Financial Ratios for Stock Valuation: 10 Numbers to Check Before You Buy Any Stock

Every year, thousands of Nigerians open CSCS accounts, buy shares on a tip from WhatsApp or Telegram, and then wonder why the stock is down 30%. The problem is rarely the market. It is buying without checking the numbers.

Financial ratios turn a company's annual report into a handful of figures you can compare quickly. Whether you invest through a stockbroking firm, an investment app, or a mutual fund, these ratios help you separate strong companies from risky ones.

This guide covers the five classic ratios, five more that serious investors use, and how to adjust them for Nigerian realities like high inflation, interest rates, and naira volatility.

Why Nigerian Investors Need to Adapt Global Ratio Rules

Most "thumb rules" you see online were designed for developed markets. In Nigeria, you must also consider:

•       High interest rates and treasury yields. If Treasury bills or FGN bonds pay a double-digit return with almost no risk, a stock must offer a much better reward to be worth the risk. A low P/E alone is not enough.

•       Inflation. Profits that grow by 15% mean little if inflation is higher. Look at real growth.

•       Naira exchange rate swings. Companies that import raw materials or owe dollar loans can post big FX losses, which hit earnings and ratios.

•      Sector differences. What is normal may vary from industry to industry.  For instance, banks, manufacturers, oil and gas firms, and telecoms each have different "normal" ratios.

•      Thin trading on some counters.  Do not consider financial ratios in isolation. Also look at the stock's technical indicators like volume being traded overtime. A cheap-looking stock may be hard to sell if it does not muster enough liquidity support.

Keep these in mind as we go through the ratios.

1. Price-to-Earnings (P/E) Ratio

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

Example: A company's shares trade at ₦50 and it earned ₦5 per share last year. P/E = 50 ÷ 5 = 10. You pay ₦10 for every ₦1 of yearly profit.

Thumb rule: A lower P/E is generally preferred when buying, but it varies from sector to sector.

Decision rules:

•       Low P/E vs. sector peers: possibly undervalued, or the market expects profits to fall. Find out which.

•       High P/E: investors expect strong growth. Be sure the growth is real.

•       Negative EPS (loss-making): P/E does not apply. 

      Guide: compare the earnings yield (1 ÷ P/E) with what Treasury bills pay.  For example, a P/E of 10 gives a 10% earnings yield. If risk-free instruments pay more, the stock must offer solid growth or dividends to justify the risk.

Watch out: One-off gains, such as selling a property or an FX revaluation gain, can inflate EPS and make P/E look artificially low.

2. Price-to-Book (P/B) Ratio

Formula: P/B = Price per Share ÷ Book Value per Share

Example: If a bank's book value is ₦40 per share and it trades at ₦30, P/B = 0.75.

Thumb rule: A lower P/B could mean the stock is undervalued. The definition of "low" varies by sector.

Decision rules:

•       P/B below 1: the market values the company below its accounting net worth. It may be a bargain, or the market may doubt asset quality (for banks, loan quality).

•       P/B above 3: you are paying a big premium. Check that ROE supports it.

•       Best for: banks, insurance companies, and asset-heavy businesses such as cement and manufacturing. Less meaningful for service and asset-light firms.

Guide: Inflation and naira devaluation can make the book value of old assets look very low compared with their real replacement cost, so P/B for long-established manufacturers can mislead.

3. Return on Equity (ROE)

Formula: ROE = Net Income ÷ Average Shareholders' Equity

Example: Net profit of ₦20 billion on average equity of ₦100 billion gives ROE = 20%.

Thumb rule: Always invest in a company with ROE above 20% for at least the last 3 years.

Decision rules:

•       Consistently above 15-20%: efficient management and strong business.

•       Volatile ROE: earnings are unpredictable.

•       ROE must beat inflation and risk-free rates. If Treasury bills pay more than a company's ROE, shareholders are better off in bills.

•       High ROE with high debt: a warning. Leverage can inflate ROE, so check D/E.

4. Debt-to-Equity (D/E) Ratio

Formula: D/E = Total Liabilities ÷ Total Shareholders' Equity

Example: Liabilities of ₦150 billion and equity of ₦100 billion gives D/E = 1.5.

Thumb rule: Companies with a D/E ratio above 1 are risky. This varies by sector.

Decision rules:

•       Below 0.5: conservative and resilient.

•       0.5 to 1: acceptable for most industries.

•       Above 1: examine interest coverage and cash flow carefully.

Guide: Banks hold customers' deposits as liabilities, so their D/E is naturally very high. Do not apply the "above 1 is risky" rule to banks. Look at capital adequacy, non-performing loans, and ROE instead.

•       Dollar-denominated debt is especially dangerous when the naira weakens, because the naira value of the debt rises, causing FX losses. Check the debt currency in the notes to the accounts.

•       High local interest rates make borrowing expensive, so heavily indebted firms can see profits squeezed quickly.

5. Current Ratio

Formula: Current Ratio = Current Assets ÷ Current Liabilities

Example: Current assets of ₦80 billion and current liabilities of ₦50 billion gives 1.6.

Thumb rule: This evaluates a company's liquidity. Always invest in a company with a current ratio above 1.

Decision rules:

•       Below 1: the company may struggle to pay short-term obligations.

•       1.5 to 2: healthy.

•       Above 3: possibly idle cash or slow-moving inventory.

Guide: Check whether "current assets" are mostly cash or mostly receivables and inventory. Cash trapped in unpaid government or customer invoices, or foreign currency owed but not yet repatriated, is weaker than it looks. Banks do not use this ratio the same way, so skip it for them.

