Impact of Financial Ratios on Stock Returns: An Empirical Study of the Indian Equity Market

This study examines the relationship between key financial ratios and stock returns in the Indian equity market over the period 2020–2025. A balanced dataset comprising 300 company-year observations — drawn from 60 companies across six major sectors (Information Technology, Automobiles, Pharmaceuticals, Energy, FMCG, and Banking) — was analysed using Ordinary Least Squares (OLS) regression, one-way Analysis of Variance (ANOVA), and principal component factor analysis. The independent variables include Return on Equity (ROE), Return on Assets (ROA), Net Profit Margin (NPM), and the Current Ratio (CR). OLS regression results reveal a low overall model fit (R²=0.0206, p=0.189), with NPM being the only predictor approaching conventional statistical significance (β=−0.0097, p=0.070). One-way ANOVA demonstrates highly significant cross-sectoral variation in ROE (F=202.51, p<0.001), confirming that financial performance differs substantially across industries. Factor analysis identifies three latent dimensions — Profitability, Liquidity, and a Residual factor — collectively accounting for 71.2% of total variance (KMO=0.71). The findings suggest that financial ratios alone are weak predictors of stock returns in the Indian equity market, while sector membership is a dominant determinant of financial performance.