Stock market investors do a whole lot of exercise and mostly their experience over the years into stock markets pays to make a good deal i.e. purchase a stock at an attractive valuation. By attractive valuation herein we mean, reasonable for an investor which though is the case considering the worth of the company, such that an investor is able to make handful gains.
For the determination of the pricing are available some valuation concepts or ratios that need to be kept in mind to know:
P/E or price to earnings multiple: The price to earnings ratio is the market price of a stock divided by the earnings per share or EPS. To determine the price to earnings ratio or P/E, one has to first arrive at the EPS. EPS is nothing but the net profit of a company divided by the outstanding shares.
The price to earnings ratio is an extremely significant ratio and tells you whether a stock is overvalued or undervalued.
For example, if company A has a price to earnings ratio of 15 and company B has a price to earnings ratio of 7 then we could argue that company B is more attractively valued than company A. However, the price to earnings ratio should be considered along with other parameters. Say for example company A and B are from different industries, then it would not be fair to compare the price to earnings ratio. For example in India, FMCG companies are always accorded a higher price to earnings ratio, as compared to the metal companies. Even if there are two companies from the same industry, there would be other parameters also to look at along with the price to earnings ratio.
Price-to-book (P/B) ratio: This ratio reflects the stock's valuation i.e is it cheap or expensive in comparison to the company's worth. In a case if you happen to come across a stock that is trading below its book, do not get trapped as it may be a value trap with poor fundamentals.
A price to book ratio of over 1 for the stock means that the stock is priced at a premium in comparison to its actual worth.
The performance gauge comes in more handy in case of financial companies and banks.
Price-to-earnings growth (PEG): The PEG ratio is an advanced version of the PE measure that factors in the earnings growth rate. The metric is obtained b dividing P/E ratio with the earnings growth rate. For investors if the PEG for a stock is less than 1 that makes it reasonable.