Valuation ratios use stock price and the elements of the balance sheet or profit and loss account or cash flows to understand whether a company is valued at a premium or discount i.e. if a company is overvalued or undervalued. It helps in decision making. How will one know if a company is overvalued or undervalued? One has to either compare the ratios with the intrinsic value or the perceived value of the company or its peer company’s valuation. The idea is to find out if the current market price reflects the performance of the company. Let us look at a few of them.
Price to earnings (PE) ratio= current market price/earnings per share (EPS)
Earnings per share of two types:
Both of these are available in the financial statements
Mar-21 | |
Current market price | 40 |
EPS | 1.14 |
PE ratio | 35.09 |
Industry leader | 69.61 |
Interpretation: The PE ratio is quite low compared to the industry leader. However, the industry leader has a better financial position. This company is struggling with its working capital and probably the market is not willing to give it a higher value.
Book value per share = (Equity capital + Reserves)/ equity shares outstanding
Mar-19 | Mar-20 | Mar-21 | |
Equity capital (a) | 22 | 22 | 20 |
Reserves (b) | 67 | 67 | 64 |
Shareholder’s fund (a)+(b) | 89 | 89 | 84 |
No of shares outstanding (c) | 2 | 2 | 2 |
Book value (a + b)/(c) | 44.54 | 44.54 | 41.94 |
Industry leader | 44.33 | 49.56 | 57.60 |
Price to book value (P/BV) ratio= current market price/book value
Mar-21 | |
Current market price | 40 |
Book value | 41.94 |
Price to book value | 0.95 |
Industry leader | 10.42 |
Interpretation: The Price to book ratio indicates whether a company is undervalued or overvalued. The higher the ratio higher is the value that the market is ready to give and vice-versa. A lower than 1 ratio indicates the stock is undervalued. This ratio has a very limited scope in terms of manufacturing companies. Its applicability is more relevant in banking and financing companies.
Price to sales ratio (P/S) = current market price/total sales of the company.
Mar-21 | |
Current market price | 40 |
Sales | 228.00 |
Price to sales | 0.18 |
Industry leader | 10.26 |
Interpretation: In our example, the market is not giving much value for the sales as compared to the industry leader. It is undervalued. However, being undervalued does not mean it’s a good buy. One has to understand the overall financial health to take a call.
Price to cash flow (P/CF) = current market price/ operating cash flow per share.
Mar-21 | |
Current market price (a) | 40 |
Operating cash flow (b) | 25.00 |
No of shares outstanding (c) | 1.99 |
operating cash flow per share | 12.56 |
Price to cash flow | 3.18 |
Industry leader | 35.41 |
Interpretation: In this example, the market is ascribing a very low price to cash flow to the company as compared to the industry leader. It is undervalued but needs further investigations before it can be a potential buy.
Profit & Loss | |||||
Figures in Rs. Crores | |||||
Mar-17 | Mar-18 | Mar-19 | Mar-20 | Mar-21 | |
Net Sales (A) | 265 | 297 | 271 | 264 | 228 |
Sales Growth % | -3.4% | 12.1% | -8.9% | -2.4% | -13.7% |
Total expenses (B) | 244 | 281 | 251 | 247 | 215 |
~~Material Cost (a) | 175 | 197 | 175 | 165 | 153 |
~~Material Cost % | 66% | 66% | 65% | 62% | 67% |
~~Operating cost (b) | 11 | 18 | 18 | 18 | 14 |
~~Manufacturing Cost % | 4% | 6% | 7% | 7% | 6% |
~~Employee Cost (c) | 27 | 30 | 27 | 26 | 23 |
~~Employee Cost % | 10% | 10% | 10% | 10% | 10% |
~~Cost of goods sold (a+b+c) | 212 | 245 | 220 | 210 | 189 |
~~Other Costs | 32 | 36 | 31 | 37 | 25 |
~~Other Cost % | 12% | 12% | 12% | 14% | 11% |
Operating Profit (A)-(B) | 21 | 16 | 20 | 17 | 13 |
OPM % to sales | 8% | 5% | 7% | 6% | 6% |
Other Income | 2 | 3 | 0 | 1 | 1 |
Interest | 10 | 10 | 7 | 7 | 5 |
Depreciation | 5 | 5 | 5 | 5 | 4 |
Profit before tax | 8 | 4 | 8 | 6 | 5 |
