Which financial, valuation ratios should you look at while picking realty stocks

The Covid pandemic’s short-term detrimental impact has eroded business values and growth prospects for most sectors across the globe. But what is also true is that there are several sectors where market movements have surprised us.

With the gradual opening up of the economy, this pandemic has become a potentially transformational event for sectors like real estate, construction and some others. Real estate demand has picked up, and registration numbers and enquiries are rising, and secondary market channels are clearly showing an uptick in the last two or three months.

The sector has witnessed positive sentiment among home buyers, not only from end-user perspective but also from long-term investors. Similarly, the market is looking ahead to better times. Many stocks in the sector have rallied lately, which is another sign that investors are anticipating a strong revival. As investors, we need to look at some parameters before investing in real estate stocks.

The demand-supply gap for quality residential housing, favourable demographics, rising income levels, availability of financing options as well as fiscal benefits available on home loan are some the fundamental factors benefitting the real estate sector.

Investing in any stock requires careful analysis of financial data to find out the company’s true worth. This is generally done by examining the company’s profit and loss account, balance sheet and cash flow statement along with various financial ratios. Though there are many important financial ratios out there, investors only tend to focus on a handful of them. Besides, specific ratios hold significance in particular sectors, and they tell the growth story better than the others.

For real estate stocks, investors should focus more on working capital-to-sales, considering the high gestation period of projects, besides the debt-to-equity ratio, operating margins and return on capital employed.

Companies with minimal debt-to-equity ratios, strong cash flows and no share pledges hold better prospects. The debt-to-equity ratio is a metric used to determine the degree of a company’s financial leverage. Undoubtedly, this metric reveals the amount of debt and equity a company can utilise to finance its operations. Besides, investors should also keep a check on the possible equity dilution as and when large funding is required for timely execution of projects.

On the valuation front, one should try and do an analysis of price-to-earnings and price-to-sales ratios before investing in a real estate stock. One should also look at the size of the ‘land bank’ , as that gives an indication of growth visibility in the company’s revenues. An investor should also look at the disclosure standards followed by a company, and that is a good reflection of its governance standards.

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