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Valuation Metrics

4 Most Popular Valuation Metrics That Every Investor Must Know | ET Money

  • Price to Book Ratio
  • Price to Earnings Ratio
  • Price to Sales Ratio
  • EV to EBITDA

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Multiple ratios can be combined to choose companies​

  • PB Ratio < 2, and PE Ratio < 15
  • EV-to-EBITDA Ratio < 10 and PS Ratio < 5

EBITDA​

Earnings before interest, tax, depreciation and amortization (EBITDA) is a measure of a company's operating performance/profitability (i.e., how much profit it makes with its present assets and its operations on the products it produces and sells, as well as providing a proxy for cash flow). Essentially, it's a way to evaluate a company's performance without having to factor in financing decisions, accounting decisions or tax environments.

https://en.wikipedia.org/wiki/Earnings_before_interest,_taxes,_depreciation,_and_amortization

Price to Book Ratio (P/B Ratio)​

Total amount of money a company can generate if it were to be liquidated

Book Value = Total Assets - Intangible Assets - Liabilities

Book Value = Shareholder's common equity - Preferred stock

P/B Ratio = Current price per share / Book value per share

Good for low turnover portfolio

Cons

  • Doesn't take intangible assets into account
  • Keeps assets at acquisition value & not at market value
  • Doesn't factor in profits, sales & growth
  • Penalizes good capital allocation decision at times

Price to Earnings Ratio (P/E Ratio / PE Ratio)​

The price-to-earnings ratio (P/E ratio) is the ratio for valuing a company that measures its current share price relative to its per-share earnings (EPS). The price-to-earnings ratio is also sometimes known as the price multiple or the earnings multiple.

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 or to compare aggregate markets against one another or over time.

PE Ratio = Current Price Per Share / Earnings Per Share = 200/8 = 25

Earnings per share

  1. Last completed FY earnings (annual report)
  2. 12 months training basis (net profit earned last 4 quarters)
  3. Equity analysts (forward pe ratio)
  4. Averaging (last 5-6 years of earnings)

Pros

  1. Simple to understand
  2. Factors in profitability
  3. Excellent relative comparison measure

Cons

  1. Potential manipulation of earnings
  2. Can hide company's true worth
  3. Misleading impression regarding cyclical stocks

KEY TAKEAWAYS

  • The price-earnings ratio (P/E ratio) relates a company's share price to its earnings per share.
  • A high P/E ratio could mean that a company's stock is over-valued, or else that investors are expecting high growth rates in the future.
  • Companies that have no earnings or that are losing money do not have a P/E ratio since there is nothing to put in the denominator.
  • Two kinds of P/E ratios, forward and trailing P/E, are used in practice

https://www.investopedia.com/terms/p/price-earningsratio.asp

Why the PE of One is Mohnish Pabrai’s Best Investing Strategy? PE Ratio Valuation with Example

PEG Ratio​

The price/earnings to growth ratio (PEG ratio) isa stock's price-to-earnings (P/E) ratio divided by the growth rate of its earnings for a specified time period.

  • The PEG ratio enhances the P/E ratio by adding in expected earnings growth into the calculation.
  • The PEG ratio is considered to be an indicator of a stock's true value, and similar to the P/E ratio, a lower PEG may indicate that a stock is undervalued.
  • The PEG for a given company may differ significantly from one reported source to another, depending on which growth estimate is used in the calculation, such as one-year or three-year projected growth.

https://www.investopedia.com/terms/p/pegratio.asp

https://www.investopedia.com/investing/use-pe-ratio-and-peg-to-tell-stocks-future

Price to Sales Ratio (PS Ratio)​

PS Ratio = Current Market Capitalization / Total Revenue (Sales)

Total Revenue (Sales)

  1. Last financial year sales
  2. Trailing 12 months sales
  3. Forward 12 months (projected sales)
  4. Average sales (last 5 years)
  • Comes in handy when examining companies in cyclical industries
  • PS Ratio is not as subjective to manipulation as PE ratio

Cons

  • Does not consider debt

EV to EBITDA Ratio​

EV - Enterprise Value

EV = Market Capitalization + Debt - Cash

Pros

  • Incorporates company's capital structure in its entirely
  • Uses the operating profits
  • Best long-term performing metric

Cons

  • Ignores depreciation

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Graham Number​

The Graham number or Benjamin Graham number is a figure used in securities investing that measures a stock's so-called fair value. Named after Benjamin Graham, the founder of value investing, the Graham number can be calculated as follows:

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The final number is, theoretically, the maximum price that a defensive investor should pay for the given stock. Put another way, a stock priced below the Graham Number would be considered a good value, if it also meets a number of other criteria.

https://en.wikipedia.org/wiki/Graham_number

8 Valuation Techniques for Beginners incl. Discounted Cash Flow | How to Value a Business?​

  • Cost Based Valuation
  • Comparable Company Valuation
  • Book Value
  • Revenue Multiplier
  • Earnings Multiplier
  • Discounted Cash Flow Model
  • Intangible Assets
  • Liquidation Value

Valuation

Value Driver

  1. Revenue Growth
  2. Operating Margin
  3. Capital Ratio
  4. Cost of Capital