Financial Metrics and Ratios - EPS, PE Ratio, PEG Ratio, PB Ratio, DE Ratio, Current Ratio, Face Value, Free cash flow
Essential Key Financial Terms Before Investing in Company Stocks
Investing in company stocks requires a strong understanding of key financial terms to make informed decisions. Here's a detailed explanation with examples for the essential financial terms you listed, organized into their respective categories:
Financial Metrics and Ratios:
Financial metrics and ratios are essential tools for analyzing a company's financial health, profitability, and operational efficiency. Here is a detailed explanation of the financial metrics:
1. Earnings Per Share (EPS): EPS indicates how much profit a company generates for each outstanding share of its stock. It is a direct measure of profitability on a per-share basis and is used by investors to assess financial performance over time.Earnings Per Share (EPS) is a financial metric that shows how much profit a company makes for each share of its stock. It is a way to measure a company’s profitability and indicates how much money shareholders would receive if the company distributed all its profits equally among its shares.
How to Calculate EPS?
The formula to calculate EPS is:
Where:
- Net Profit: The total profit a company earns after deducting all expenses, taxes, and interest.
- Preferred Dividends: The fixed dividends paid to preferred shareholders (if applicable).
- Outstanding Shares: The total number of shares currently held by shareholders in the market.
Interpreting EPS:
High EPS: Indicates that the company is earning more profit per share, which is generally a good sign for investors.
Low EPS: May indicate that the company is not generating sufficient profits or has issued too many shares, diluting the earnings.
Consistent Growth in EPS: A company whose EPS consistently grows year after year is seen as financially stable and a good investment opportunity.
Benefits of EPS (Earnings Per Share)
1. Measures Profitability Per Share: EPS provides a clear measure of a company's profitability on a per-share basis. It helps investors understand how much profit the company is generating for each share they own.
2. Easy to Compare Across Companies: EPS helps investors to compare the profitability of companies within the same industry, even if they differ significantly in size or scale. This makes it a useful tool for benchmarking.
3. Helps in Stock Valuation: EPS is a critical component of valuation metrics like the Price-to-Earnings (P/E) ratio, which helps investors determine whether a stock is overvalued, undervalued, or fairly priced.
4. Dividend Potential: Companies with a stable or growing EPS are more likely to pay consistent or higher dividends. Thus, EPS is a useful indicator for dividend-seeking investors.
5. Reflects Management Efficiency: EPS is an indicator to know how efficiently the company’s management uses its resources to generate profits. A rising EPS shows that management is effectively growing earnings.
6. Useful for Growth Analysis: EPS growth over time shows a company's ability to increase profits and expand its operations. Investors prefers EPS growth to assess long-term growth potential.
Example:
Year 1 EPS: ₹12Year 2 EPS: ₹15
Year 3 EPS: ₹18
A consistent increase in EPS indicates company's growth.
7. Basis for Investment Decisions: EPS helps investors to evaluate whether a stock aligns with their investment goals. Growth-oriented investors look for rising EPS for increasing capital gains, while income-focused investors may use EPS to gauge dividend-paying potential.
8. Helps in Identifying Market Trends: Investors can identify market trends and cycles by tracking EPS over multiple quarters or years. An improving EPS is a signal to positive business momentum.
9. Enhances Investor Confidence: A consistently high or growing EPS builds confidence in shareholders, as it indicates financial stability and profitability.
10. Correlates with Market Sentiment: EPS often influences investor sentiment and stock prices. Positive EPS can take stock prices higher, while negative surprises may lead to declines.
Limitations of EPS (Earnings Per Share):-
1. Does Not Account for Debt or Leverage: EPS only reflects net income and does not consider how much debt the company uses to generate those earnings. A highly leveraged company may show a high EPS, but it could be at greater financial risk if it struggles to pay its debt.
Example:
- Company A and Company B both report an EPS of Rs15.
- Company A has no debt, while Company B has Rs 300 crore in debt.
