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bobby_dreamer

Stock market terms

quest-for-wealth, notes20 min read

# Financial Ratios

  • Liquidity Ratios : Current ratio, Quick ratio
  • Leverage Financial Ratios : Debt to equity ratio, Interest coverage ratio
  • Efficiency Ratios : Asset turnover ratio, Inventory turnover ratio, Days sales in inventory ratio
  • Profitability Ratios : Gross margin ratio, Operating margin ratio, Return on assets ratio, Return on equity ratio, Return on Capital Employed

# General

  • Bull market : When the stock market as a whole is on the rise for a sustained period of time, it is called as a bull market. IPOs usually happen in the bull market.

  • Bear market : Bear market reflects a prolonged fall in prices of stocks on a consistent basis. Typically, when stock prices fall by 20% or more from recent highs due to prevailing negative sentiments of investors, markets are said to be in a bearish phase.

  • Face value : When a company issues shares, each share has a face value. This refers to the value of the stock at the time of issuance. The company that issues the stock decides the face value and it does not change over time. Mostly its 10 nowadays but in 80s it used to be 100s and recent trend is 1. 1's are greedy or too much mouth too feed from promoter perspective. Splits reduce the facevalue and introduce more number of shares into the market, its basically to introduce more volume of shares being traded or the value has become too high for retail investors to trade.

  • Dividend : Dividend is the amount of money a company pays to its shareholders out of its profits not from borrowed money. However, it is not compulsory for a company to give dividends even if it makes a profit. Many companies reinvest their profits back into the business itself for growth and expansion.

  • Convertible securities : As the name suggests, convertible securities refer to those securities which can be converted into other securities. Convertible preferred stock is a common convertible security. It can be converted into a common stock. A convertible security has a lower pay-out than a security that doesn’t have this feature.

  • Debenture : A debenture is a form of fixed-income instrument which isn’t backed by any collateral of the issuer. It is often used to issue loans by companies, and as a debenture holder, you become a creditor of the company. A debenture has a fixed rate of interest, and the interest amount is payable half-yearly or yearly. Issuing it allows the company to get the required funds with ease, without diluting its equity holdings.

  • Market capitalisation : It’s the aggregate valuation of a firm based on the current share price multiplied by the total number of outstanding stocks. For example, if a company has 20 million outstanding shares with the current market price being Rs. 100 per share, the market capitalisation of the company is Rs. 200 crores.

  • Bid : The bid is the maximum amount a buyer is willing to pay to acquire stock. A buyer may purchase stock only if the price does not exceed the bid price he has placed.

  • Ask : Ask is the minimum amount a holder of a security is willing to sell for. A seller will sell the security only if the bid price matches or exceeds the ask price.

  • Compound Annual Growth Rate : Compound annual growth rate, or CAGR, is the mean annual growth rate of an investment over a specified period of time longer than one year. It represents one of the most accurate ways to calculate and determine returns for individual assets, investment portfolios, and anything that can rise or fall in value over time. The CAGR is a mathematical formula that provides a "smoothed" rate of return.

    Compound Annual Growth Rate (CAGR) = ( ( ( Ending Investment Value / Beginning Investment Value ) power(1/No of years) ) - 1 ) * 100

    Let’s assume that Bill’s Auto Manufacturing plant invested $75,000 in new automated manufacturing equipment. Without considering saving the amount saved in labor costs, Bill was able to bring in an extra $25,000 of work over the past five years because of this capital investment. Thus, Bill’s ending value of his investment would be $100,000. Here’s how to calculate CAGR for his business:

    CAGR = ( ( ( $100,000 / $75,000 ) power(1/5) ) -1 ) * 100

    As you can see, Bill made an average of 5.86% on his investment in new automated equipment. This means that if we could smooth out the earnings and make them equal over the five span, Bill would have made 5.86% every single year. Like I said before, we are trying to simplify the example, so we aren’t considering the effects of labor savings on the return.

