Fundamental Analysis — A Beginner's Framework
How to read financial statements, key ratios (PE, PB, ROE, ROCE, D/E), valuation methods, and red flags.
Ever wondered how Warren Buffett picks stocks? He reads financial statements. In India, tools like Screener.in make this accessible to everyone. Let's learn to read the numbers behind every listed company.
What Are Financial Statements?
Every listed company publishes three key statements each quarter and annually. These are filed with BSE/NSE and available free on Screener.in.
Key Ratios Every Investor Must Know
Ratios turn raw numbers into comparable insights. Here are the six most important ones.
| Ratio | Formula | Good Range |
|---|---|---|
| P/E (Price to Earnings) | Share Price ÷ EPS | 15-25 for large caps |
| P/B (Price to Book) | Share Price ÷ Book Value | Below 3 is reasonable |
| ROE (Return on Equity) | Net Profit ÷ Shareholder Equity × 100 | Above 15% |
| ROCE (Return on Capital Employed) | EBIT ÷ Capital Employed × 100 | Above 20% |
| D/E (Debt to Equity) | Total Debt ÷ Equity | Below 1 for most sectors |
| EPS (Earnings Per Share) | Net Profit ÷ Total Shares | Growing year-on-year |
Ramesh checks Infosys on Screener.in. He finds:
- P/E Ratio: 22 (reasonable for IT sector)
- ROE: 31% (excellent, above 15% benchmark)
- D/E: 0.07 (almost debt-free)
- 5-year profit CAGR: 14%
All ratios look healthy. He adds it to his watchlist for further study.
How to Value a Stock — DCF Basics
The simplified DCF approach:
- Estimate free cash flow for the next 5-10 years
- Apply a discount rate (usually 12-15% for Indian equities)
- Add a terminal value for cash flows beyond Year 10
- Divide total by number of shares to get intrinsic value per share
Use the PE-based valuation instead. If a stock's 10-year median PE is 20 and current EPS is ₹50, fair value = 20 × 50 = ₹1,000. Compare with the current market price.
Red Flags to Watch Out For
Not every profitable company is a good investment. Watch for these danger signs:
- Consistently negative cash flow despite rising profits — could mean creative accounting
- Debt growing faster than revenue — the company is borrowing to survive
- Frequent related-party transactions — promoters may be siphoning money
- Pledged promoter holding above 30% — promoters are using shares as collateral
- Auditor qualifications or frequent auditor changes — serious governance concern
- Inventory or receivables growing much faster than sales — possible channel stuffing
Before investing, search for the company on SEBI's orders database. Past penalties for insider trading or fraud are major red flags.
Sector-Specific Ratio Benchmarks
Different sectors have different "normal" ranges. A bank's D/E above 10 is normal, but for an FMCG company it would be alarming.
| Sector | Key Ratio to Focus | Typical Range |
|---|---|---|
| Banking | NPA Ratio, NIM | NPA below 2%, NIM 3-4% |
| IT Services | ROE, Revenue Growth | ROE 25%+, Growth 10%+ |
| FMCG | P/E, Volume Growth | P/E 40-60, Growth 8%+ |
| Pharma | R&D Spend, ROCE | R&D 8%+, ROCE 15%+ |
| Real Estate | D/E, Pre-sales | D/E below 1 |
How to Use Screener.in Like a Pro
- Go to screener.in and create a free account
- Use the Screens feature to filter stocks (e.g., ROE > 20, D/E < 0.5, PE < 25)
- Check the 10-year financial history for consistency
- Read annual report links provided on each company page
- Export data to Excel for custom analysis
Key Takeaways
- Read all three financial statements — P&L, balance sheet, and cash flow
- Focus on six key ratios: PE, PB, ROE, ROCE, D/E, and EPS
- Use PE-based or DCF valuation to estimate fair value
- Watch for red flags like pledged shares, negative cash flow, and auditor changes
- Use Screener.in to screen and analyse stocks for free
A company shows rising profits but consistently negative operating cash flow. What does this suggest?
Deepen your understanding of markets at Stock Market Learning Hub.
Try Our Free Tools
Put what you've learned into action with our calculators and courses.