- Despite similar EPS, Company B is riskier due to its debt obligations.
2. Ignores Cash Flow: EPS focuses solely on accounting profits, and ignores actual cash flow. A company may report a high EPS but is a company experiences cash flow issues, it could affect its ability to pay dividends or reinvest in the business.
3. Can Be Manipulated: Companies can influence EPS through accounting practices or financial strategies. Some common methods include:
- Stock Buybacks: The company reduces the number of outstanding shares by repurchasing shares, artificially inflating EPS even if earnings remain unchanged.
- Accounting Adjustments: A company can temporarily boost EPS by adjusting depreciation methods or recognizing revenue early
Example: A company buys back 10% of its shares, reducing the denominator in the EPS formula. Even if net income stays flat, EPS will increase, and will give a misleading impression of improved profitability.
4. Does Not Reflect Future Earnings: EPS is based on past performance and it does not indicate a company’s future earning potential. A company with a stable or growing EPS might face future challenges which are not reflected in the current EPS figure.
5. Impact of Inflation: EPS does not adjust for inflation. Inflation can consume the real value of reported profits, and make EPS comparisons over long periods less meaningful.
Example: A company with consistent EPS growth of 6% per year might not actually be growing in real terms if inflation is also 6%.
6. Incomplete View of Financial Health: EPS measures profitability, but it does not address other critical aspects of financial health, such as Liquidity (ability to meet short-term obligations), Solvency (ability to manage long-term debt), and Operational efficiency.
Thus, EPS plays a crucial role in stock valuation, growth analysis, and decision-making for both individual and institutional investors. However, it should always be analyzed alongside other financial metrics to provide a comprehensive view of a company’s financial health.
2. Price-to-Earnings (P/E) Ratio: The P/E ratio shows the market’s valuation of a company in terms of its earnings. It represents the amount investors are willing to pay for every unit of earnings. The P/E ratio is widely used in stock analysis and provides insight into whether a stock is overvalued, undervalued, or fairly valued relative to its earnings.
Formula
- Market Price per Share: The current trading price of one share of the company.
- Earnings per Share (EPS): The company's net earnings (profit) divided by the total number of outstanding shares.
Types of P/E Ratios
Trailing P/E:
It uses earnings from the last 12 months (historical data).Formula:
It provides a snapshot of how the company performed recently.
Forward P/E:
It uses projected earnings for the next 12 months.
Formula:
It reflects market expectations of future earnings.
Example:
Suppose, a company, ABC Ltd, with the following details:
Current Market Price of Stock = Rs 50EPS (last 12 months) = Rs 5
Interpretation of P/E Ratio
- High P/E Ratio: It indicates high investor expectations for future growth. It could also mean the stock is overvalued.
- Low P/E Ratio: It may suggest the stock is undervalued or has low growth prospects.
Negative P/E Ratio: It occurs when a company has negative earnings (losses). In this situation, it requires alternative valuation metrics.
Benefits of P/E Ratio
Simplifies Valuation: The P/E ratio simplifies the valuation and provides a simple way to compare the valuation of different companies or industries.
Comparison Tool: It helps investors to compare a company’s valuation against its peers, the industry average, or the broader market.
Insights into Growth Expectations: A high P/E ratio shows that investors expect the company to grow its earnings significantly in the future.
Historical Analysis: When we Compare a company’s current P/E ratio with its historical average, we can analysis whether the stock is overvalued or undervalued.
Forward-Looking: The forward P/E ratio, using projected earnings, provides insight into expected future performance.
Limitations of P/E Ratio:
- Earnings Manipulation: Companies can use accounting techniques or financial strategies to adjust EPS up or down, which can make the P/E ratio misleading.
- Not Applicable for Negative Earnings: If a company has negative earnings (losses), the P/E ratio is not meaningful.
- Industry Variations: Different industries have different average P/E ratios, it makes cross-industry comparisons less meaningful.
