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Sunday, July 31, 2011

Stock Evaluation


Price to Earnings ratio

The most commonly used ratio, it compares the price of a stock to the company's earning per share (EPS). The EPS can either be for past four quarters or for next four quarters.

HOW IT IS DERIVED
Stock price (Rs 50)
------------------- = PE (20)
EPS (Rs 2.50)

KEEP IN MIND
The PE varies across industries because of the different growth prospects. The average PE of the IT industry is 22.32, compared with 10.26 of the steel industry.

WHAT DOES IT IMPLY?
The PE indicates how much investors are willing to pay per rupee of net profit earned by the company. It helps an investor compare the valuation of a stock to that of its peers in the same industry. A high PE ratio suggests that the stock is overvalued, but this could also be because the market expects a higher earnings growth from the company. On the other hand, a low PE ratio denotes that the stock is undervalued, though this can also be because of its poor prospects.



Price to Book Value ratio

This ratio compares the price of a stock with its book value. The book value is the net value of the company's total assets minus the liabilities. It is what shareholders will be left with if the company goes bankrupt.

HOW IT IS DERIVED
Stock price (Rs 80)
----------------------------- = PBV (1.6)
Book value per share (Rs 48

KEEP IN MIND
A low PBV doesn't always indicate that the stock is attractive. MTNL owns swathes of prime land in Delhi and Mumbai and, hence, has a PBV of 0.45, but the prospects of state-run telecom firm aren't too bright.

WHAT DOES IT IMPLY?
A low ratio indicates that the stock is attractively priced. In some cases, it may also be less than 1, which means the business is going for less than what it is worth. PBV is a good indicator while sizing up banking stocks, but may not be very meaningful for sectors such as pharma and IT because they also have intangible assets like intellectual property, which is not factored into the calculation.


Price to Sales ratio

The ratio compares the price of the stock to the revenue earned per share. The revenue for the past four quarters is used in the calculation.

HOW IT IS DERIVED
Stock price (Rs 20)
------------------------ = PS (0.5)
Revenue per share (Rs 40)

KEEP IN MIND
This ratio is based only on sales and does not reflect profitability. It serves as a good evaluation tool when used in combination with other ratios.

WHAT DOES IT IMPLY?
A low PS ratio usually indicates a value buy because the investor is paying less for each unit of sales. The ratio is more relevant for companies which have long gestation periods (infrastructure firms) or with highly volatile input costs (cement). PS is also useful for evaluating firms whose turnover grows faster than profits (dotcom firms).








Debt to Equity ratio

It measures a company's leverage by comparing its debt with its equity base. The ratio indicates the proportion of the company's assets that are being financed through debt.

HOW IT IS DERIVED
Total long-term debt (Rs 1,500 crore)
-------------------------------------- = Debt-equity ratio (2)
Shareholder equity (Rs 750 crore)

KEEP IN MIND
The debt-equity ratio varies across industries. Capital-intensive sectors, such as real estate and auto, will have a higher ratio compared with an IT services company with no capex.

WHAT DOES IT IMPLY?
A debt-equity ratio of more than one indicates that the company is leveraged. Too high a ratio (above 15-20) reflects risk because it shows that the company does not have a strong asset base. Excessive debt also means a large interest outgo, which could eat into the profits.
 






 

Monday, November 8, 2010

First Post

Decided to start blogging and here I am. Right now am already late for work, need to take a bath & rush to work as I have a client meeting in an hour. Here I am, my first blog and I already have an excuse to postpone it :-).