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📊 Series 7: Understanding Company Fundamentals

Day 4: Key Ratios Every Investor Should Know (P/E, ROE, Debt-to-Equity)

When I first started investing, I used to look at stock prices and think that was all that mattered. “This stock is $10 — that’s cheap!” I would tell myself. But over time, I learned a hard truth: price alone means nothing. What really matters is value.

To understand value, you need to know how to analyze a company’s financial strength — and that’s where ratios come in. Financial ratios are like a doctor’s report for a company. They help you check its health, efficiency, profitability, and level of debt, all from a few numbers.

Today, I want to share three of the most important ratios every investor should know:

1. Price-to-Earnings (P/E) Ratio — tells you how expensive or cheap a stock is.

2. Return on Equity (ROE) — shows how effectively a company uses its money.

3. Debt-to-Equity (D/E) — reveals how much risk the company is taking on.

Once you master these three, you’ll be able to look at any stock and instantly tell if it’s worth your attention.

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🧮 What Are Financial Ratios, and Why Do They Matter?

Think of financial ratios as shortcuts to understanding a company’s story. They summarize a lot of complex data into simple, easy-to-compare numbers.

When you go to a doctor, you don’t read every single detail of your blood test — you look at the key indicators: blood pressure, cholesterol, heart rate. Ratios work the same way.

Here’s why they’re powerful:

• They allow you to compare companies within the same industry.

• They show trends over time, so you can spot improvement or decline.

• They help you avoid overpaying for stocks that look good on the surface but are weak inside.

Now, let’s break down the three key ratios that form the foundation of smart investing.

💵 1. Price-to-Earnings (P/E) Ratio — How Expensive Is the Stock?

The P/E ratio is one of the most talked-about numbers in the investing world. It tells you how much investors are willing to pay for each dollar of a company’s earnings.

Formula:
P/E = Price per share ÷ Earnings per share (EPS)

For example, if a company’s stock price is $50 and its EPS is $5, then its P/E ratio is 10. This means investors are paying $10 for every $1 of profit the company makes.

So what does this number tell us?

• A high P/E usually means investors expect strong future growth. But it can also mean the stock is overpriced.

• A low P/E might suggest the stock is undervalued or that investors have low expectations.

But here’s a key lesson I’ve learned — a high P/E doesn’t always mean it’s bad, and a low P/E doesn’t always mean it’s good. You must compare it with:

• The company’s historical P/E (Is it higher or lower than usual?)

• Other companies in the same industry (Is it more expensive than peers?)

• The overall market average (How does it compare to the index?)

For example, tech companies often have higher P/Es because they’re expected to grow fast, while banks or utility companies tend to have lower P/Es.

So I always remind myself: Don’t just look at the number — understand the story behind it.

📈 2. Return on Equity (ROE) — How Well Is the Company Using Its Money?

ROE is one of my favorite ratios because it tells you how effectively a company uses shareholders’ money to generate profits. It shows whether the management is truly good at growing value.

Formula:
ROE = Net Income ÷ Shareholders’ Equity

In simple terms, it measures how much profit the company makes for every dollar invested by shareholders.

Let’s say a company earns $1 million in profit and has $10 million in equity. Its ROE would be 10%. That means for every $1 shareholders have invested, the company generated $0.10 in profit.

Why is this important? Because a company with a consistently high ROE usually has:

• Strong management

• Competitive advantages

• Efficient use of capital

However, be careful — a very high ROE might sometimes be the result of high debt. If a company borrows a lot of money, its equity becomes smaller, which can artificially boost ROE.

That’s why I always check ROE together with the Debt-to-Equity ratio, which we’ll cover next.

⚖️ 3. Debt-to-Equity (D/E) Ratio — How Much Risk Is the Company Taking?

The Debt-to-Equity ratio shows how much a company relies on borrowing (debt) compared to its own money (equity).

Formula:
D/E = Total Debt ÷ Shareholders’ Equity

For example, if a company has $5 million in debt and $10 million in equity, its D/E ratio is 0.5. That means it uses 50 cents of debt for every $1 of equity.

A low D/E ratio means the company isn’t overly dependent on borrowed money — that’s generally safer.
A high D/E ratio means it’s taking on more debt, which can be risky during bad times or recessions.

