Understanding various valuation metrics

Hello, I am Umesh Tripathi, and we are learning the concepts of Fundamental Analysis. 
In this video, we are going to learn about the different aspects of Stock Valuation Metrics what stock valuation is, the difference between absolute and relative valuation, and what valuation ratios are, along with certain examples. 

So, whenever we talk about valuation, right? While judging the fundamentals of a company, we try to figure out its overall intrinsic value. 
You must have heard the saying “Price is what you pay, value is what you get.” 

Let’s assume there is a company called XYZ. I want to buy the stock of XYZ. The current price of XYZ stock is ₹100. 
Now, this ₹100 is the price I have to pay to buy this particular stock. Behind this price, we analyze the fundamentals, assess financial ratios, and arrive at an intrinsic value, through which we can determine the valuation. 

At any given point of time, I have three options to figure out whether the company XYZ is undervalued, overvalued, or fairly valued. 
How do I find this out? By comparing its current price with its intrinsic value. 

Basically, the valuation ratios help us determine whether the stock is overvalued or undervalued. 

Now, if we talk about absolute valuation, under absolute valuation we try to figure out the intrinsic value of the stock. 
As we discussed in the case of XYZ, we are figuring out its intrinsic value. 
We have some common methods for absolute valuations to figure out the intrinsic value — such as Discounted Cash Flow (DCF) or the Dividend Discount Model (DDM), which is generally used for dividend-paying companies. 

The plus point of absolute valuation is that it helps us in long-term investing decision-making. 
However, the downside is that it is heavily based on assumptions. 
When we talk about discounted cash flow, we estimate what the future cash flows could be, and based on those assumptions we calculate the intrinsic value. 
So, since this is assumption-based, it’s usually not used for companies with unpredictable cash flows. 

Now, coming to relative valuation — in relative valuation, we compare two or more companies from the same industry using certain ratios such as Price-to-Earnings (P/E) ratio, Price-to-Book (P/B) ratio, or EV/EBITDA ratio. 
Using these ratios, we compare companies to see whether a certain company, say XYZ, is undervalued or overvalued compared to another company ABC. 

For example, let’s say we have two companies. 
One has a P/E ratio of 20, and the other has a P/E ratio of 15. 
In this case, the company with a P/E ratio of 15 looks more promising for its earnings compared to its price. 

Some common ratios used are: 
Price-to-Earnings (P/E) ratio, Price-to-Book (P/B) ratio, EV/EBITDA ratio, and PEG (Price-to-Earnings Growth) ratio. 
We use these for relative valuation. 

So, to sum up: 

• Absolute valuation determines the intrinsic value of a certain stock using its fundamentals. 

• Relative valuation compares similar companies within the same industry or sector. 

As for methodology, Discounted Cash Flow and Dividend Discount Models are used under absolute valuation, while ratios like P/E, P/B, EV/EBITDA, and PEG are used under relative valuation. 

Let’s take some examples. 
Under absolute valuation, as we discussed earlier, it helps us figure out whether the current price we are paying is actually worth it compared to its intrinsic value. 
In relative valuation, we compare it with its peers to check whether a particular stock is overpriced, fairly priced, or not. 

Basically, valuation ratios help us analyze companies against their peers and figure out whether a company is underpriced or overpriced compared to similar firms. 

Now let’s look at some examples of valuation ratios: 

As discussed, P/E ratio is one of the most important valuation ratios, followed by P/B ratio, EV/EBITDA ratio, and PEG ratio. 

The Price-to-Earnings ratio is calculated by dividing the current market price per share by the Earnings Per Share (EPS). 
This tells us how much investors are willing to pay for ₹1 of the company’s earnings. 

If the P/E ratio is high, it could mean that growth expectations are high — or that the stock is moving towards being overvalued. 

For example, we discussed two companies earlier — one with a P/E of 20 and another with a P/E of 15. 
The company with a P/E of 20 may appear overvalued compared to the one with a P/E of 15. 

Now, let’s take an example. 
If the stock price is ₹500 and the Earnings Per Share (EPS) is ₹25, dividing 500 by 25 gives a P/E ratio of 20, meaning investors are paying ₹20 for every ₹1 of the company’s earnings. 

Next, the Price-to-Book ratio (P/B) is another valuation metric used to figure out or compare stock valuations. 
It is calculated by dividing the current market price by the book value of the company. 
Book value basically means the net asset value recorded in the company’s books. 

For example, if a company’s stock price is ₹200 and its book value is ₹100, the P/B ratio is 2x, meaning the stock is trading at two times its net asset value. 

Now, let’s discuss the EV/EBITDA ratio — Enterprise Value divided by Earnings Before Interest, Taxes, Depreciation, and Amortization. 
The formula is simple: EV/EBITDA = Enterprise Value ÷ EBITDA. 

Enterprise Value (EV) is calculated as Market Capitalization + Debt - Cash. 
This ratio measures the value of the company relative to its operating earnings. 

For example, if a company’s Enterprise Value is ₹10,000 crore and its EBITDA is ₹1,000 crore, the EV/EBITDA ratio is 10x. 
This helps compare operational value across different capital structures. 

Next is the PEG ratio (Price-to-Earnings Growth ratio) — a valuation metric that considers the EPS growth rate. 
It is calculated as the P/E ratio divided by the annual EPS growth rate. 

For example, if a company’s P/E ratio is 20 and its annual EPS growth is 10%, then the PEG ratio is 2. 
If the PEG ratio is less than 1, the stock is considered undervalued. 

So, to sum up valuation metrics help us understand the company’s financial strength and assist in comparing it against peers to determine whether it is undervalued or overvalued. 

As we discussed, these tools help in making smart investing decisions, helping us understand what you pay versus what you get. 

That’s all for this video. 
See you in the next one. 
Subject to market risks. Please read all related documents carefully before investing.