Courtesy : ET
Valuation
Parameters You Should Know
Knowing them will enable you to buy stocks at the right price.
PE RATIO: SHARE PRICE/EARNINGS PER SHARE
The price-to-earnings ratio is the most commonly used valuation parameter. A
lower PE indicates either an attractively valued stock or one whose prospects
are poor. You may compare the current PE of a stock with its own historical
valuations (say, 5-year average), the industry average. the industry average,
and the PE of a broad market index, such as the Sensex or S&P 500.
PE ratio can be of two types: forward and TTM (trailing 12 months). Forward PE
is based on the earnings estimates provided by analysts. The advantage of using
it is that stocks respond to the prospects of a stock. The risk is that earnings
estimates often go wrong. TTM PE is based on past four quarters' earnings, so
it can't be wrong. However, it is backward looking.
PB RATIO: PRICE/BOOK VALUE
The price to book value compares the price of a stock with its book value
(value of shares originally issued, plus retained earnings). The book value is
a proxy for the liquidation value of the company. It is a good measure for
judging the valuations of asset-heavy companies. It is also well suited for
banking and other financial services companies. It is not a good measure for
asset-light, service firms.
EV/EBITDA:
ENTERPRISE
VALUE/EBITDA
This valuation ratio compares the enterprise value of a stock with its EBITDA
(earnings before interest, tax, depreciation and amortisation), a measure of a
stock's operating profits. The EPS gets affected by 'other income', which is
income not derived from the company's operations, but from, say, sale of an
asset. This can artificially inflate the EPS and bring down the PE. This
doesn't happen with EBITDA. The latter is, hence, a better reflection of a
company's earnings capability. EV or enterprise value measures a company's
value. It is the sum of the market value of the firm and its longterm debt,
minus its cash.
PEG
RATIO: PE
RATIO/EPS GROWTH RATE
Here you compare a company's PE ratio with its 3- or 5-year EPS growth rate.
Sometimes, a company's PE may appear high compared to its own historical
valuation or the industry average. This usually happens with high-growth
companies. If you wait for its PE ratio to fall, it may never happen. The PEG
ratio, by comparing the PE with the EPS growth rate, offers a justification for
investing in such a stock. The PEG ratio should be be below 1. If it is
less than 0.5, it is very attractive.
Before
You Invest
No quick gains
At the very outset, investors must accept that the equity markets are not a
route to quick riches. "Greed and speed are the worst enemies of sound
investing," says investment analyst R Balakrishnan, a former mutual fund CEO.
All direct investments in equities should be made with a time horizon of at
least 3-5 years. If you ignore this tenet and adopt a high-churn strategy, you
will soon come to grief. "You may get lucky on your first punt and make
some quick money. Then, inevitably, you will buy something that will keep
sinking," says Balakrishnan.
If the markets tank and the uneducated investor is left holding stocks of
suspect quality, his corpus value erodes rapidly and does not recover for a
long time, if ever. Many investors get so badly singed by their first such
brush with the equity markets that they decide to stay away from stocks
forever.
Educate
yourself
Before you start investing directly in equities, make the effort to educate
yourself. "If you won't invest time in educating yourself, then direct
stock investing is not for you," says Balakrishnan. Learn the ropes of
investing from an unbiased source with no conflict of interest. Says Dhawan:
"Many brokerage houses today run short-term learning programmes on equity
investing. Brokerages earn more when you transact more. Hence, they have a
vested interest in teaching you investment strategies that involve a high
churn," he says.
In our view, the approach with which you stand the best chance of making money
is one based on fundamental analysis and buy-and-hold. Also, by reading
investment classics, you may have the best chance of developing an approach
that is time-tested.
Valuation Parameters You Should Know
Knowing them will enable you to buy stocks at the right price.
PE RATIO: SHARE PRICE/EARNINGS PER SHARE
The price-to-earnings ratio is the most commonly used valuation
parameter. A lower PE indicates either an attractively valued stock or
one whose prospects are poor. You may compare the current PE of a stock
with its own historical valuations (say, 5-year average), the industry
aver ..
Valuation Parameters You Should Know
Knowing them will enable you to buy stocks at the right price.
PE RATIO: SHARE PRICE/EARNINGS PER SHARE
The price-to-earnings ratio is the most commonly used valuation
parameter. A lower PE indicates either an attractively valued stock or
one whose prospects are poor. You may compare the current PE of a stock
with its own historical valuations (say, 5-year average), the industry
aver ..
Valuation Parameters You Should Know
Knowing them will enable you to buy stocks at the right price.
PE RATIO: SHARE PRICE/EARNINGS PER SHARE
The price-to-earnings ratio is the most commonly used valuation
parameter. A lower PE indicates either an attractively valued stock or
one whose prospects are poor. You may compare the current PE of a stock
with its own historical valuations (say, 5-year average), the industry
aver ..