But just like the P/E ratio, the “right” D/E number depends on the industry. Utility companies or property developers often use more debt because their businesses are asset-heavy. In contrast, tech companies usually have lower D/E ratios because they can grow with less borrowing.

What I’ve learned is this:
Debt is not always bad — it’s a tool. But when used recklessly, it can destroy even a great business.

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🧩 How These Ratios Work Together

Each ratio tells one part of the story:

• P/E Ratio shows how the market values the company.

• ROE shows how efficiently the company creates profit.

• D/E Ratio shows how safely it’s growing.

When I analyze a company, I don’t look at these ratios in isolation. I connect them together.

For example:

• A company with a high ROE but also high D/E might be using debt to boost returns — that’s risky.

• A low P/E and steady ROE might signal an undervalued gem.

• A rising P/E with falling ROE could mean the market is overhyping a weakening business.

Seeing how they interact helps me judge whether a company’s growth is real and sustainable or artificial and risky.

🔍 A Simple Example

Let’s imagine two companies:

Company A

• P/E = 10

• ROE = 8%

• D/E = 0.3

Company B

• P/E = 30

• ROE = 20%

• D/E = 1.5

At first glance, Company A looks cheaper with a lower P/E. But Company B has a higher ROE — it’s more profitable with the money it uses. However, it also carries more debt.

So which one is better? It depends on your comfort level with risk. If you prefer stability, you might choose Company A. If you’re comfortable with more risk for higher potential returns, Company B could be interesting.

This is the beauty of understanding ratios — you can make decisions based on data and logic, not emotion or hype.

📊 Other Helpful Ratios to Explore

Once you’ve mastered these three, here are a few others worth learning later:

• Current Ratio – measures short-term financial health (liquidity).

• Gross Margin – shows how much profit a company makes before expenses.

• EPS Growth Rate – reveals whether profits are growing over time.

• Price-to-Book (P/B) – compares stock price to the company’s net assets.

These ratios build on the same foundation — helping you see beyond the surface and understand how a business truly performs.

💬 My Personal Lesson

When I began investing, I used to buy stocks based on news or tips. I didn’t look at ratios. Sometimes I got lucky. But more often, I lost money. Once I learned how to use ratios, I stopped guessing and started thinking like an owner.

Today, before I buy any stock, I run it through this quick checklist:

1. Is the P/E ratio reasonable compared to the industry?

2. Is the ROE above 10% and stable over time?

3. Is the D/E ratio at a safe level?

If a company passes these three, I dig deeper. If not, I move on. No emotion. No fear of missing out. Just logic.

💡 Key Takeaways

• Ratios are shortcuts to wisdom. They turn raw financial data into clear insights.

• P/E tells you the price investors are paying for earnings.

• ROE tells you how efficiently a company turns equity into profits.

• D/E tells you how much risk the company is taking through borrowing.

• Always compare ratios within the same industry. Context matters.

• Use multiple ratios together to see the full picture — never rely on just one.

Final Takeaways

Numbers don’t lie — but they can be misunderstood. That’s why learning to read them properly gives you an edge. Financial ratios aren’t just for accountants or analysts. They’re the language of smart investors who want to make informed decisions.

Once you understand these three ratios, you’ll never look at a company the same way again. You’ll be able to see beyond the stock price and into the heart of the business.

Call to Action:
Take 15 minutes today to analyze one company you like. Look up its P/E, ROE, and D/E ratios. Write them down and think about what they mean. Is the stock fairly valued? Is it managing debt well? Is it efficiently using shareholders’ money?

By doing this regularly, you’ll train your eyes to see what most people miss — and that’s how real investors build long-term wealth.

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DISCLAIMER

I make no representations, warranties, or guarantees, whether expressed or implied, that the content provided is accurate, complete, or up-to-date. Past performance is not indicative nor a guarantee of future returns.

I am an individual content creator and not regulated or licensed by the Monetary Authority of Singapore (MAS) as I do not provide investment services.

All forms of investments carry risks, including the risk of losing your entire invested amount. Such activities may not be suitable for everyone. You are strongly encouraged to seek advice from a professional financial advisor if you have any doubts or concerns.