  • Leverage : Leverage in the stock market means borrowing capital to invest in more shares than one is financially capable of buying with the singular motive to boost profits. Leverage means amplification of comparatively smaller investment force into a correspondingly greater profit. Leverage can result in exponential gains; however, it can also result in massive losses.

  • Growth Stocks : Growth stocks are the stocks considered to have the potential and the ability to outperform the market in the future. Growth companies are companies that have generated considerable, sustainable, and better-than-average returns in the market and are expected to continue providing substantial returns. In simple words, growth stocks are backed by healthy and consistent earnings and robust performance in the past and are touted to continue their growth pattern in the future as well.

  • Value stocks : A value stock is a stock that the investor feels is trading at a market price below their intrinsic value. Value stocks are stocks that an investor may consider are currently undervalued but is later expected to reach its real inherent value. Value investing means uncovering the actual intrinsic value of the stocks through evaluation of financial statements, often ignored intangible assets, of the concerned company then develop the patience to wait for the prices to fall below their intrinsic value. The investor consequently purchases when the securities are trading at a price below their intrinsic value and then sell them when the prices reach their true worth. Intrinsic value is the net present value of all future cash flows expected to be generated through the lifespan of the business. Warren Buffet, the legendary investor, is the most successful practitioner of value investing.

  • Large-cap stock : Large-cap stocks are stocks of well-established companies with a market capitalisation above Rs 20000 crores.

  • Mid-cap stocks : Mid-cap stocks are stocks of companies with a market capitalisation between Rs 5000 crores and 20000 crores.

  • Small-cap stocks : Most small-cap companies are early start-ups and entrepreneurial ventures that present the opportunity to earn astronomical returns. Understandably they are companies with inconsistent returns and low revenues. Many of these companies can go bust. But at the same time, many such companies are unicorns that are trading abysmally below their intrinsic value.

  • Share buybacks : A share repurchase refers to the management of a public company buying back company shares that were previously sold to the public. There are several reasons why a company may decide to repurchase its shares. For instance, a company may choose to repurchase shares to send a market signal that its stock price is likely to increase, to inflate financial metrics denominated by the number of shares outstanding (e.g., earnings per share or EPS), or to attempt to halt a declining stock price, or simply because it wants to increase its own equity stake in the company.

  • Book value : Book value can also be thought of as the net asset value (NAV) of a company, calculated as its total assets minus intangible assets (patents, goodwill) and liabilities. Book value can also be thought of as the net asset value (NAV) of a company, calculated as its total assets minus intangible assets (patents, goodwill) and liabilities. When compared to the company's market value, book value can indicate whether a stock is under- or overpriced.

    Book value = Total Assets – Total Liabilities
    (or)
    Book value = Total Assets – (Intangible Assets + Total Liabilities)

    Book value per share is the mostly common used metric by investor to see if a company is overpriced or undervalued. But, it cannot be used in isolation. Value investors extensively rely on the book value of an organisation and its associated metrics like BVPS and P/B ratio. A P/B ratio below 1 often indicates that a company’s stocks are undervalued since its market capitalisation is lower than its book value. Similarly, a high P/B ratio might imply that a company’s stocks are overvalued.

    BVPS = Shareholder’s equity or Net value of assets / total number of outstanding shares

    Price to Bookvalue = Price / Bookvalue

  • Accounts Receivable : Accounts receivable (AR) is the balance of money due to a firm for goods or services delivered or used but not yet paid for by customers. Accounts receivables are listed on the balance sheet as a current asset. AR is any amount of money owed by customers for purchases made on credit. Accounts receivable decreases from the previous years (you have to compare by going back a few years), this means that more cash has entered the company from customers paying off their credit accounts.

  • Accounts Payable : Accounts payable are amounts due to vendors or suppliers for goods or services received that have not yet been paid for. The sum of all outstanding amounts owed to vendors is shown as the accounts payable balance on the company's balance sheet.

