What is ‘Valuation’?
The process by which the actual value of company is determined is called Valuation. There are many techniques that can be used to determine the value of a company. A analyst looking to invest in the company looks at the promoters background, company history, sector in which it operates, the composition of its capital structure, the prospect of future earnings.
Why Valuation is important?
Every stock is priced differently. And by simply looking at the price of a particular, it would be hard to understand which one is cheap and which is costly.To find the value of a company many techniques should be implemented because once the valuation is determined it is easier to decide whether to to make an investment of not.
How is valuation measured?
Normally analysts compare the stock’s price with the company’s profits. You first calculate how many profits the company earns on a per-share basis. This is called the Price-to-Earnings or PE ratio. It helps you understand how many rupees you are paying for every rupee of profit earned. The more you have to pay, the costlier is the stock. Other measures are the Price-to-Book Value (PB or PBV), Price-to-Sales and Price-to-Ebitda.
The Earnings Yield valuation:
Those were the common valuation measures. Here’s a relatively unknown thumb rule—the relative valuation of debt and equity. Take the current PE of the Sensex. Now, inverse this amount and multiply by 100. The number you get is the earnings yield of the Sensex. If the earnings yield of the Sensex is higher than the current yield of a 10-year government bond, then you can safely say that markets are relatively undervalued and vice-versa.
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