CENTRE FOR INVESTMENT EDUCATION AND LEARNING Equity Valuation and Analysis Author 1 & Author 2 Location - Date
Basic Approaches to Valuation Price of an equity share in secondary market is dynamic Investors use information on the company to assess how a company will perform Profitability is the key factor used in stock analysis Focus in equity valuation is on the future earnings and the estimates of growth in earnings 2
Basic Approaches to Valuation Fundamental analysis is based on the premise that fair value of an equity share can be estimated from information about the company Technical analysis is about looking for clues in the share price itself, for its future behaviour. 3
Approaches to Fundamental Analysis EIC Framework Understanding fundamental factors impacting the earnings of a company Micro and macro data and information Economic(E), Industry (I) and Company (C) analyses Top-Down Approach Scanning the macro economic scenario and then identifying industries to choose from and zeroing in on companies Bottom-Up Approach Beginning at company-specific factors and moving up to the macro factors Quantitative tables Financial ratios 4
Price Earning Multiple Indicates how much the market values per rupee of earning of a company Presented as a multiple of a company s earnings Formula: Example: Company with PE ratio of 12x means stock is trading at twelve times its earnings Market Price per share / Earning per share Historical PE is based on past earnings Little value Forward PE is based on expected future earnings Helps to assess to what extent is current price discounting the future earnings 5
Interpretation of PE Ratio Gauge if the market is undervalued or overvalued PE multiple of the index is high market is overvalued PE multiple of the index is low market is undervalued PE multiple moves high when prices run ahead of the earnings numbers PE multiple drops when markets correct and uncertainty about future earnings increases Value investors buy when the stocks are trading at a low PE Analysts compare the PE of one company with another, to check relative value PE of a large stable company will be higher than its smaller riskier peer 6
PEG Ratio PE multiple and the earnings growth rates are linked Earnings growth rate of a stock should be approximately equal the PE ratio To be fairly valued, PEG Ratio should be 1 Formula for PEG Ratio: PE Ratio / Earnings Growth Rate Useful in identifying value stocks Have growth potential but are trading at a low PE 7
Price to Book Value (PBV) Ratio Compares market price of the stock to its book value Formula: Current Market Price / Book Value per share Book Value per share = Net worth (capital + reserves) per share Realizable value of the assets is not reflected in the book value is a key limitation If PBV Ratio is less than 1, stock is deemed to be undervalued PBV Ratio would be high in a bullish market 8
Dividend Yield Compares the dividend per share to market price per share Formula: Dividend per share / Market Price per share A higher dividend yield would mean that the income potential of the share is not yet reflected in market prices. Preferred by value investors A lower dividend yield is associated with a higher valuation for a share Used to assess market cycles A bull market will be marked by falling dividend yields, as prices move up. A bear market will have a relatively higher and increasing dividend yields as prices tend to fall. 9
Technical Analysis involves studying the price and volume patterns to understand how buyers and sellers are valuing a stock and acting on such valuation Three essential elements are studied History of past prices Volume of trading Time span Uses price charts, points of support and resistance levels in charts and price trends to assess buying interest in a particular stock 10
Technical Indicators Tools used to understand underlying patterns in prices in terms of strength, persistence and reversal Moving average Rate of change in price Relative strength indicators Moving-average convergence-divergence indicators 11