  • Pledging of shares : It means of taking loans against the shares that one holds. Usually, if a promoter of a company wants to borrow a loan to meet their business or personal requirements, it may opt for pledging of shares. In this process, the promoter keeps the shares of the company or companies as collateral to lenders. Promoters may pledge shares for many reasons like to address working capital requirements, to fund existing or new ventures, to acquire companies or stakes in other companies, etc. Important thing is

    • If the promoter fails to pay back the amount than the lender can sell the stakes in open market. Share prices gets locked up in lower circuit here.
    • If the promote pays back the amount, pledge will be released.
    • In some cases, these promoters release pledged over the fear of losing control of their businesses or when the stock prices recover.
  • Diversification : Capital is allocated in a way that doesn't expose too much to one particular risk or asset, but rather spreads it out to reduce the risks.

# Ratios

  • Earnings per share ratio : This ratio measures the amount of net income earned for each share outstanding:

    Earnings per share ratio = Net earnings / Total shares outstanding

  • Current ratio : This ratio indicates a firm’s liquidity position. A company with a high current ratio can better meet its short-term liabilities. In other words, the company has enough back-up, and its day-to-day workings will not be affected due to the pressure of working capital. This ratio is arrived at by dividing current assets with current liabilities.

    Current ratio = Current assets / Current liabilities

  • Quick Ratio : The Quick Ratio, also known as the Acid-test or Liquidity ratio, measures the ability of a business to pay its short-term liabilities by having assets that are readily convertible into cash. These assets are, namely, cash, marketable securities, and accounts receivable.

    A result of 1 is considered to be the normal quick ratio. It indicates that the company is fully equipped with exactly enough assets to be instantly liquidated to pay off its current liabilities. A company that has a quick ratio of less than 1 may not be able to fully pay off its current liabilities in the short term, while a company having a quick ratio higher than 1 can instantly get rid of its current liabilities. For instance, a quick ratio of 1.5 indicates that a company has $1.50 of liquid assets available to cover each $1 of its current liabilities.

    Quick Ratio = [Cash & equivalents + marketable securities + accounts receivable] / Current liabilities
    (or)
    Quick Ratio = [Current Assets – Inventory – Prepaid expenses] / Current Liabilities

  • Debt-to-equity ratio : This ratio tells how much outside funding is used by the company to run its operations as against its funds. Generally, the lower debt-to-equity ratio, the better it is. This ratio is arrived at by dividing the total liabilities by total shareholder’s equity. You can easily find this ratio in a company’s balance sheet.

    Debt to equity ratio = Total liabilities / Shareholder’s equity

  • Debt Ratio : measures the relative amount of a company’s assets that are provided from debt

    Debt ratio = Total liabilities / Total assets

  • Interest Coverage Ratio (ICR) : Its a financial ratio that is used to determine how well a company can pay the interest on its outstanding debts. Higher the better.

    ICR = EBIT / Interest expense

    Where:

    • EBIT is the company’s operating profit (Earnings Before Interest and Taxes)
    • Interest expense represents the interest payable on any borrowings such as bonds, loans, lines of credit, etc.

    Another variation is:

    Interest Coverage Ratio = EBITDA / Interest Expense

    Where:

    • Earnings before interest, taxes, depreciation and amortization (EBITDA) as the numerator
  • Price-to-Earnings Ratio : It is the relationship between a company’s stock price and earnings per share (EPS). A high P/E ratio means two things - either the company’s stock is overvalued, or investors expect high growth rate in the future. You can arrive at the PE ratio by dividing the current stock price by earnings per share. In simple terms, Companies with a high Price Earnings Ratio are often considered to be growth stocks. This indicates a positive future performance, and investors have higher expectations for future earnings growth and are willing to pay more for them. Companies with a low Price Earnings Ratio are often considered to be value stocks. It means they are undervalued because their stock price trade lower relative to its fundamentals.