Five More Ratios Serious Nigerian Investors Use

6. PEG Ratio - price-to-earnings-to-growth

Formula: PEG = P/E ÷ Annual EPS Growth Rate (%)

P/E ignores growth; PEG adds it. A P/E of 12 with 24% earnings growth gives PEG = 0.5.

•       Below 1: potentially undervalued relative to growth.

•       Around 1: fairly priced.

•       Above 2: expensive.

Be careful with inflation-driven growth. A company growing profits 25% in an environment of high inflation may be growing less than it appears in real terms.

7. Return on Capital Employed (ROCE)

Formula: ROCE = EBIT ÷ (Total Assets − Current Liabilities)

ROCE includes debt, so leverage cannot flatter it the way it can with ROE.

•       Above 15%: good. Above 20%: excellent.

•       ROCE should clearly exceed the company's borrowing costs, which are high in Nigeria.

8. Interest Coverage Ratio

Formula: EBIT ÷ Interest Expense

With high borrowing rates, this ratio matters a lot.

•       Above 3: comfortable.

•       Below 1.5: danger zone. A small drop in profit could make interest payments hard to meet.

9. Dividend Yield and Payout Ratio

Formulas:

•       Dividend Yield = Annual Dividend per Share ÷ Share Price

•       Payout Ratio = Dividends ÷ Net Income

Example: A share priced at ₦20 paying a ₦2 dividend yields 10%.

Dividends are a major reason many Nigerians invest in stocks.

•       Compare yield to treasury bill and bond rates. A 10% yield is less attractive if risk-free returns are higher, unless the share price is also growing.

•       High yield with payout above 80-90%: may not be sustainable.

•       Very high yield: may simply mean the share price has crashed.

•       Remember tax: dividends are subject to withholding tax, so your net receipt is lower than the declared amount. Check current rules and your broker's statement.

•       Look for companies with a record of consistent, growing dividends over several years, and check the qualification date and closure date so you don't miss the entitlement.

10. Operating and Net Profit Margins

Formula: Operating Margin = Operating Profit ÷ Revenue

Example: Operating profit of ₦15 billion on revenue of ₦100 billion gives 15%.

•       Stable or rising margins: pricing power and good cost control.

•       Falling margins: rising input and energy costs, FX pressure, or competition.

•       Compare with direct competitors, such as one cement maker against another, not against a telecom firm.

Bonus ratio: EV/EBITDA. Useful when comparing companies with very different debt levels.

Quick Reference Table

Ratio	What It Tells You	Thumb Rule	Investor Note
P/E	Price vs. profit	Lower preferred, by sector	Compare with T-bill yields
P/B	Price vs. net assets	Low may mean undervalued	Best for banks, insurers, manufacturers
ROE	Return on shareholders' money	Above 20% for 3+ years	Should beat inflation and T-bills
D/E	Debt level	Above 1 is risky	Not for banks; watch dollar debt
Current Ratio	Short-term liquidity	Above 1	Check receivables quality
PEG	Value vs. growth	Below 1 attractive	Adjust for inflation
ROCE	Capital efficiency	Above 15%	Must exceed borrowing cost
Interest Coverage	Debt affordability	Above 3	Crucial at high interest rates
Dividend Yield / Payout	Income and sustainability	Payout below 60-70%	Net of withholding tax
Operating Margin	Cost control	Stable or rising	Watch FX and energy costs

Sector Cheat Sheet for the Nigerian Market

•       Banks: focus on P/B, ROE, dividend yield, non-performing loans, and capital adequacy. Ignore current ratio and the D/E "above 1" rule.

•       Consumer goods and manufacturing: watch margins, D/E, FX exposure, and interest coverage.

•       Oil and gas: earnings swing with crude prices and FX. Use multi-year averages rather than a single year.

•       Telecoms and tech: look at margins, ROCE, and free cash flow.

•       Insurance: P/B, ROE, and claims experience.

A 5-Step Screening Process

1.     Quality: ROE and ROCE above 15% for at least 3 years.

2.     Safety: D/E (sector-adjusted), interest coverage above 3, current ratio above 1.

3.     Growth: steady revenue and EPS growth, ideally above inflation.

4.     Valuation: P/E, P/B, and PEG against sector peers and the stock's own history.

5.     Reward vs. risk-free: does the expected return clearly beat what treasury bills and FGN bonds offer?

A stock that passes all five deserves deeper research. One that fails two or more is usually best skipped.

Common Mistakes Nigerian Investors Make

•       Buying on tips alone without reading the financial statements.

•       Using one ratio in isolation. A cheap P/E with heavy dollar debt can be a trap.

•       Ignoring FX and inflation effects on reported profits.

•       Applying one rule to every sector, especially to banks.

•       Chasing price jumps in thinly traded stocks that are hard to sell later.

•       Skipping the notes to the accounts, where debt currency, related-party dealings, and one-off items hide.

Where to find the numbers: audited annual reports and quarterly results published on the NGX website and company investor-relations pages, plus your stockbroker's research. Only invest through SEC-registered brokers and platforms.

Final Thoughts

Ratios will not predict the market, but they protect you from overpriced, over-indebted, or low-quality companies. Start with P/E, P/B, ROE, D/E, and the Current Ratio, then add PEG, ROCE, coverage, and dividend analysis. Most importantly, always ask: does this stock reward me enough compared with the safe returns available in Nigeria today?

Bookmark this guide as your pre-purchase checklist.