareholders has contributed into it. Higher the ROE means that the company is more efficient in generating income from the money that shareholders have contributed to it.
ROE can be found by (NET INCOME / SHAREHOLDERS EQUITY)
4) RETURN ON CAPITAL EMPLOYED (ROCE)
Return on capital employed (ROCE) is a financial ratio that helps us to understand the efficiency and profitability of company in which the capital of that company is applied .
ROCE can be found by EBIT / CAPITAL EMPLOYED
EBIT is EARNINGS BEFORE INTEREST AND TAX
EBIT can be found by PAT + TAX + INTEREST
CAPITAL EMPLOYED can be found by EQUITY + DEBTS
5) RETURN ON ASSETS (ROA)
RETURN ON ASSETS (ROA) is a financial ratio that helps us to understand how profitable a company is relative to its assets. RETURN ON ASSET gives as idea to the investors how efficiently a company’s management is using its assets to generate earnings.
ROA can be found by NET INCOME / TOTAL ASSETS
