Warren Buffett is one of the best teachers when it comes to investing or generating wealth from the stock market.

Warren Buffett is one of the best teachers when it comes to investing or generating wealth from the stock market.

Now, talking about picking up stocks, Warren Buffett picks up stocks rationally. We will talk about some of the powerful tools/ratios which Warren Buffett uses to pick value stocks. Remember that all these ratios that we will discuss now need to be compared to businesses in the same industry to get useful information before investing in any company.

So the four ratios are Return on Equity (ROE), Return on Capital Employed (ROCE), Return on Asset (ROA), Debt to equity (DE) ratio.

1. ROE of the company is the Net income divided by shareholder’s equity. This ratio indicates how efficiently a company/management is utilizing its equity base to generate profit for shareholder.

2. Return on capital employed is the Net operating profit (EBIT) divided by capital employed.
ROCE is very useful when comparing the performance of companies in capital –intensive sectors such as steel and telecom. It gives better tools as compared to ROE because it shows how well the company is using both its Debt as well as equity.

3. Return on Asset (ROA) is Net income divided by total assets. This ratio indicates how efficiently management is using its assets to generate earnings. This ratio helps us to know how well the company is churning its assets to generate profits. Higher ratios are useful for investors as it shows that the company is more efficiently managing its assets and making more profits.

4. Debt to equity ratio is the company’s total Debt by its shareholder equity. (Total Debt includes short term debt + long term debt + other fixed payments). This ratio is used to evaluate a company’s financial leverage. Warren Buffett often selects companies which have low Debt to equity ratio. Companies which have a high Debt to equity ratio can be on the edge of becoming bankrupt.

Keeping all this in mind, we realise the Sir Warren Buffet is a value investor. He mostly focuses on value and growth investing strategies which can be used by an average investor like you and me to create wealth. So in case you wish to invest, the Warren Buffet way, you need to: Read through the financial statements and compare the various ratios. Give much importance to the companies that are churning their assets efficiently to generate earnings. Focus on companies which are consistent in growth and business.

Once these points are established, you will be able to make a better analysis of future value of the company. Thereby meeting your financial goals with greater surety.

Thank you for watching the video.