- Ignores Growth: The P/E ratio doesn’t consider earnings growth. A low P/E doesn’t always mean a stock is undervalued if the company has weak growth prospects.
Short-Term Volatility: Stock price fluctuations can affect the P/E ratio in the short term, even if the underlying fundamentals are unchanged.
The P/E ratio helps investors assess a stock’s value and understand market expectations for its future earnings. However, it works best when combined with other metrics for better investment decisions.
3. PEG Ratio
The PEG Ratio (Price/Earnings-to-Growth Ratio) is a financial tool used to evaluate whether a stock is fairly priced by comparing its P/E Ratio (Price-to-Earnings) to its expected earnings growth rate. Unlike the P/E ratio, the PEG ratio also considers the company's future growth, making it a more accurate way to determine if a stock is overvalued or undervalued.
The PEG ratio measures the relationship between a company's P/E ratio and its expected earnings growth rate.
Formula:
PEG Ratio=P/E Ratio/Earnings Growth Rate
Where:
P/E Ratio: Price of a stock divided by its earnings per share (EPS).
Earnings Growth Rate: Projected annual growth rate of a company's earnings (expressed as a percentage).
Interpretation of PEG Ratio:
PEG < 1: The stock may be undervalued, implying its price doesn't fully reflect its earnings growth potential.
PEG = 1: The stock is fairly valued, balancing price with growth.
PEG > 1: The stock may be overvalued, as its price may not be justified by its growth prospects.
Company A:
Stock Price: Rs 100
Earnings Per Share (EPS): Rs 5
P/E Ratio: 100/5=20
Expected Earnings Growth Rate: 25%
PEG Ratio=P/E Ratio/Expected Earnings Growth Rate
PEG Ratio=20/25= .8
Company B:
Stock Price: Rs 150
Earnings Per Share (EPS): Rs 6
P/E Ratio: 150/6=25
Expected Earnings Growth Rate: 15%
PEG Ratio=P/E Ratio/Expected Earnings Growth Rate
PEG Ratio= 25/15=1.67
Company A: With a PEG ratio of 0.8, which is less than 1, it indicates that the stock is likely undervalued relative to its earnings growth potential, and making it attractive to growth investors.
Company B: With a PEG ratio of 1.67, which is more than 1, it interpretates that the stock appears overvalued compared to its growth prospects.
When to Use the PEG Ratio
Growth Stock Screening: We can use the PEG ratio to identify companies with strong growth potential at a reasonable price.
Sector Analysis: PEG ratio can be used to compare companies in fast-growing industries where P/E ratios alone may be misleading.
Portfolio Diversification: It helps balancing the portfolio by including undervalued growth stocks.
Advantages of the PEG Ratio:
Incorporates Growth: The PEG ratio provides a more balanced view of a company's valuation by including the growth rate,
Identifies Undervalued Growth Stocks: A low PEG ratio [which is less than 1 ] may indicate that the stock is undervalued relative to its growth prospects.
Industry Comparisons: It is useful for comparing companies in the same industry or sector with similar growth profiles.
Mitigates P/E Ratio Limitations: It is helpful to overcomes the limitation of the P/E ratio, which can be misleading for fast-growing companies with high earnings multiples.
Limitations of the PEG Ratio
Reliance on Growth Projections: The PEG ratio is dependent on future earnings growth estimates, which can be uncertain or inaccurate.
Ignores Qualitative Factors: It does not take into account for business risks, competitive scenario, or management quality.
Not Suitable for All Companies: It is ineffective for the companies having negative or highly volatile earnings or for mature companies with low growth rates.
Short-Term Bias: The short- to medium-term growth rate is typically used, which may not reflect long-term performance.
Investors use the PEG ratio to identify growth stocks that may be undervalued relative to their earnings potential. However, it should be combined with other metrics and qualitative factors for a better investment decision.
Price-to-Book Ratio [P/B Ratio]
The Price-to-Book Ratio (P/B Ratio) is a financial metric that compares a company’s market value to its book value. It provides insight into how investors perceive the value of a company relative to its net assets.
