While there are numerous metrics to measure the intrinsic value of a stock, following three metrics are fundamental in stock valuation.

• Book Value per share
• Price to Earnings (P/E) Ratio
• Dividend yield

Why Book Value per share is important?

Book Value is a term used to signify the total value of a company’s assets, i.e. book value of all assets (after depreciation) minus book value of all liabilities. In other words, book value of a company is its net worth. The net worth of company divided by number of issued shares will give the book value per share.

In asset light industries like service industry, book value per share will hold little or no importance for investors. Companies with substantial physical assets such as those in manufacturing business or banking industry will have significant assets.

While considering investment in stocks of such companies, book value per share is the most important figure for the investors. When you divide the current price of the share of a company with its book value per share, you get P/B (price to book value) ratio. P/B ratio serves as a highly useful comparison tool while taking an investment decision.

If the P/B ratio is lower than 1.0, it means that the stock of the company is undervalued. It presents an excellent opportunity for value investors, who are always looking to add undervalued stocks to their portfolio.

In practical terms, a P/B ratio of less than one means that if the company were to go bankrupt and goes into liquidation, the shareholders would make a profit on their investment even after all the liabilities of the company are settled.

Why P/E Ratio is an important metric?

Price to Earnings Ratio or P/E is one of the most widely used metric by investors and analysts to determine stock valuation. In addition to showing whether a company’s stock price is overvalued or undervalued, the P/E ratio can also reveal how a stock’s valuation compares to its industry group or a benchmark like NIFTY index companies.

The P/E ratio helps investors determine the market value of a stock as compared to the company’s earnings. In short, the P/E shows what the market is willing to pay today for a stock based on its past or future earnings.

A high P/E could mean that a stock’s price is high relative to earnings and possibly overvalued. Conversely, a low P/E might indicate that the current stock price is low relative to earnings.

However, companies that grow faster than average typically have higher P/Es, such as technology companies. A higher P/E ratio shows that investors are willing to pay a higher share price today because of growth expectations in the future. But commodity companies typically command a lower P/E ratio.

Currently Nifty 50 companies have an average P/E Ratio of 27.23 as on 20-Nov-2019. Nifty is considered to be in oversold range when Nifty P/E value is below 14 and it’s considered to be in overvalued range when Nifty P/E is near or above 22.

The market quickly bounces back from the oversold region because intelligent investors start buying stocks looking to snatch up bargains and they do the exact opposite when Nifty P/E is in the overbought region.

What is Dividend yield?

Dividend yield is an easy way to compare the relative attractiveness of various dividend-paying stocks. It tells an investor the yield he/she can expect by purchasing a stock. Dividend yield is the relation between a stock’s annual dividend payout and its current stock price.

For example, let us assume that a company pays an annual dividend of Rs. 10 per share and its stock price is Rs 200 per share. The dividend yield will be 5% (10/200).

The  dividend yield on stocks will generally be lower than bond yields. Currently, 10-Year Government of India Bonds have a yield of about 6.53%. NIFTY 50 companies have an average dividend yield of 1.24% as on 20-Nov-2019. However, within NIFTY 50 companies, there are some companies like HPCL, Vedanta, NMDC etc. which offer a much higher dividend yield of above 6%.

A high dividend yielding stock gives comfort to investors. But the investors need to check whether the company is paying such high dividends consistently for last 5 to 10 years.