New investors keep making the same mistake. They hear a hot stock tip from a friend or see a post online. Then they rush to buy the stock without understanding anything about the business. They think they’re investing, but they’re just guessing.
That’s why so many beginners lose money fast. They don’t know what they’re buying. They don’t know if the company is strong or weak. And they don’t have a way to tell the difference.
You don’t have to fall into this trap. There’s a better way. Smart investors use a few simple numbers to check if a stock is worth buying. These numbers are easy to learn. And once you understand them, you’ll be able to spot bad companies in seconds—and find good ones before they take off.
This article will teach you the three most important numbers every beginner must learn. These are the numbers real investors use every day. They aren’t hard to remember. And they could save you thousands of dollars.
Why You Need These Three Ratios Before You Buy Anything
Imagine you’re about to put your money into a company. Wouldn’t you want to know if that company is making money? Wouldn’t you want to check if it’s drowning in debt? Wouldn’t you want to know if the stock price is fair—or way too high?
That’s what these three financial ratios tell you. They give you the key facts. They let you see what’s going on behind the scenes. And they help you avoid bad investments before it’s too late.
These are the three ratios:
- Price-to-Earnings Ratio (P/E)
- Debt-to-Equity Ratio (D/E)
- Return on Equity (ROE)
Each ratio tells you something different. The P/E ratio tells you if the stock is too expensive. The D/E ratio tells you if the company is in trouble. The ROE tells you if the company is making smart use of its money. Together, they give you the full picture.
These three tools can help you avoid big losses. They can also help you find hidden winners that others overlook. And best of all—they’re simple to use. No math degree required.
Ratio 1: Price-to-Earnings (P/E)
The first ratio you should learn is the price-to-earnings ratio, also called the P/E ratio. This number tells you how much you are paying for each dollar the company earns in profit. It’s one of the fastest ways to judge whether a stock is cheap or expensive.
To calculate the P/E ratio, you take the stock’s current price and divide it by the company’s earnings per share. For example, if a stock costs $40, and the company earns $4 per share, then the P/E ratio is 10. That means you are paying $10 for every $1 of the company’s profit.
A low P/E ratio usually means the stock is cheaper. It might be a bargain. Sometimes it means investors aren’t excited about the company. Other times it means the company is strong but ignored. That’s why it’s smart to look closer when you see a low P/E.
A high P/E ratio usually means the stock is expensive. Investors might believe the company will grow fast. But it also means the stock has a lot of pressure. If the company doesn’t meet those expectations, the price can fall quickly. High P/E stocks can be exciting, but they carry more risk.
The best way to use this ratio is to compare it to other companies in the same business. If you’re looking at a car company, compare it to other car companies. If you’re looking at a software company, compare it to other software companies. Different industries have different average P/Es, so make sure you’re looking at the right group.
You should also check how the P/E ratio changes over time. If the ratio is falling, it might mean the stock is getting cheaper. If it’s rising, it could mean the stock is getting expensive—or the company is growing fast. You want to know why it’s changing.
Understanding this one ratio can stop you from overpaying for stocks. It helps you buy with logic, not emotion. It helps you avoid hype and focus on facts.
Ratio 2: Debt-to-Equity (D/E)
The second ratio every beginner must know is the debt-to-equity ratio, or D/E. This number tells you how much debt a company has compared to the money it actually owns. This is important, because too much debt can destroy a business.
To find the D/E ratio, you take the total amount of debt the company owes and divide it by the amount of money the company has invested by its owners (called equity). For example, if the company has $50 million in debt and $100 million in equity, then the D/E ratio is 0.5. That means for every dollar it owns, it has 50 cents in debt.
A low D/E ratio is usually a good sign. It means the company is not depending too much on borrowed money. If there’s a slowdown or crisis, the company will have an easier time surviving. It won’t have to make huge interest payments. It won’t need to borrow more. And it won’t need to panic.
A high D/E ratio is a warning. It means the company is loaded with debt. It might be growing fast, but it’s taking a big risk. If profits drop or the economy changes, the company could struggle to pay its bills. It might have to cut jobs, sell assets, or stop paying dividends. In bad times, high debt companies can fall fast.
It’s also important to look at the D/E ratio over time. Is it going up every year? That’s a danger sign. It means the company is borrowing more and more. Is it going down? That’s a good sign. It means the company is paying off debt and becoming more stable.
Some industries use more debt than others. For example, banks and utility companies often have higher D/E ratios. But in general, lower is safer.
This ratio helps you stay away from companies that might collapse when things get hard. It helps you focus on strong, stable businesses. And it gives you peace of mind, knowing the company can survive tough times.
Ratio 3: Return on Equity (ROE)
The third must-know ratio is return on equity, or ROE. This number shows you how well the company is using its money to make a profit. It tells you if the business is efficient—or wasteful.
To calculate ROE, you divide the company’s net income (the profit it makes) by its equity (the money from shareholders). If a company earns $20 million and has $200 million in equity, the ROE is 0.10, or 10%. That means the company makes 10 cents of profit for every dollar its owners have invested.
A high ROE is a strong signal. It means the company is using its money wisely. It knows how to take investor money and turn it into real gains. This is what great companies do. They don’t just grow—they grow efficiently.
A low ROE is a warning. It means the company is not earning much profit for the money it’s using. Maybe costs are too high. Maybe sales are too low. Maybe the business is just badly run. In any case, low ROE tells you the company might not be a good place to put your money.
Most experts like to see ROE above 10%. That means the company is making decent returns. If ROE is below 10%, be careful. It doesn’t always mean the company is bad—but it does mean you should look closer.
ROE is also more useful when you look at the trend. Is it going up every year? That’s a great sign. It means the company is getting stronger. Is it falling year after year? That’s a bad sign. It means the company is losing its edge.
This ratio is your way of asking: “Is this company working for me?” If the answer is yes, the ROE will show it. If not, it’s time to move on.
Use All Three Ratios to Make Better Choices
Now that you’ve learned all three ratios, it’s time to see how they work together. One ratio alone is helpful. But using all three gives you real power. You’ll be able to spot strong companies and avoid weak ones—before anyone else.
Let’s say you are looking at two companies.
Company One has a P/E of 20, a D/E of 0.4, and an ROE of 14%.
Company Two has a P/E of 7, a D/E of 1.8, and an ROE of 3%.
Company One is more expensive. But it’s stable and making strong profits for its investors. Company Two looks cheaper. But it’s drowning in debt and barely earning anything.
Most beginners would pick Company Two because it looks cheap. But now you know better. You know that the price alone doesn’t tell the full story. You know how to read the numbers that really matter.
These three ratios help you make smart decisions. They help you avoid hype. They help you stay calm. They help you invest with confidence.
You don’t need to wait. Start today. Go to a stock website and look up a company. Check the P/E, D/E, and ROE. Write them down. Then do the same for another company. Compare them.
Ask yourself:
Is this stock priced fairly?
Is the company in good financial shape?
Is it rewarding its investors?
Do this with five companies this week. Then five more next week. The more you practice, the sharper your skill becomes.
These three ratios are your foundation. Use them every time you look at a stock. They will help you make decisions with facts, not feelings. And over time, they will help you grow your money the smart way.
If you’d like a cheat sheet for these three ratios—what they mean, how to use them, and what numbers to aim for—just let me know. I’ll prepare a printable guide you can keep by your side when analyzing stocks.