Key Concepts in Price-to-Book Ratio [P/B Ratio]:
Book Value: This is often referred to as the company’s "net worth" and excludes intangible assets such as brand value or goodwill. It represents the net asset value (NAV) of a company.
Book Value=Total Assets−Total Liabilities
Market Value: This is the total value of the company’s stock.
Market Value=Stock Price × Number of Shares Outstanding
P/B Ratio: The P/B Ratio compares the company’s market value to its actually worth on paper (book value).
P/B Ratio= Market Price per Share/ Book Value per Share
How to Interpret P/B Ratio:
P/B < 1: The stock is trading for less than the company’s net worth. It means the stock is undervalued or that the company has been going through some problems (e.g., bad management or poor profitability).
P/B = 1: The stock is valued exactly at its net worth.
P/B > 1: Investors are paying more than the net worth of the company. It means the stock is overvalued or when investors believe the company will grow or has valuable intangible assets (like a strong brand).
Example: Suppose a company has:
Total Assets = Rs 500 million
Total Liabilities = Rs 200 million
Shares Outstanding = 10 million
Stock Price = Rs 40
Step 1: Calculate Book Value
Book Value= Total Assets− Total Liabilities= 500−200 = 300 million
Step 2: Book Value per Share
Book Value per Share=Book Value/Shares Outstanding = 300/10 = 30
Step 3: Calculate P/B Ratio
P/B Ratio= Market Price per Share/ Book Value per Share = 40/30 = 1.33
It means Investors are paying Rs1.33 for every Rs 1 of net assets the company owns.
Advantages of the P/B Ratio
Simplicity: It is easy to calculate using publicly available data such as market price and financial statements and it also offers a quick snapshot of whether a company is trading above or below its net asset value.
Indicator of Undervaluation: If a P/B ratio less than 1, it means that the market values the company at less than its net assets, and it is potentially undervalued company. It might provide opportunities for value investors.
Asset-Heavy Companies: We can use P/B Ratio in the stocks of banks, manufacturing, real estate, and utilities because these sectors often have tangible assets that dominate their balance sheets. The P/B ratio can help identify undervalued companies in these sectors.
Comparing Companies Within the Same Industry: P/B Ratio is most effective when used to compare companies operating in similar sectors and under similar accounting practices.
Less Sensitive to Earnings Volatility: Unlike Price-to-Earnings (P/E) Ratio, the P/B ratio is not directly influenced by temporary fluctuations in earnings, making it useful for companies with inconsistent profitability.
Comparable Across Time: Book value changes less frequently compared to earnings, so it provides a stable measure to compare over longer periods.
Ignores Intangible Assets: The P/B ratio ignores intangible assets like brand value, patents, or intellectual property. This means it might undervalue companies in tech or services where intangible assets are very important.
Does Not Reflect Current Market Value: The book value is based on historical cost accounting and this can make the book value significantly different from the true liquidation value of the assets.
For example: Real estate purchased decades ago might be listed at its original cost, not its current market value.
Not Suitable for All Industries: The P/B ratio works well in asset-intensive industries but it is less effective for companies in Service sectors (e.g., consulting, education) and Tech industries, where intangible assets drive value.
Does Not Consider Profitability: A low P/B ratio might mean the stock is undervalued, but it could also mean the company is unprofitable or poorly managed. For example, if a company has falling earnings and high debt, investors may avoid it, causing the stock to trade below its book value.
Limited Use During High Inflation: In case of high inflation, historical asset values can become outdated, making the book value unreliable.
Overlooked Leverage: Companies with high debt may look cheap based on the P/B ratio, but the risk from their debt is not considered.
In summary, the P/B ratio is a simple way to see if a company’s stock is overvalued or undervalued relative to its net assets. It works best when combined with other financial ratios.
