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Important financial parameters you should know before investing

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Investing is an art which does require skill and understanding of many financial variables to make an informed decision. Here are few of such variables narrated as under-

Market Capitalization

What is Market Capitalization?

Market capitalization refers to the total currency (INR,USD, etc.) market value of a company's outstanding shares of stock. Commonly referred to as "market cap," it is calculated by multiplying the total number of a company's outstanding shares by the current market price of one share. This calculation doesn't include cash or debt.

Market capitalization refers to how much a company is worth as determined by the stock market. Market capitalization does help to determine size of a company because company size is a basic determinant of various characteristics in which investors are interested, including risk. It is also incorrectly known to some as what the company is really worth or in other words the value of the business. But the same is not correct.

In an acquisition, the market cap is used to determine whether a takeover candidate represents a value buy or not to the acquirer and decisions are taken accordingly.

Is market capitalization the same as market value?

Market capitalization is basically the number of a company's shares outstanding multiplied by the current price of a single share. Market value is more amorphous and more complicated, assessed using numerous metrics and multiples, such as price-to-earnings, price-to-sales, and return-on-equity.

Why is market cap higher than book value?

The market may assign a higher value to the company due to the earnings power of the company's assets. It is seen that mostly all consistently profitable companies does have market values greater than their book values.

One of the highest-valued firms in terms of market cap is oil behemoth Saudi Aramco.

P/ E Ratio

What Is Price-to-Earnings Ratio - P/E Ratio?

The price-to-earnings ratio (P/E ratio) is the ratio for valuing a company that measures its current share price relative to its per-share earnings (EPS). The price-to-earnings ratio is also sometimes known as the price multiple or the earnings multiple. It is calculated by dividing the current market price of the stock by its earning per share (EPS). It shows the sum of money you are ready to pay for each rupee worth of the earnings of the company. PE = Market price / EPS.

P/E ratios are used by investors and analysts to determine the relative value of a company's shares in an apples-to-apples comparison.

A high P/E ratio could mean that a company's stock is over-valued, or else that investors are expecting high growth rates in the future. Conversely, a low P/E might indicate that the current stock price is low relative to earnings.

Companies that have no earnings or that are losing money do not have a P/E ratio since there is nothing to put in the denominator.

What is a good PE ratio?

A higher P/E ratio shows that investors are willing to pay a higher share price today because of growth expectations in the future.

Book Value

What is Book Value?

Book value can be understood as the net asset value of a company calculated as total assets minus intangible assets (patents, goodwill) and liabilities meaning it is the difference between that company's total assets and total liabilities. The formula for calculating book value per share is the total common stockholders' equity less the preferred stock, divided by the number of common shares of the company. Book value reflects the total value of a company's assets that shareholders of that company would receive if the company were to be liquidated. Book value can be positive, negative, or zero. If the price-to book value per share is less than one, it means the stock is trading below its book value.

Why is book value different from market value?

The difference between book value and market value. The book value of an asset is its original purchase cost, adjusted for any subsequent changes, such as for impairment or depreciation. Market value is the price that could be obtained by selling an asset on a competitive, open market.

Is Book value the same as equity?

The equity value of a company is not the same as its book value. It is calculated by multiplying a company's share price by its number of shares outstanding, whereas book value or shareholders' equity is simply the difference between a company's assets and liabilities.

Why is book value important?

Book value is considered important in terms of valuation because it represents a fair and accurate picture of a company's worth. This means that investors and market analysts do get a reasonable idea of the company's actual worth. Book value is primarily important for investors using a value investing strategy.

What if book value is negative?

If a company's book value per share is higher than its market value per share i.e., its current stock price, it means that the stock is considered undervalued and vice versa. If book value is negative, where a company's liabilities exceed its assets, that means that the entity is heading towards insolvency.

Is a high book value per share good or bad?

The book value per share is the amount of the assets that will go to common equity in the event of liquidation. So higher book value means the shares have more liquidation value. On a rational basis, the higher the book value, the more the share is worth and is considered safe from investment point of view.

 

Earnings Per Share

What Is Earnings Per Share - EPS?

Earnings per share (EPS) is calculated as a company's profit divided by the outstanding shares of its common stock. The result is an indicator of a company's profitability. It is common for a company to report EPS that is adjusted for extraordinary items and potential share dilution. The higher a company's EPS, the more profitable it is considered. Basic and Diluted EPS is shown in the Financial statements. While calculating the EPS, it is advisable to use the weighted ratio, as the number of shares outstanding can change over time.

EPS indicates how much money a company makes for each share of its stock.A higher EPS indicates more value because investors does prefer companies whose profits are on a high.

EPS (earnings per share) increases when earnings (net profit) increases, or when the quantity of shares is reduced. So, a company can increase its EPS by increasing its net profit. It can also increase its EPS by repurchasing its own stock. In both case, the EPS ratio will be increased.