Tax | 2 | 1 | 1 | 3 | 3 |
Tax % | 19% | 34% | 8% | 42% | 52% |
Net Profit | 7 | 3 | 8 | 4 | 2 |
EPS in Rs | 3.03 | 1.14 | 3.49 | 1.71 | 1.14 |
Dividend Pay-out | 0 | 0 | 0 | 0 | 0 |
Dividend Pay-out % | 0% | 0% | 0% | 0% | 0% |
Balance Sheet | |||||
Figures in Rs. Crores | |||||
Mar-17 | Mar-18 | Mar-19 | Mar-20 | Mar-21 | |
Liabilities | |||||
Share Capital (A) | 22 | 22 | 22 | 22 | 20 |
~~Equity Capital | 22 | 22 | 22 | 22 | 20 |
~~~Outstanding number of shares | 2 | 2 | 2 | 2 | 2 |
Reserves (B) | 107 | 110 | 67 | 67 | 64 |
Borrowings (C) | 61 | 70 | 62 | 58 | 64 |
Current Liabilities (D) | 66 | 74 | 52 | 46 | 44 |
~~Trade Payables | 48 | 55 | 34 | 31 | 26 |
~~Advance from Customers | 2 | 0 | 0 | 0 | 1 |
~~Other liability items | 16 | 18 | 18 | 16 | 17 |
Total Liabilities (A+B+C+D) | 257 | 275 | 203 | 193 | 192 |
Assets | |||||
Fixed assets | |||||
~~Land | 11 | 11 | 8 | 8 | 16 |
~~Building | 30 | 32 | 20 | 20 | 20 |
~~Plant Machinery | 44 | 55 | 44 | 46 | 47 |
~~ Equipment | 1 | 1 | 1 | 1 | 1 |
~~Computers | 1 | 1 | 1 | 1 | 1 |
~~Furniture n fittings | 3 | 4 | 2 | 2 | 2 |
~~Vehicles | 2 | 2 | 2 | 2 | 2 |
~~Intangible Assets | 6 | 6 | 6 | 6 | 6 |
~~Other fixed assets | 1 | 1 | 2 | 1 | 1 |
Gross Block (A) | 99 | 115 | 85 | 88 | 96 |
Less: Accumulated Depreciation (B) | 44 | 49 | 40 | 45 | 49 |
CWIP © | 1 | 0 | 0 | 0 | 0 |
Net Block (A+B-C) | 56 | 66 | 45 | 43 | 48 |
Investments (D) | 1 | 1 | 0 | 0 | 0 |
Current Assets(E) | 199 | 209 | 158 | 150 | 144 |
Inventories | 75 | 81 | 52 | 50 | 46 |
Trade receivables | 80 | 87 | 80 | 73 | 71 |
Cash Equivalents | 8 | 13 | 7 | 1 | 10 |
Loans n Advances | 16 | 9 | 11 | 13 | 11 |
Other asset items | 21 | 19 | 7 | 13 | 6 |
Total Assets (A+B+C+D+E) | 257 | 275 | 203 | 193 | 192 |
Cash Flows | |||||
Figures in Rs. Crores | |||||
Cash from Operating Activity (A) | 0 | 18 | 4 | 10 | 25 |
Profit from operations | 21.69 | 17.16 | 20.02 | 17.8 | 14.09 |
Receivables | -18.8 | -6.92 | -15.42 | 7.14 | 1.63 |
Inventory | -15.49 | -6.43 | 0.13 | 2.08 | 4.47 |
Payables | 18.86 | 7.09 | 0.54 | -6.3 | -4.88 |
Loans Advances | -0.46 | 0.58 | -3.96 | 0.82 | 7.03 |
Other WC items | -4.29 | 8.85 | 3.55 | -9.99 | 5.56 |
Working capital changes | -20.17 | 3.17 | -15.16 | -6.26 | 13.81 |
Interest paid | 0 | 0 | 0 | 0 | 0 |
Direct taxes | -1.84 | -2.41 | -0.45 | -1.76 | -3.15 |
Advance tax | 0 | 0 | 0 | 0 | 0 |
Other operating items | 0 | 0 | 0 | 0 | 0 |
Cash from Investing Activity (B) | -3 | -14 | -3 | 0 | -9 |
Fixed assets purchased | -4.25 | -15.58 | -3.46 | -3.56 | -8.83 |
Fixed assets sold | 0.06 | 0.94 | 0.04 | 0.15 | 0.08 |
Capital WIP | 0 | 0 | -0.33 | 0.23 | 0.03 |
Investments purchased | -0.25 | 0 | 0 | -0.15 | 0 |
Investments sold | 0 | 0.01 | 0.69 | 0 | 0 |
Interest received | 1.32 | 1.74 | 0.2 | 0.21 | 0.16 |
Other investing items | 0.56 | -0.78 | -0.07 | 3.06 | -0.87 |
Cash from Financing Activity (C) | 10 | -1 | -2 | -14 | -7 |
Proceeds from shares | 0 | 0 | 0 | 0 | 0 |
Proceeds from borrowings | 0 | 8.93 | 7.98 | 0.38 | 25.93 |
Repayment of borrowings | 0 | 0 | -2.99 | -8.17 | -19.97 |
Interest paid fin | -2.3 | -9.99 | -6.93 | -6.69 | -4.78 |
Other financing items | 12.17 | 0 | 0 | 0 | -8.14 |
Net Cash Flow | 7 | 3 | 0 | -5 | 8 |
Limitations of ratio analysis
Ratio analysis is a tool to understand the financial statements to compare its present performance with its past performance and also with peers.
Familiarity with the ratios helps in a quick understanding of the performance of the company. It helps in understanding the performance trends of various aspects of the company. It also helps in identifying areas of weakness. Forecasting is possible with ratio analysis. It also, analysis how efficiently the management is conducting the business.
Following is the broad classification of ratios:
The broad limitations of ratio analysis are as follows
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