    P/E = Current market price / Earnings per share
    (or)
    P/E = Market Capitalization / Total Net Earnings

  • Price/Earnings to Growth (PEG) Ratio : The PEG ratio is a company’s Price/Earnings ratio divided by its earnings growth rate over a period of time (typically the next 1-3 years). The PEG ratio adjusts the traditional P/E ratio by taking into account the growth rate in earnings per share that are expected in the future.

    PEG = (P/E) / Earnings per Share growth rate

    For example, a stock with a P/E of 20 and projected earning growth next year of 10% would have a PEG of 20 / 10 = 2.

    • If PEG ratio=1, it means that the share at today’s prices is fairly valued.
    • If PEG ratio>1, it indicates that the share is possibly over-valued.

    PEG ratio<1, it indicates that the share is possibly under-valued.

  • Working Capital : Working capital is a measure of a company's liquidity, operational efficiency, and short-term financial health. If a company has substantial positive working capital, then it should have the potential to invest and grow. If a company's current assets do not exceed its current liabilities, then it may have trouble growing or paying back creditors, or even go bankrupt.

    Working Capital = Current Assets - Current Liabilities

    • Working capital ratio = Current Assets/Current Liabilities
      • indicates whether a company has enough short term assets to cover its short term debt. Anything below 1 indicates negative W/C (working capital). While anything over 2 means that the company is not investing excess assets. Most believe that a ratio between 1.2 and 2.0 is sufficient. Also known as "net working capital".
  • Yield/Dividend Yield : It’s a measurement of return of investment (ROI) in terms of percentage. For calculating stock yield, you need to divide the current price of a share by the annual dividend paid by the company for it. Note that higher yields are supposed to be an indicator of low risk and greater income. However, it may not always be a positive sign as in the case of rising dividend yield resulting due to a fall in stock price.

  • Asset turnover ratio(ATR) : This ratio shows how efficiently a company can use its assets to generate sales. The total asset turnover ratio calculates net sales as a percentage of assets to show how many sales are generated from each dollar of company assets. For instance, a ratio of .5 means that each dollar of assets generates 50 cents of sales.

    Higher ratio is always more favorable. Higher turnover ratios mean the company is using its assets more efficiently. Lower ratios mean that the company isn't using its assets efficiently and most likely have management or production problems.

    Asset turnover ratio = Net sales / Average total assets

    For instance, a ratio of 1 means that the net sales of a company equals the average total assets for the year. In other words, the company is generating 1 dollar of sales for every dollar invested in assets.

  • Inventory turnover ratio : Inventory turnover, or the inventory turnover ratio, is the number of times a business sells and replaces its stock of goods during a given period. It considers the cost of goods sold, relative to its average inventory for a year or in any a set period of time.

    A high inventory turnover generally means that goods are sold faster and a low turnover rate indicates weak sales and excess inventories, which may be challenging for a business.

    Inventory Turnover Ratio = (Cost of Goods Sold)/(Average Inventory)

    Where:

    • Average inventory is usually calculated by adding the beginning and ending inventory and dividing by two. The cost of goods sold is reported on the income statement.

    If 1 company sells what they make in that year that year itself. So > 1 is very good

    Example, For fiscal year 2019, Walmart Stores (WMT) reported annual sales of $514.4 billion, year-end inventory of $44.3 billion, beginning inventory of $43.8 billion, and an annual COGS of $385.3 billion.

    Walmart's inventory turnover for the year equaled.
    $385.3 billion ÷ ($44.3 billion + $43.8 billion)/2 = 8.75

  • Days Sales in Inventory (DSI) : Days Sales in Inventory (DSI), sometimes known as inventory days or days in inventory, is a measurement of the average number of days or time required for a business to convert its inventory into sales. In addition, goods that are considered a “work in progress” (WIP) are included in the inventory for calculation purposes.

    The DSI value is calculated by dividing the inventory balance (including work-in-progress) by the amount of cost of goods sold. The number is then multiplied by the number of days in a year, quarter, or month.