Debt-to-Equity Ratio
The Debt-to-Equity Ratio (D/E) is a financial metric used to measure the proportion of a company's financing that comes from debt compared to equity. It shows how much debt a company is using to finance its operations relative to its shareholders' equity.
Formula:Debt-to-Equity Ratio = Total Liabilities / Shareholders’ Equity
Where:
- Total Liabilities: All the money the company owes (loans, bonds, etc.).
- Shareholders' Equity: The money invested by owners/shareholders plus any retained profits.
Interpreting the Ratio:
Less than 1: The company is primarily financed by equity.
Equal to 1: Debt and equity are equally used.
Greater than 1: The company is using more debt than equity for financing.
Example Calculation
Let’s say a company has:
Total Liabilities: Rs 500,000
Shareholders' Equity: Rs 250,000
Debt-to-Equity Ratio = 500,000 / 250,000 = 2
This means the company has Rs2 of debt for every Rs1 of equity.
Low Debt-to-Equity Ratio: A low Debt-to-Equity (D/E) ratio reflects that a company relies more on equity financing (i.e., funds from shareholders) than on debt (i.e., loans or borrowed funds) to fund its operations, expansion, or investments. While this seems like a safe and conservative financial strategy, it comes with both benefits and limitations.
Advantages of a Low D/E Ratio
Lower Financial Risk: This is especially beneficial during economic downturns or periods of low revenue, where debt-laden companies may struggle to meet obligations.
Attractive to Investors and Creditors: Low reliance on debt makes the company a safer investment.
Stability in Cash Flows: The company has more flexibility in using its cash for operations, reinvestment, or distribution to shareholders due to its fewer obligations to pay lenders,
Limitations of a Low D/E Ratio
While a low D/E ratio has advantages, it may also indicate that the company is not fully utilizing the benefits of leverage (debt financing):
Missed Growth Opportunities: A company that avoids debt may limit its ability to grow rapidly because borrowing allows companies to access additional capital for expansion, acquisitions, or investments without diluting ownership. A company that avoids debt may limit its ability to grow rapidly.
Inefficient Capital Structure: A company that relies solely on equity may lose out on these cost-saving opportunities, making its capital structure less efficient. Debt financing often comes with tax benefits because interest payments are tax-deductible, unlike dividends paid to shareholders
Slower Returns for Shareholders: Debt allows companies to invest in growth projects that could generate higher returns. If the company doesn’t use debt and if the return on equity (ROE) may be lower, it potentially disappoints investors.
High Debt-to-Equity (D/E) ratio: A high D/E ratio shows that the company has a significant portion of its funding coming from debt rather than shareholders' equity. It indicates that a company relies more on debt than equity to finance its operations, growth, and investments. While debt can help increase returns in favourable conditions, it also increases financial risk, especially if the company struggles to meet its repayment obligations
Benefits of a High D/E Ratio
Amplifies Returns: If the company uses debt effectively, it can achieve higher returns for shareholders without diluting ownership. Example: If a company borrows money at 5% interest to invest in a project that generates a 15% return, it creates a profit margin on the borrowed funds.
Preserves Ownership: Debt allows a company to raise capital without issuing additional shares, which helps maintain existing shareholders' ownership percentages.
Tax Savings: Interest payments on debt are tax-deductible, reducing the company’s tax burden and making debt financing cost-effective.
Risks of a High D/E Ratio
Default Risk: A company having high debt might face challenges during economic downturns or periods of declining revenue. If the company cannot generate enough cash flow, it is unable to fulfill its financial obligations to repay borrowed money. This could involve missing scheduled interest payments, failing to repay the principal amount when due, or violating terms set by lenders
Reduced Profitability: High-interest expenses can gulp the profits, and reduce the company’s net income and returns to shareholders.
Creditworthiness: A high D/E ratio can negatively impact the company’s credit rating, making it harder or more expensive to borrow in the future.
Why Debt-to-Equity Ratio Important:
Risk Assessment: It helps investors and creditors understand the financial stability and risk level of a company.
