Investing in the stock market requires patience. This means, before investing in a business it is important to check the financial health and prospects of the company. These have a bearing on the profitability and in-turn on your investment. One of the ways to assess if a stock is worth your investment is through valuation learnt from best stock market courses in Delhi. The reason behind looking for valuation is even if you invest into good stock but at wrong price, you might end up in loss. Thus, investing in a good stock at a right price is essential, and valuation learnt from best stock market courses isthe key to it.
Valuation is the technique to determine the true worth of the stock. After considering several valuation parameters a company could be determined as overvalued, undervalued or at par. Let’s see how to do a valuation analysis of a company in various ways.
Market Based Approach
Under market-based approach, one
- Identifies a comparable firm (same industry, similar business, and markets)
- Identifies the suitable multiple to be used (detailed below)
- Chooses the correct variable depending on the industry
Price/Earnings=Price Per Share/Earnings Per share Price to Earnings Ratio is the ratio of share price of a stock to its earnings per share (EPS). PE ratio is one of the most popular valuation metrics of stock. P/E ratios are used by investors and analysts to determine the relative value of a company’s shares in an apples-to-apples comparison. It can also be used to compare a company against its own historical record. Even several stock market free webinar tells you to look for PE ratio.
Let us look at some examples-FMCG industry!
The average PE is 64.9 and three companies are trading more than the average PE they are Nestle, P&G and Hatsun Agro. This is called an apple-to-apple comparison.
|P & G Hygiene||90.09|
Though the PE of Nestle looks higher than its peers, it is also important to check if the company’s PE has increased in recent times or it has always been higher for this. We will compare it with its historical data. We can see that the company has always been trading at these levels. This method is extremely popular and often taught in best stock market courses.
|3 Years PE||79.7|
|5 Years PE||78|
But there are some limitations with using PE:
- PE ratio may not be suitable for cyclical companies, whose earnings fluctuate significantly over the business cycle. During a downturn, their earnings may be depressed, leading to very high PE ratios, making the company appear more expensive than it is.
- PE ratio only considers the past earnings of a company and does not consider its growth prospects. A high PE ratio might indicate a high-growth company, but it could also mean an overvalued stock if the growth expectations are not met. So along with PE one can also use PEG that takes growth into account.
- PEG: The price/earnings-to-growth (PEG) ratio is a company’s stock price to earnings ratio divided by the growth rate of its earnings for a specified time. See that PEG is less than 1.5 times.
- Price/Sales: The price-to-sales ratio describes how much someone must pay to buy one share of a company relative to how much that share generates in revenue for the company. The lower the P/S ratio, the better. P/S ratio is arrived by dividing the company’s total market capitalization by its trailing 12-month revenue. P/S ratio is usually used to value a loss-making company. So, for all new age of internet companies this becomes the best metric to value. Here we can see that Zomato and Policy Bazaar are trading slightly at premium valuation. As these company starts to increase its scale the P/S decreases.
For example- Amazon for having been unprofitable until 2003, seven years after it went public. On Jan. 1, 2003, Amazon’s market capitalization (the sum of the price of all its outstanding shares) was $7.3 billion. Its trailing 12-month revenue was $3.9 billion. Divide $7.3 billion by $3.9 billion and you get about 1.8, which was Amazon’s P/S ratio at the time.
(iii) Price to book value
The Price to Book (P/B Ratio) measures the market capitalization of a company relative to its book value of equity. It is often told to look for this parameter in stock market free webinar.
The book value refers to the amount the shareholders would receive if the company were to shut down immediately, liquidate, and pay off all its liabilities. The amount that remains is the book value. The book value is calculated by subtracting the company’s total liabilities from its total assets. This value can be found in the company’s balance sheet.
Why should one use PB to value banks?
As per stock market courses online free with certificate, P/BV is particularly relevant for sectors where income (and thus, value) is entirely dependent on the value of assets, such as banking.
Financial companies’ balance sheets are crucial in evaluating their operations and financial health. Financial companies, especially banks and insurance companies, are heavily reliant on their assets and liabilities to generate revenue and profit. For financial institutions, the book value is a significant indicator of their financial strength and stability.
