Ratios, valuation and business quality

Reading for India · about 4 min

What this cluster is for

Most explanations of financial ratios teach you the formulas. You finish able to define a P/E ratio, and you still cannot look at 2 companies and say anything useful about either.

These 6 lessons are built around a single idea, and it is worth stating before anything else.

A ratio is a question, not an answer.

Every ratio in this cluster is a fraction. Somebody chose what went on top and what went underneath, and those choices are where the meaning lives. A P/E of 8 is not information until you know what is in the E. An ROE of 30% is not information until you know whether it came from a good business or from borrowing.

So each lesson pairs its ratio with the second question that makes it mean something, and ends with a check you run on your own holdings in about 5 minutes.

By the end of this cluster you will be able to:

Find out whether the P/E your app shows used trailing or forward earnings, and how much of that profit was a one-off
Split any company's ROE into margin, efficiency and borrowing, and see which one produced it
Read a P/B ratio against the return earned on that book, which is the only way it means anything
Say whether a beta describes any risk you actually care about
Measure your own return per unit of drawdown, against an index
Test a claim that a company has a moat, against a number that would already have fallen if it did not

Nothing here is a tip. Nothing here names a company to buy. Everything here should still work in 2036, on a business that does not exist yet.

The reading order

The first 3 lessons are about the company. The next 2 are about your portfolio. The last one is about the thing the numbers cannot see. Read them in order the first time.

Valuing the company

The P/E ratio, and why ratios matter — why ratios exist at all, and why a low P/E is more often a warning than a discount. Check which E your P/E used.
Book value and the P/B ratio — book value is what the company paid, not what the assets are worth. Never read P/B without ROE beside it.
Profitability and debt ratios: ROE, D/E and more — the DuPont split, and the difference between a business that earns its return and one that borrows it.

Measuring your own risk

Beta and CAPM: how the market prices risk — beta measures co-movement with an index, not the chance of permanent loss. Read the R-squared beside it.
The Sharpe ratio for investors — 2 portfolios can return 15% and be nothing alike. Return per unit of movement is the result.

What the numbers cannot see

Beyond numbers: business quality and moats — a moat is a mechanism, not a record. A moat that exists shows up as a gross margin that does not fall.

The checklist

Every article ends in an action. Collected here, they are one long afternoon on your own portfolio, and they are the most valuable thing in this cluster. Tick them off as you go.

Before you buy anything

The P/E, and which E it used — trailing or forward, consolidated or standalone. (1)
"Other income" plus "exceptional items", as a share of net profit. (1)
P/B and ROE together, never P/B alone. (2)
The DuPont split: margin × asset turnover × leverage. (3)
Interest coverage — operating profit divided by the interest bill. (3)
Name the moat mechanism in 1 sentence, or write "none". (6)

Once a year, on everything you hold

Gross margin for 5 straight years, written in a row. (6)
Financial leverage for 3 straight years. Rising leverage with rising ROE is the pattern that ends badly. (3)
Share count over 5 years. A falling count means part of the EPS growth was arithmetic. (1)
For a lender: gross and net non-performing assets, and provision coverage. (2)
The related-party transactions note in the annual report. (3)
Your portfolio's return, and your worst drawdown, over 3 years. Divide one by the other. Compare with the index. (5)

Habits that cost nothing

Ask "compared to what?" before accepting any multiple. Its own 10-year range, or its direct competitors. Never the index. (1)
Read the R-squared beside every beta. A low one makes the beta noise. (4)
Write down what would actually damage each holding permanently, in 6 words. Compare that list with the beta list. (4)
Use a risk-free rate in the same currency as the money you are counting. (4, 5)
Never compare a ratio across 2 different industries. (1, 2)

India and the United States, equally

Every article covers both markets at the same depth, then says where the 2 differ and what that difference tells you.

The divergences here are not decorative. Four of them change what a number means.

Indian shares have traded at persistently higher multiples than most other emerging markets, for reasons that are partly explainable and partly not. Applying an American rule about what P/E is "normal" will make you sell good businesses too early for a decade.

Promoter control changes what ROE means. Where a family controls a listed Indian company, value can move through royalty payments, related-party transactions and rent. The related-party note is where a high ROE is confirmed or undermined.

Banks and lenders cannot be valued on the same ratios as manufacturers. Their book value is a judgement about loan losses, their leverage is the business rather than a risk, and their profit depends on provisions set by management under a regulator's rules.

American buybacks flatter EPS and ROE in a way Indian buybacks historically did not. A US company with flat profit and a steady buyback reports growing earnings per share and rising return on equity while standing still. Indian buybacks were less common, partly for tax reasons that changed from 1 October 2024.

Investing material written for American conditions reaches Indian readers every day. Copied without translation, it quietly costs money. Those sections are the translation.

A note on what this is not

These lessons are free and they will stay free. They are the text version of the ideas in our video course, written for anybody who cannot spend money on learning right now.

They will take you longer than the videos would. But the goal is the same one it has always been: fewer people in the 95%.