A negative P/E may not be reported. Instead, the EPS might be reported as “not applicable' for quarters in which a company reported a loss. Investors buying stock in a company with a negative P/E should be aware that they are buying shares of an unprofitable company and be mindful of the associated risks.

Important financial parameters you should know before investing

What is a good earnings per share?

EPS is typically considered good when a company' s profits exceeds those of peer companies in the same sector.

What's more important EPS or revenue?

Company's gross revenue may be one of the parameter for success, but for an ideal investor, the most important metric of all the metrics is earnings per share (EPS).

 

Price-To-Book (P/B Ratio)

What Is the Price-To-Book (P/B Ratio)?

It is calculated by dividing the company's stock price per share by its book value per share (BVPS). Book value is the net asset value of a company calculated as total assets minus intangible assets (patents, goodwill) and liabilities. It is also known as price-equity ratio.

The P/B ratio measures the market's valuation of a company relative to its book value. The market value of equity is typically higher than the book value of a company. P/B ratios under 1 are typically considered solid investments, meaning the market value is lower than the book value and hence a potential candidate for value buying.

Limitations of using P/B Ratio

Investors find the P/B ratio useful because the book value of equity provides a relatively stable and intuitive metric they can easily compare to the market price. The P/B ratio can also be used for firms with positive book values and negative earnings since negative earnings render price-to-earnings ratios useless, and there are fewer companies with negative book values than companies with negative earnings.

P/B ratios can be less useful for service and information technology companies with little tangible assets on their balance sheets. The book value can become negative because of a long series of negative earnings, making the P/B ratio useless for relative valuation.

Other potential problems in using the P/B ratio stem from the fact that any number of scenarios, such as recent acquisitions, recent write-offs, or share buybacks , can distort the book value figure in the equation. In searching for undervalued stocks, investors should consider multiple valuation measures to complement the P/B ratio.

The price-to-book ratio compares a company's market value to its book value. The market value of a company is its share price multiplied by the number of outstanding shares. The book value is the net assets of a company.

Is a high book value per share good or bad?

The book value per share is the amount of the assets that will go to common equity in the event of liquidation. So higher book value means the shares have more liquidation value. Strictly speaking, the higher the book value, the more the share is worth.

What is the difference between book value and fair value?

Fair Value Vs. Book Value. Typically, fair value is the current price for which an asset could be sold on the open market. Book value usually represents the actual price that the owner paid for the asset.

Intrinsic Value

What Is Intrinsic Value?

Intrinsic value is a measure of what an asset is worth. This measure is generally arrived at by means of various financial models rather than using the currently trading market price of that asset.

How do you tell if a company is overvalued or undervalued?

If the “market price of stock is greater then the intrinsic value' of the stock then it is overvalued while if the “market price of the stock is less then the intrinsic value' of the stock the then it is undervalued.

Intrinsic Value Calculation

There is no universal standard for calculating the intrinsic value of a company, but financial analysts build valuation models based on aspects of a business that include qualitative, quantitative and perceptual factors.

Qualitative factors- such as business model, governance, and target markets- are those items specific to the what the business does. Quantitative factors found in fundamental analysis include financial ratios and financial statement analysis. These factors refer to the measures of how well the business performs. Perceptual factors seek to capture investors perceptions of the relative worth of an asset. These factors are largely accounted for by means of technical analysis.

Creating an effective mathematical model for weighing these factors is the bread and butter work of a financial analyst. The analyst must use a variety of assumptions and attempt to reduce subjective measures as much as possible. In the end, however, any such estimation is to a certain extent subjective. The analyst compares the value derived by this model to the asset's current market price to determine whether the asset is overvalued or undervalued.

Some analysts and investors might place a higher weighting on a corporation's management team while others might view earnings and revenue as the gold standard. For example, a company might have steady profits, but the management has violated the law or government regulations, the stock price would likely decline. By performing an analysis of the company's financials, however, the findings might show that the company is undervalued.

Typically, investors try to use both qualitative and quantitative to measure the intrinsic value of a company, but investors should keep in mind that the result is still only an estimate and can make incorrect decisions in case the estimate is not fructified correctly.

Conclusion

While all the above parameters does have a role to play, there is always an element of risk considering many other factors and risks, such as Environmental risks, political risks and so on. A stock's market value is a forward-looking metric that reflects a company's future cash flows. Hence the future analysis and perception does have a bearing on the market value to a great extent.

Disclaimer:

Investopedia and Money Control website has been referred while preparing this article. This article is meant for understanding purposes only and in no way be deemed to be an advice or solicit any marketing or investment suggestion whatsoever. Any decisions based on this article would not held me liable for any action whatsoever. Please get in touch with your investment advisor to understand the same before investing. Thanks!


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