__Extended DuPont Analysis__The Extended DuPont provides an additional decomposition of the Profit Margin Ratio (Net Income/Sales) into two burden components, Tax and Interest, times the Operating Profit Margin. This is a positive refinement of the traditional DuPont Analysis to provide a refinement of the profit margin ratio into the operating profit margin ratio by taking out the effects arising from taxes and interest expense. As a result, it provides both management and the financial analyst with finer information about a company and its immediate competitors.

Formally, the Extended DuPont formula is:

ROE = (Net Income/EBT) * (EBT/EBIT) * (EBIT/Sales) * (Sales/Total Assets) * (Total Assets/Shareholders’ Equity)

Each term in the decomposition has a specific meaning:

Profit Margin Ratio =Net Income/Sales now decomposes into:

Net Income/Earnings Before Taxes = Tax Burden Ratio

Earnings Before Taxes/Earnings Before Interest and Taxes = Interest Burden Ratio

Earnings Before Interest and Taxes/Sales = Operating Profit Margin

Asset Turnover Ratio or Asset Use Efficiency = Sales/Total Assets

Financial Leverage Ratio= Total Assets/Shareholders Equity

Net Income is measured after taxes. So if taxes are zero the tax burden equals one and so the lower this number, the higher the tax burden. Similarly, if Interest Expense is zero then interest burden ratio equals one and therefore the higher the financial leverage, the lower is this number. The advantage of adjusting for taxes and interest is to gain better insight into the firm’s profit margin by focusing upon the operating profit margin.

Note that the product of the first four terms is now ROA. This is driven by operations, financing and the management of taxes. A nice property of the Extended DuPont formula is that one can examine the breakdown of ROA from the perspective of major firm decisions --- investment, financing and tax decisions.

__ROE Ratio__
Return on Equity (RoE) : One of the trends observed in 2012 is a play on ROE.Most of the indian entities of MNCs like Hindustan Unilever and Colgate are companies with light balance sheets. Smaller share holder capital, smaller assets and giving good returns. They have been giving good dividends and that is one of the ways where they can please their masters sitting abroad. They remained the the flavor of 2012 due to good ROE and also riding on the renewed interest in FMCG business as such, completly ignoring the PE ratio and even the PEG ratio

Most of us are familiar with the price of a share (P).

We should have also heard of its earnings per share (E).

The ratio of this two is the P/E of the stock.

A stock by itself CANNOT have a ’high’ or ’low’ PE!

Its always relative to something else (e.g., the industry average).

When you see the ’talking heads’ on CNBC speaking of high or low PEs, they are actually making incomplete statements unless they specify relative to WHAT.

But even this is not enough as the industry as a whole could be in a slump or growth phase.

To know if a scrip is ’fairly valued’ or not, we have to add another component.

This is the earnings growth (G) expressed as CAGR over the number of years you want to go forward (usually related to the time frame of your position).

This is always a projection/estimate.

Now the good part, this

If the ratio is around 1 (say 0.9 - 1.1), the future earnings growth ’matches’ the current PE and the share is fairly valued (HOLD).

If the PEG more than 1, the PE is higher than the project earnings growth rate so the scrip is OVER valued (SELL).

If its less than 1, its UNDER valued (BUY).

Caution:

This ratio is more applicable for GROWTH (above market PE) as opposed to VALUE (below market PE) stocks.

**Ratio Analysis : PEG Ratio**

__what does P stand for__Most of us are familiar with the price of a share (P).

__what does E stand for__We should have also heard of its earnings per share (E).

The ratio of this two is the P/E of the stock.

A stock by itself CANNOT have a ’high’ or ’low’ PE!

Its always relative to something else (e.g., the industry average).

When you see the ’talking heads’ on CNBC speaking of high or low PEs, they are actually making incomplete statements unless they specify relative to WHAT.

But even this is not enough as the industry as a whole could be in a slump or growth phase.

To know if a scrip is ’fairly valued’ or not, we have to add another component.

__what does G stand for__This is the earnings growth (G) expressed as CAGR over the number of years you want to go forward (usually related to the time frame of your position).

This is always a projection/estimate.

Now the good part, this

**PEG ratio**as it is called can give a much better idea than pure PE about the valuation of any stock.If the ratio is around 1 (say 0.9 - 1.1), the future earnings growth ’matches’ the current PE and the share is fairly valued (HOLD).

If the PEG more than 1, the PE is higher than the project earnings growth rate so the scrip is OVER valued (SELL).

If its less than 1, its UNDER valued (BUY).

Caution:

This ratio is more applicable for GROWTH (above market PE) as opposed to VALUE (below market PE) stocks.

**What the PEG ratio is saying about Indian markets**

The Sensex PEG ratio is at 0.85 in January, which looks set to be the third month in a row that it is under one, suggesting a buy signal

Peter Lynch in his investment classic,

*One up on Wall Street*, recommends the price-earnings growth, or PEG ratio, as a means of valuing growth stocks.
This is different from valuing companies as a multiple of their earnings—the more commonly used price-earnings, or PE, multiple. A company with profits of Rs.100 crore and value at Rs.1,000 crore would have a PE multiple of 10.

There is a disadvantage to this. Companies whose profits are growing fast typically trade at higher multiples. This would mean that a fast-growing company which has a multiple of 15 may look more expensive than a no-growth company with a PE of 10. Lynch advocated dividing the PE ratio by expected earnings growth, thus arriving at the PEG ratio.

If growth is higher than the PE multiple, then the ratio would be less than one, signalling that a stock is inexpensive relative to its growth. It is considered expensive if the PEG is greater than one.

The Sensex PEG ratio has been under one since November. It is currently at 0.85. This looks set to be the third month in a row that the PEG ratio is under one, suggesting a buy signal. This is the longest stretch of such low valuations since 2013. It dipped below one on three separate occasions during 2013. There was a rebound after two months on each occasion.

The PEG ratio is calculated based on one-year forward PE estimates divided by long-term growth estimates. To be sure, any signal based on the PEG ratio comes with its own set of caveats. It paints a poor picture of stable companies whose high growth phase is behind them even though they may offer high dividend income. A low PEG may make a company look cheap, but this does not account for the high growth that India itself is going through relative to the rest of the world.

While the Sensex PEG indicates a buy signal, not everyone is convinced about future growth.

Dhananjay Sinha, head, institutional research, and economist and strategist, Emkay Global Financial Services, pointed out that markets trading at the lower end of earnings multiple should also be seen in the context of the fact that there has been little growth in earnings. He pointed out that analysts have been bullish on earnings only to downgrade them for a long time now, always postponing growth to the next year.

"Next year is a mirage," he said.

The past 12-month Sensex EPS (earnings per share) at the end of the September 2015 quarter was lower than the corresponding figure for September 2014. The same holds true for June and March. December quarter earnings, which are still coming in, are also lacklustre and yet another round of earnings downgrades may be around the corner.

Drastic steps will need to be taken before growth picks up, said independent market analyst Anand Tandon. "The government has to go out and spend like crazy…hope is not a plan," he said.

So are the markets cheap now?

Maybe not just yet.

__PE Ratio : trailing PE vs Forward PE__
EPS comes in two main varieties. Because there are two types of EPS metrics, there are also two most common types of P/E ratios: Forward P/E and Trailing P/E.

The first is what you see listed in the fundamentals section of most finance sites; it says something like "P/E (ttm);" ttm is a Wall Street acronym for trailing 12 months. This is a number reported as fact, based on the company's performance over the past 12 months.

The other type of EPS is found in a company's earnings release, which often provides EPS guidance. This is the company's best educated guess of what it will earn in the future.