The P/B ratio helps investors and analysts understand how the market values a financial company’s equity relative to its recorded assets and liabilities. Therefore, for valuing a financial company always check PB ratio. We can see that the Public Sector Banks are trading at a very cheap valuations than the private sector banks. So, it’s better to compare private sector bank with another private sector bank.
|Name||CMP / BV|
|St Bk of India||1.54|
|Kotak Mah. Bank||3.34|
|Bank of Baroda||0.97|
EV/EBITDA is a financial ratio used to evaluate the valuation of a company. It stands for “Enterprise Value to Earnings Before Interest, Taxes, Depreciation, and Amortization.” The ratio is calculated by dividing the enterprise value (EV) of a company by its EBITDA.
The formula for EV/EBITDA is as follows:
EV/EBITDA = Enterprise Value / EBITDA
Enterprise Value = Market Capitalization + Total Debt – Cash and Cash Equivalents
EBITDA = Earnings Before Interest, Taxes, Depreciation, and Amortization
Where it is used ?
EV/EBITDA is frequently used in capital-intensive industries such as manufacturing, construction, utilities, oil and gas, mining, renewable energy sectors and infrastructure. These industries often have substantial investments in fixed assets, and EBITDA helps measure their operating performance without the impact of depreciation. When we compare it with peers we can say that Apollo and Max healthcare are trading at a premium valuation.
|Name||EV / EBITDA|
All these ratios are simply available in the screener. You can simply go to add ratio section in the screener and add whichever ratio you want.
2. Asset based approach
This method is just finding how much is the company worth. The Net Asset Value (NAV) is the easiest to understand. It is calculated simply as fair value of the assets of the business less the external liabilities owed. The key here is determining fair value, especially of assets since fair value may differ significantly from acquisition value (for non-depreciating assets) and recorded value (for depreciating assets).
Also, the true value of your company may be significantly higher than the simple addition of the net assets. Things which you never paid for may form part of the value, as would a unique way of doing business that gives your company an advantage. Put simply, it is the value any objective person would pay to set up a business that is the same.
Simply put, the asset-based value is equal to the book value of the company or the equity that the shareholders hold. The value is determined by subtracting the liabilities from the assets.
Let’s calculate the Net Asset Value for Britannia
It will simply be to add the Share capital + Reserves = 3510+24=3534
This type of valuation can be used by private equity firms and venture capitalists when evaluating companies with asset-heavy business models or during early-stage investments when future earnings potential may be uncertain.
3. Income based approach-DCF
Discounted cash flow (DCF) refers to a valuation method that estimates the value of an investment using its expected future cash flows. DCF analysis attempts to determine the value of an investment today, based on projections of how much money that investment will generate in the future. This method is widely popular but often not taught in stock market courses online free with certificate.
The weighted average cost of capital (WACC) is typically used as a hurdle rate, meaning the investment’s return must outperform the hurdle rate. In other words, for an investment to be considered a good decision, its expected return should be higher than the WACC.
A disadvantage of DCF is its reliance on estimations of future cash flows, which could prove inaccurate. To remove complexities, we can simply use a DCF calculator. This is finology DCF Calculator:
Here we will do the DCF of Britannia
1. For Free cash flow just add this ratio on screener “Free Cash Flow 3Yrs” then divide this by 3.
2. Discount rate is simply the individual investor’s required rate of return. For relatively predictable and reliable companies use less discount rate and vice-versa. It basically means what return are you expecting of this investment. So, as we are investing in equities, we at least expect a return of 15%.
3.Growth Rate(1-5years) -Means it what rate the company will grow in the next 5 years. Looking at past growth rate I am taking 15%.
4. Growth Rate(6-10years)-So for growth rate after 5 years I am taking it to be 10% to be conservative
5. Terminal growth rate is the growth rate after 10 years.
6. Market capitalization, share price and Net debt will just be simply available from screener
7. The margin of safety provides a measure of how much room for error or uncertainty exists in the valuation. Here we are taking it to be 10%.
So according to the DCF model the share price of Britannia after margin of safety is 1336 which is very low than the current share price which is 4904. This shows that the share is overvalued.
Valuation is very subjective, and each one can arrive at different values depending on their inputs which they take. One must choose the right valuation method and correct metrics from best stock market courses in Delhi, while analysing an industry.