/Which valuation ratios can help identify the best auto stocks

Which valuation ratios can help identify the best auto stocks

The automobile sector is one of the largest sectors in terms of revenue and is considered the bellwether of both consumer demand and the overall health of the economy. The sector, by virtue of its deep connects with several key segments of the economy, occupies a prominent place in the country’s growth canvas. Rising income and greater availability of credit and financing options have been the key growth drivers for the sector.

Before investing in automotive stocks, investors should understand how economic cycles affect auto companies and how these companies work to maximise profits and stay competitive through good and bad times. Investing in any stock requires careful analysis of financial data to find out a company’s true worth. The analysis of a stock should be based on certain factors, including macroeconomic indicators, sectoral trend, government policy, competition, capital structure, operational efficiency, financial ratios etc. Besides, monthly sales data released by SIAM should be monitored. SIAM (Society of Indian Automobile Manufacturers) is the apex national body representing Indian automobile industry. Investors should also look at the sales volumes data. And then, it is important to take a look at the financial ratios to gain an overall idea of how a company is performing.

The key ratios to look at are operating income, as well as operating margins to track an auto company’s financial performance over time. Among the financial ratios, one should analyse three parameters — namely liquidity ratio, valuation ratio and profitability ratio. The liquidity ratio is a type of financial ratio which is used to determine a company’s ability to pay its short-term debt obligations. This metric can help determine if a company can use its current or liquid assets to cover the current liabilities.

The inventory turnover ratio shows how many times a company has sold and replaced its inventory over a given period. The valuation ratio shows the relationship between the market value of a company or its equity and some fundamental financial metrics. Investors should also closely watch price to earnings (P/E) and price to book value (P/BV) ratios besides the EPS. Profitability ratios such as the return on equity (RoE) can help analyse an auto stock, as this can show how a company is operating. RoE is a key financial ratio for evaluating almost any business, and it is certainly considered an important metric to analyse companies in the auto sector. It helps investors measures a company’s net profit in relation to shareholder equity, essentially how profitable a company is for its investors. The asset turnover ratio is another profitability ratio, that measures a company’s ability to generate sales from its assets.

With the above-mentioned ratio analyses, conclusion can be drawn regarding several aspects such as financial health, profitability and operational efficiency of the undertaking. Using these ratios, investors can choose the right companies to invest in or compare the financials of two or more companies to figure out the better bet.

(DK Aggarwal is the CMD of SMC Investment and Advisors)

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