Fundamental's of Stock Picking : Profitability Ratio's

Profitability ratios measure a company's ability to generate profit and cash flow relative to sales, assets and equity. Common examples of profitability ratio's include :
- Return to sales,
- Return on Investment
- Return on equity
- Return on Capital Employed
- Operation Profit Margin
- Gross profit margin
- Net Profit margin

Companies with high profitability ratios
- generate adequate cash flow
- can fund capital expenditures from internal accruals
- often reward investors with rich dividend, bonus shares, buy back and open offers.
- No need for debt
- No fear of equity dilution
- In better position to grab opportunities like diversification, acquisition, expansion or plain investment in other companies / MFs
- Evergreen Investment options - irrespective of market directions

Among them Return on equity and ROCE are basic ratios that we must understand before investing. Companies with High ROE and ROCE usually reward investors in times of slowdown. They also go for organic and inorganic growth.

Return on equity:
- is also known as Return on Networth:
- measures overall efficiency
- Indicates how much profit a company earned in comparision to the total amount of share holders equity
- = (Net profit - Prefence dividend)/ share holders equity

ROCE :
- also known as ROI
- Indicates how well a company can generate cash from Total Capital Employed
- = Operation Profit / capital Employed
- Capital employed includes long term funds from owners and creditors
- Considered as primary measure of profitability-since it compares inputs with outputs