    A low DSI reflects fast sales of inventory stocks and thus would minimize handling costs, as well as increase cash flow. On the other hand, a high DSI value generally indicates either a slow sales performance or an excess of purchased inventory (the company is buying too much inventory), which may eventually become obsolete. However, it may also mean that a company with a high DSI is keeping high inventory levels to meet high customer demand. It is also important to note that the average days sales in inventory differs from one industry to another.

    DSI = 365 days / Inventory turnover ratio
    (or)
    DSI = (Average Inventory / Cost of Sales) x 365

    Example, For fiscal year 2019, Walmart Stores (WMT) reported annual sales of $514.4 billion, year-end inventory of $44.3 billion, beginning inventory of $43.8 billion, and an annual COGS of $385.3 billion.

    Its days inventory equals:
    (1 ÷ 8.75) x 365 = 42 days

    This indicates that Walmart sells its entire inventory within a 42-day period, which is impressive for such a large, global retailer.

  • Gross margin ratio : It shows how much profit a company makes after paying off its Cost of Goods Sold (COGS). The ratio indicates the percentage of each dollar of revenue that the company retains as gross profit.

    For example, if the ratio is calculated to be 20%, that means for every dollar of revenue generated, $0.20 is retained while $0.80 is attributed to the cost of goods sold. The remaining amount can be used to pay off general and administrative expenses, interest expenses, debts, rent, overhead, etc.

    Gross Margin Ratio = (Revenue – COGS) / Revenue
    (or)
    Gross margin ratio = Gross profit / Net sales

  • Operating margin ratio : Also known as OPEX. The operating ratio shows how efficient a company's management is at keeping costs low while generating revenue or sales. The smaller the ratio, the more efficient the company is at generating revenue vs. total expenses. It shows percentage of profit a company produces from its operations, prior to subtracting taxes and interest charges. It is calculated by dividing the operating profit by total revenue and expressing as a percentage. The margin is also known as EBIT (Earnings Before Interest and Tax) Margin. Operating Profit Margin differs across industries and is often used as a metric for benchmarking one company against similar companies within the same industry.

    An operating ratio that is decreasing is viewed as a positive sign, as it indicates that operating expenses are becoming an increasingly smaller percentage of net sales. A limitation of the operating ratio is that it doesn't include debt.

    Operating margin ratio = (Operating expenses + CoGS) / Net sales
    (or)
    Operating margin ratio = Operating Profit / Total Revenue

    Where:

    • Operating Profit = Sales - COGS - Operating Expenses - Depreciation & Amortization
  • Return on equity ratio : Return on Equity (ROE) is the measure of a company’s annual return (net income) divided by the value of its total shareholders’ equity, expressed as a percentage (e.g., 12%). Alternatively, ROE can also be derived by dividing the firm’s dividend growth rate by its earnings retention rate (1 – dividend payout ratio). Also known as Return on Net Worth(RoNW)

    Return on Equity is a two-part ratio in its derivation because it brings together the income statement and the balance sheet, where net income or profit is compared to the shareholders’ equity. The number represents the total return on equity capital and shows the firm’s ability to turn equity investments into profits. To put it another way, it measures the profits made for each dollar from shareholders’ equity.

    Return on equity ratio = Net income / Shareholder’s equity
    (or)
    Return on Net Worth = Net after-tax profits ÷ (Shareholder capital + Reserves)
    (or)
    Return on Equity Ratio = (Net Earning after taxes - Preferred Dividends)/Common Equity Dollars

    ROE must be compared to the historical ROE of the company and to the industry’s ROE average – it means little if merely looked at in isolation. In order to satisfy investors, a company should be able to generate a higher ROE than the return available from a lower risk investment. A high ROE could mean a company is more successful in generating profit internally. However, it doesn’t fully show the risk associated with that return. A company may rely heavily on debt to generate a higher net profit, thereby boosting the ROE higher.

