In this post, we would discuss the first group of ratios, which covers Price Ratios. The most common price ratios in this category that you would come across are P/E, PEG and P/BV. Lets quickly discern them bare thread, one by one, along with how to use them practically.
Pro Tip:- Many websites such as Money Control, Smart Investing, Trendlyne and Value Research etc provide most of the ratios, but would recommend screener.in for easy access to almost all the ratios.
Price – Earnings (P/E) Ratio
It is simply the ratio of current stock price divided by the average EPS. Generally it is represented as PE TTM, where TTM means Trailing Twelve Months or twelve months average. It signifies that for every one rupee generated as profit, how much investment is needed and whether market is overvaluing or undervaluing a particular stock.
Ideally lower PE would be preferred signifying greater profits per Rs invested and for that it needs to be compared with sector and market PE along with the historical values of the same company. For example if we compare ITC or HUL PE with its historical values, these may seem very high but when these are compared with sector PE , suddenly the valuation appears reasonable.
Pro Tip:- Always compare PE of any company first with its peers then market and lastly with historical values to see if the current price of shares are reasonable.
Price – Earnings Growth (PEG) Ratio
In the first segment, this is my favourite ratio as this establishes relation between present share price, EPS and the projected growth rate of any company. PEG is derived by dividing PE by the projected growth rate of the company. The beauty of this ratio is that, it eliminates subjectivity from the equation. For example; generally a company which is growing fast would have a higher PE and that may dissuade many novices like me from investing in it.
To remove subjectivity, simply divide PE value by projected growth rate and you would find that the higher PE may be justified because of higher growth rate in many companies. For example; if we compare HUL with PE of 68.3 and Dixon Technologies with PE of 162, Dixon appears way to expensive but bring in PEG, which is 4.75 for HUL and a meagre 2.72 for Dixon, suddenly Dixon emerges as potential winner even when it is trading at all time high.
Pro Tip:- Generally a PEG figure of one may be taken as a benchmark, if less than one — the share is under valued. Greater the PEG — greater the over valuation.
The Price – to – Book Value (P/BV) Ratio
Though it doesn’t classically fit in the league of price to profit ratios, but certainly it deserves a place here as this reflects true valuation of a financial sector stock such as banks, insurance and micro finance companies for whom, the profits may tell a misleading story because of NPAs (Non Performing Assets) and Provisioning. It is a ratio of share price to book value per share or it can also be calculated by dividing market capitalisation (total number of shares X current share price) by total book value of the company (total assets — total liabilities). In short, it represents market sentiments that for every one Rs of book value, how much money investors are willing to pledge in this company.
Pro Tip:- P/BV is always preferred for calculating valuation of finance sector companies. Any value lesser than one indicates that the share is under priced and may be a gold mine for value investing.
Guys, if we dig past the big sounding names, these are nothing but common sense and in a way save us from a lot of hard work, don’t you think so?
But please be cautious as not to get lured by just one figure. These numbers are to be analysed holistically, as a doctor sees a blood report.
This is a guest post by Dhruv Srivastava