How to check if a stock is overvalued or undervalued? | What is PE Ratio? What is PEG Ratio?

while investing in the stock market two things are most important fundamentals of the company and valuations of the company ideally you would want to invest in companies that are fundamentally strong and available at attractive valuation in fact there is a famous quote from warren buffett he says whether we are talking about stocks or socks i like buying quality merchandise when it is marked down but the biggest question is how to identify if the company is overvalued undervalued or fairly valued hello everyone my name is sahil and this is my personal finance academy where i explain everything about money management in layman's language in this video i will teach you how you can identify the valuation of the company within a few minutes so let's get started today mrf share is available at rupees 82000 whereas apollo tire is available for rupees 225. now if i ask you which share is costly some of you might answer that mrf is very costly as compared to apollo tire right that's wrong many investors new to the world of stock market end up deciding the valuation of the company based on the stock price which is wrong so what is the right way to check the valuation of a company the most popular formula to understand the valuation of the company is p e ratio it is also known as price to earning ratio now let's try to understand what exactly is p ratio and why is so important if i ask you as an investor what is the most important criteria to gauge the performance of the company the answer is earning at the end of the day you are interested to know how much profit company has generated isn't it so profits of the company should ideally decide whether you should invest in the company or not if the profits are increasing more people would be interested in investing in the company so this would increase the demand for the company and eventually the share price if the profits are falling then people would like to sell their share which would eventually increase the supply and lower the demand and result in fall in the share price in short the share price should ideally move in relation with the earning hence you have a p ratio which is calculated as price per share divided by earnings per share now in an ideal world the share price should move with the earnings but that doesn't happen in the real world sometimes the price go up much above the earnings this could be due to multiple reason like macro environment including government policy lot of inflow of money or micro factors like expectation of better earning in the future or sometimes just without any reason and sometimes the price fall even though the earnings are good for example due to covet the market crashed and the share price of every company fell down irrespective of their earnings so let's say if the price per share or share price of the company is rupees 150 and its earning per share is rupees 5 then you can say that the p ratio of the company is 30 in other words you can also say that investors are willing to pay rupees 30 per share for earnings of one rupee per share tomorrow if the share price of the company becomes 180 and earnings remain the same that is rupees 5 per share then the p ratio would become 36 and if the share price fall to rupees 125 and earnings remains the same then p ratio would become 25 please note that the share price of a company changes every single day hence pe will change accordingly but the earning changes quarterly based on the quarterly result normally the earnings are considered for the last four quarter many people get confused and consider the p e ratio based on the last financial year for example currently we are in march 2021. now we don't have complete earning for fr21 it doesn't mean we need to take fy 20 earnings we need to take the last four quarter of data as of today we have earnings till december 20. so we need to take last four quarters that is march 20 july 20 september 20 and december 20. this would give the latest pe ratio now next question is how to know if a pe of 25 30 or 35 is overvalued or undervalued to get the answer for this question you need to do two things now this is very important first check the p ratio of the company in the last three to five years and identify the median p then compare the current p with the median p if the current p is more than the median p then you can say that company is overvalued and if the current pe is less than the median pe then you can say that the company is undervalued let's take three real world example if you look at the itc pe ratio movement its median p in last five year is 30.7 currently it is trading at a p ratio of 19.6 so itc is trading at much lower level as compared to its fire median pe in july 17 it was at the pe of 41 but since then the pe has fallen so itc is looking undervalued at current levels if you look at the hdfc bank pe ratio movement its median p in last five year is 27.9 currently it is trading at a p ratio of 26.7 so sdfc bank is trading at similar levels as compared to its 5-year median pe that makes sdfc bank a fairly valued stock during code sdfc bank share price tank and p touched a level of 16.9 making it highly undervalued that was a golden opportunity to invest although sdfc bank is still a good buy at current valuation if you look at the jubilant footwork pe ratio movement its median p e in last five year is 77 currently it is trading at a p e ratio of 227 so jubilant food work is trading at much higher level as compared to its 5 year median pe that makes it a highly overvalued stock now secondly you need to look at the p ratio of the industry for example if infosys is trading at a p of 25 then what is the p e ratio of entire iit industry ideally there should not be too much of a difference if the companies are at par for example if you want to compare infosys pe with industry then you can look at the pe ratio of tcs wipro and hcl that are at par with infosys this would give you an idea of the p moment of the stock as compared to other companies in the same sector now there could be a case where p ratio of some companies are on higher side as compared to other companies it is mainly because of their high earning potential in the future for example let's say there is a company which is currently trading at a pa of 15 but the future of the company is not too bright on the other side this company which is currently trading at a pe of 50 but it is relatively small company with amazing growth respect now which one would you choose in that case you should know the pe g ratio what is pg ratio it is calculated as p e divided by its future earning growth if a company a has a p e of 15 but the future growth potential in earning is 5 then pg ratio is three whereas if a company b has a pe ratio of 40 but the future growth potential on earning is 20 percent then pg ratios two in this case company b is undervalued as compared to company a even though pe of company b is on higher side as compared to company a normally a pg ratio of less than 1 is ideal but it is extremely difficult to find great company with pg ratio of less than 1 so you can consider pg ratio of less than 2 as undervalued or fairly valued for example itc has a pg ratio of 1.9 sdfc bank has a pg ratio of 1.3 and jubilant food work has a pg ratio of 10.3 so itc and sdfc bank are looking fairly valued and jubilant food work is looking overvalued with pg ratio as well friends please note if the earning of the company are negative then you can't use p e ratio it means that if there is company which isn't loss then you can't calculate its p ratio you can visit websites like screener dot in where you can get the details like p ratio p g ratio etc now question is when p e ratio doesn't work although p ratio is the most popular and widely used ratio to gauge the valuation of the company there can be instance where p ratio doesn't work or rather doesn't show the clear picture of valuation for example due to covet the earnings of the company tanked but the prices increased in the last one year in that case the p became very high now in this situation it is difficult to say that the company is overvalued or undervalued it is because covert was an exceptional situation and it has nothing to do with companies performance if the earnings fall due to companies performance then certainly there is a problem but code was external situation for example irctc is currently trading at a p ratio of 130 but its median p of last one year is 68 but this high p e is mainly due to covet where earnings of irctc fell down drastically and hence the p went up so in that case you need to look at future earnings you need to think what is the earning company will generate in the future to do that you can also take an average of historical earning growth so if the annual learning of the company is 50 then 55 then 60 so you can say that companies earning are growing at 10 percent and you can assume that the next earning should be 66 but this is only applicable for companies whose performance gets impacted due to external reason like covet please note that a p of less than its median doesn't always mean that the company is undervalued there could be some problem within the company and hence investors are selling the share with the expectation that the future earning will fall likewise a company can have high pe than its median pe where investors are buying the share with the expectation that the earnings will increase in the future so you need to make sure that you do an in-depth research and not just invest or exit simply based on p e ratio so in this video we discussed about how to check the valuation of the company i hope this would help you identify good companies at attractive valuation and avoid companies trading at higher valuation if you think that this video is really helpful do share it with your friends i will see you with another video till then take care

Channel: Sahil Bhadviya

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Keywords: sahil bhadviya, How to check if the company is overvalued or undervalued?, What is PE Ratio?, What is PEG Ratio?, PE ratio, PEG ratio, valuation of company, how to know valuation of stock, overvalued, overvalued and undervalued stocks, undervalued stocks, how to calculate valuation of stock, valuation analysis, pe vs peg ratio, undervalued companies 2021

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Length: 12min 0sec (720 seconds)

Published: Mon Mar 29 2021