    RoE = Net income / Equity

    Where:

    • Equity = Return on Assets * Leverage
      • Return on Assets = Net Income / Total Assets
      • Leverage = Total Assets / Equity

Impact of Debt on RoE

  • Return on Capital Employed(RoCE) : It measures how efficiently a company is using its capital to generate profits. Capital employed equals equity plus non-current liabilities (or total assets minus current liabilities), in other words all long-term funds used by the company. It indicates efficiency/profitability of a company's capital investments. It should be higher than the rate at which the company borrows. If it is not the case, increase in borrowing will reduce shareholder earnings.

    RoCE does not account for depreciation and amortisation of capital. Because capital employed is the denominator, a company with higher depreciated assets may report a higher RoCE without an increase in profit. Also, RoCE is low for companies that are capital intensive. For companies with insignificant debt, RoE and RoCE are the same. RoCE has little impact on stock prices by the time it is known.

    Return on Capital Employed(debt free companies) = EBT/Equity
    (or)
    Return on Capital Employed = Net Profit Afer Tax / ( Total Assets - Current Liabilities )

    Return on Invested Capital : ROIC is generally based on the same concept as ROCE, but its components are slightly different.

    RoIC = Net operating profit after tax / invested capital

    Where:

    • Net operating profit after tax: This is a measure of EBIT x (1 – tax rate). This takes into consideration a company’s tax obligations, but ROCE usually does not.
    • Invested capital in the ROIC calculation is slightly more complex than the simple calculation for capital employed used in ROCE. Invested capital may be either:
      • Net working capital + property plant and equipment + goodwill and intangibles
      • Total debt and leases + total equity and equity equivalents + non-operating cash and investments
  • Price-to-Sales(P/S) Ratio : The ratio shows how much investors are willing to pay per dollar of sales. It can be calculated either by dividing the company’s market capitalization by its total sales over a designated period (usually twelve months) or on a per-share basis by dividing the stock price by sales per share. The P/S ratio is also known as a sales multiple or revenue multiple.

    Like all ratios, the P/S ratio is most relevant when used to compare companies in the same sector. A low ratio may indicate the stock is undervalued, while a ratio that is significantly above the average may suggest overvaluation.

    PSR = Market Capitalization / Total Revenue
    (or)
    PSR = Share Price / Total Sales

    If this ratio is lower than P/E, it is better. <1 is preferred.

    Some investors are even more conservative and add the current long-term debt of the company to the total current market value of its stock to get the market capitalization. The logic here is that if you were to acquire the company, you would acquire its debt as well, effectively paying that much more. This avoids comparing PSRs between two companies when one has taken out enormous debt to use to boost sales, and the other has lower sales but no additional nasty debt.

    Market Capitalization = (Shares Outstanding x Current Share Price) + Current Long-term Debt

  • EV/EBIT Ratio : The enterprise value to earnings before interest and taxes (EV/EBIT) ratio is a metric used to determine if a stock is priced too high or too low in relation to similar stocks and the market as a whole. The EV/EBIT ratio compares a company’s enterprise value (EV) to its earnings before interest and taxes (EBIT). A high ratio indicates that a company’s stock is overvalued. Ultimately, the lower the EV/EBIT, the more financially stable and secure a company is considered to be. However, the EV/EBIT ratio can’t be used in isolation.

    EV/EBIT = Enterprise Value / EBIT

    Where:

    • EV = Equity Market Capitalization + Total Debt − Cash (& Cash Equivalents)
  • Cash Profit Margin : Some analysts use "earnings before interest, tax, depreciation and amortisation" (EBITDA) to sales ratio, called cash profit margin, to measure operating performance. They prefer to use EBITDA margin because they believe that it focuses on cash operating items.

    However, this assumption is not correct and is misleading because sales, cost of sales, and other operating expenses (other than depreciation and amortisation) often include non-cash items. Moreover, depreciation is a real operating expense, and it, to some extent, reflects consumption of resources. Therefore, cash profit margin is misleading and fails to measure the operating performance appropriately.