Leverage Indicator: It shows how effectively a company uses debt to fund its operations and growth.
Comparison Tool: an be used to compare companies within the same industry to assess financial health.
Limitations of Debt-to-Equity Ratio:
Industry Differences: D/E ratios vary by industry. For example- capital-intensive industries like utilities may naturally have higher D/E ratios. Technology or service-based industries may have lower D/E ratios.
Doesn’t Show Debt Quality: The ratio doesn’t differentiate between short-term and long-term debt or assess the cost of debt.
Accounting Variations: Different accounting practices can affect the calculation of liabilities and equity.
A high D/E ratio can be a double-edged sword. It enables growth and expansion but increases financial risk. In some industries, high D/E ratios are standard due to the nature of the business (e.g., utilities). A wise investor always look at the company’s ability to generate consistent cash flows and its interest coverage ratio to determine whether a high D/E ratio is manageable.
Current Ratio
The Current Ratio is a financial liquidity ratio that measures a company’s ability to cover its short-term liabilities with its short-term assets. Investors, creditors, and analysts use this indicator to assess a company's short-term financial health.
Formula
Current Ratio=Current Assets/Current Liabilities
Where:
Current Assets: Assets that are expected to be converted into cash or used up within one year. It includes Cash and cash equivalents, Accounts receivable, Inventory, Marketable securities, Prepaid expenses.
Current Liabilities: Obligations that are due within one year. It includes Accounts payable, Short-term loans, Taxes payable, Wages payable, Interest payable.
Interpretation of the Current Ratio:
The current ratio helps determine whether a company has enough short-term assets to cover its short-term liabilities.
Current Ratio > 1 → It means the company has more current assets than current liabilities. This generally indicates a good liquidity position.
Current Ratio < 1 → It means that the company may struggle to pay off its short-term obligations, which could be an indicator of financial instability.
Current Ratio = 1 → It means the company’s current assets are just enough to cover its current liabilities, leaving no margin for safety.
What Is an Ideal Current Ratio?
A current ratio between 1.5 and 2 is often considered healthy. However, the ideal ratio depends on the industry. Retail and manufacturing companies (which rely on inventory) may have higher current ratios while Technology and service companies (which have fewer tangible assets) may have lower current ratios.
Example:
Suppose a company has
Current Assets = Rs 500,000
Current Liabilities = Rs 250,000
Current Ratio=500,000/250,000=2
A current ratio of 2 means the company has twice the amount of current assets needed to cover its short-term liabilities.
Advantages of the Current Ratio
1. Simple and Easy to Calculate: It requires only basic financial data from a company’s balance sheet and can be quickly computed and understood, making it a convenient tool for financial analysis.
2. Provides a Quick Snapshot of Liquidity: It helps determine whether a company has enough current assets to cover its short-term liabilities.
3. Useful for Short-Term Financial Planning: It helps business to monitor their working capital and ensure they have enough assets to meet obligations and guide decision-making on cash management, debt repayment, and operational efficiency.
4. Helps in Creditworthiness Assessment: Lenders and creditors use the current ratio to assess a company's ability to repay short-term loans. Investors also use it to gauge the company’s financial stability before making investment decisions.
5. Allows Industry and Competitor Comparisons: Companies can compare their current ratio with industry benchmarks to assess their standing. It helps identify whether a business is managing liquidity better or worse than competitors.
6. Assists in Risk Management: A declining current ratio over time may indicate rising financial risk or cash flow problems. It helps company to take early corrective actions, such as reducing expenses or securing additional funding to resolve financial risk.
7. Can Be Used in Trend Analysis: Tracking the current ratio over time helps company and analysts to spot trends in liquidity. A consistently improving ratio may indicate strong financial management, while a declining trend could signal trouble.
Limitations of the Current Ratio:
1. Ignores the Quality of Current Assets: A high current ratio does not necessarily mean a company has strong liquidity. Because few current assets (like inventory or accounts receivable) may be difficult to convert into cash quickly.
