The Most Important Metrics For Value Investors…!!
Value investing is getting popular day by day, especially among new investors. An investor like Warren Buffet is the best example of the importance of value investing in life. It not only excites curiosity in the market, but also proves to be quite beneficial in the long term. For those, who are still new to the concept, value investing is a long-term strategy that focuses upon a thorough analysis to identify and purchase those stocks, in which market price is lower than intrinsic value. The reason for this could be various factors, but most important of them will be human behavior. Generally, most of the occasions, common stocks are subject to irrational pricing in both directions i.e. Upside or downside due to excessive volatility. This allows the investor to speculate the price of the share. It’s also called a flaw of the market, where the price of a financial product is either quite higher or lower than it’s fundamental or true intrinsic value. That’s the reason value-based investing is based upon the long term, as prices of security naturally tend to come at a price of their intrinsic value over some time. The basic idea behind this is to identify those stocks which are undervalued and wait until its true intrinsic value is not achieved. Let’s look at the important metric, which helps us in determining a value stock:
- P/E Ratio: It is one of the most important metrics to determine a value stock. It is called Price to earnings ratio, which measures the ratio of the market value of a company to its earnings. If the P/E ratio is more than 1 then the company is said to be overvalued and in case if the P/E ratio is less than 1 then it is considered to be undervalued.
- PEG Ratio: It exhibits past growth rate of a company’s earnings, which in turn beneficial to whether to buy or sell a stock. It is basically price to earnings ratio divided by its expected earnings growth rate. Let’s try to understand with an example. Suppose a company with a P/E ratio of 20 is expected to grow at 10%. Then the PEG ratio is 2. The lower the value of the PEG ratio, it means more than the company is undervalued compared to its earnings projection. Higher the value, the more likely it is overvalued. It is quite useful in comparing companies in the same industry but different stages of life cycle.
- Debt to equity ratio: It is mainly considered as a leverage ratio that calculates the weight of total debt and financial liabilities against total shareholder’s equity. It provides a glimpse of how much debt a company is carrying in proportion to its equity. Too much debt will be disastrous for a company as well as for investors in tough times. Debt to equity ratio less than one means that the company has borrowed more money than its shareholders have invested in it. In case, if the company generates higher than the rate at which it borrows money, then there is not an issue. Otherwise, risk will be quite higher for an investor.
- Return on Equity (ROE): It gives you an indication of the performance of the company and how efficiently it is using shareholders’ equity to generate a profit. In simple words, it shows how much profit each rupee of common stockholder is generated over a period. It is calculated by dividing a company’s Net Income or total earning by the total number of shareholder equity, which can be easily found in its balance sheet.
- Price to Book value (P/BV): It is one of the most popular metrics to select the value stock among investors. It is calculated as the company’s stock price divided by the net asset of the company. It gives us an idea of how much investors are willing to pay for the company’s asset. For example, a stock with a PBV ratio of 3 means that for every Rs 1 of book value, they are paying Rs1. Higher the PBV, the more expensive the stock will be.
Rather than looking for a single metric to invest in the stock market, an investor should look for multiple metrics, depending upon the data available when one would access the potential investment is right for them as a value investor.
*Disclaimer: investment in securities market are subject to market risks, read all the related documents carefully before investing