    Some companies use "free cash flow" as a metric to measure operating performance. Free cash flow is calculated by adding depreciation to operating profit and deducting increase in investment in fixed assets and working capital. Free cash flows form the basis for estimating the intrinsic value of the company. A company that focuses on the intrinsic value of the company does not focus on the free cash flow from year to year.

    A company may have low or negative cash flows in the initial years due to heavy investments that are expected to generate high free cash flow in subsequent years. Those companies use 'value' as the measurement metric. They compare intrinsic value at the end and at the beginning of the year.

# Banking Ratios

  • CASA ratio : It is the proportion of current account and savings account deposits in the total deposits of the bank. A low CASA ratio means the bank relies heavily on costlier wholesale funding, which can hurt its margins

  • Credit to deposit ratio (CD ratio) : This ratio indicates how much of the advances lent by banks is done through deposits. It is the proportion of loan-assets created by banks from the deposits received. The higher the ratio, the higher the loan-assets created from deposits. Deposits would be in the form of current and saving account as well as term deposits. The outcome of this ratio reflects the ability of the bank to make optimal use of the available resources. A high credit-deposit ratio suggests an overstretched balance sheet, and may also hint at capital adequacy issues.

  • Capital adequacy ratio (CAR) : A bank's capital ratio is the ratio of qualifying capital to risk adjusted (or weighted) assets. The RBI has set the minimum capital adequacy ratio at 9% for all banks. A ratio below the minimum indicates that the bank is not adequately capitalized to expand its operations. The ratio ensures that the bank do not expand their business without having adequate capital.

    CAR = Tier I capital + Tier II capital / Risk weighted assets

    It must be noted that it would be difficult for an investor to calculate this ratio as banks do not disclose the details required for calculating the denominator (risk weighted average) of this ratio in detail. As such, banks provide their CAR from time to time.

    Tier I Capital funds include paid-up equity capital, statutory and capital reserves, and perpetual debt instruments eligible for inclusion in Tier I capital. Tier II capital is the secondary bank capital which includes items such as undisclosed reserves, general loss reserves, subordinated term debt, amongst others.

  • Non-performing asset (NPA) ratio : The net NPA to loans (advances) ratio is used as a measure of the overall quality of the bank's loan book. An NPA are those assets for which interest is overdue for more than 90 days (or 3 months).

    The net NPA is that portion of bad loans which has not been provided for in the books. Higher ratio reflects rising bad quality of loans.

    NPA ratio = Net non-performing assets / Loans given

  • Provision coverage ratio(PCR) : Banks usually set aside a portion of their profi ts as a provision against bad loans. A high PCR ratio (ideally above 70%) means most asset quality issues have been taken care of and the bank is not vulnerable.

    Provision coverage ratio = Cumulative provisions / Gross NPAs

  • Return on assets (ROA) : Return on Assets (ROA) is a type of return on investment (ROI) metric that measures the profitability of a business in relation to its total assets. This ratio indicates how well a company is performing by comparing the profit (net income) it’s generating to the capital it’s invested in assets. The higher the return, the more productive and efficient management is in utilizing economic resources.

    Returns on asset ratio is the net income (profits) generated by the bank on its total assets (including fixed assets). The higher the proportion of average earnings assets, the better would be the resulting returns on total assets. A lower RoA means that bank is not able to utilise assets efficiently. Negative RoA implies assets are yielding negative return.

    ROA = Net profits / Avg. total assets

    Example, If a business posts a net income of $10 million in current operations, and owns $50 million worth of assets as per the balance sheet, what is its return on assets. $10 million divided by $50 million is 0.2, therefore the business’s ROA is 20%. For every dollar of assets the company invests in, it returns 20 cents in net profit per year.

  • Net interest margin : This is the difference between interest earned by a bank on loans and the interest it pays on deposits. NIM will be high for banks with higher low-cost deposits or high lending rates. Low NIM and high NPA is a bad combination.

    Net Interest Margin = (Interest Income – Interest Expense) / Total Assets

Thats all for now