2. Doesn't Consider Cash Flow: A company may have a good current ratio but still struggle with cash shortages due to delayed customer payments or seasonal fluctuations.
3. Industry Differences Make Comparisons Tricky: Different industries have different working capital structures. A manufacturing company might have a high current ratio due to large inventories, while a tech company may operate efficiently with a lower current ratio. That’s why comparing across industries can be misleading.
4. Can Be Manipulated: Companies can temporarily inflate their current ratio by delaying payments to suppliers or selling off long-term assets just before reporting, it increases current assets.
5. Doesn't Consider Short-Term Debt Structure: The ratio does not show whether a company’s short-term liabilities are due immediately or spread out over time. A company may have a high current ratio but still face liquidity issues if a large debt payment is due soon.
The Current Ratio is a valuable financial metric due to its simplicity and quick insight into liquidity. However, it should be used with other financial metrics to get a complete picture of a company’s health.
What is Face Value
Face Value is the original price of a share or bond decided by the company when it is issued. It does not change with market fluctuations and is mainly used for accounting purposes.
Example of Face Value in Stocks
Suppose, a company issues 10,000 shares and decides that each share will have a face value of Rs10.
This means the total value of the shares in the company’s books is Rs 1 lakh (10,000 × Rs10).
However, when these shares are traded in the stock market, their market price may go up or down based on its demand and supply.
If the share price rises to Rs 500, the face value still remains ₹10—it won’t change unless the company decides to split the stock.
Features and significance of Face Value:
Face value is fixed at the time of issuance: The company decides the face value at the time of issuance. When a company issues shares, it assigns a fixed face value to them, usually a small amount like ₹1, ₹2, ₹5, or ₹10 per share.
It is different from the market price: Market price is usually different from the face value. Market price fluctuates based on the demand and supply of the shares, and company performance, whereas the face value remains constant unless the company decides to change it through corporate actions like a stock split.
It is used for dividends, stock splits, Bonus shares and bonds: Face value is used for dividends, stock splits and bonds.
Dividends: Dividends are often declared as a percentage of face value. For example: If a company decides to give 100% dividend on a stock with ₹10 face value, it simply means a dividend payout of ₹10 per share.
Stock Splits: A company may reduce the face value to split shares. For example: A Rs10 face value stock is split into two Rs 5 face value shares, doubling the number of shares in circulation.
Bonus Shares: It is issued based on face value, increasing the number of shares without affecting market capitalization.
Bonds: Interest and maturity amounts are based on face value. For example, a bond has a face value of ₹1,000 and an interest rate of 8% per annum. The annual interest paid to the bondholder will be ₹80 [8% of ₹1,000] and at maturity, the bondholder will receive the face value (₹1,000) back.
What is Free Cash Flow (FCF) in the Stock Market?
Free Cash Flow (FCF) is a key financial metric used in the stock market to assess a company's financial health and ability to generate cash after covering operating expenses and capital expenditures. It represents the cash available for investors, dividends, share buybacks, or debt repayment.
Formula for Free Cash Flow:
FCF=Operating Cash Flow−Capital Expenditures
Operating Cash Flow (OCF) is the cash generated from core business operations.
Capital Expenditures is the money spent on acquiring or upgrading physical assets like machinery, equipment, and buildings.
Why is Free Cash Flow Important?
Financial Strength Indicator - A company with positive FCF indicates that it has extra money to invest, pay debts, or return value to investors.
Dividend & Buyback Potential- Companies with strong FCF are more likely to reward investors with dividends or buybacks.
Better than Net Profit - Companies with strong FCF are more likely to reward investors with dividends or buybacks. Net profit can be affected by accounting tricks, but FCF shows the real cash situation.
Stock Valuation- Investors use FCF to see if a stock is overvalued or undervalued.
A company with high FCF is usually strong, while a company with negative FCF needs closer analysis. Investors use FCF to pick solid stocks that can grow and reward shareholders.
Dr. Swati Gupta
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