Hello friends, today we are going to talk about the most important topic of capital market. This topic is very important because if you are not aware of this topic, then you are not aware about capital market / stock market. The name of that topic is value investing. Before jumping in this topic please keep one thing in your mind that in this article, i will not tell you about which shares will come under this category or in which share you should invest. I am here just to give some basic knowledge about value investing . I will also share some important financial ratios which will help you to find out whether a share comes under this category or not.

In simple words, value investing refers to find out those shares which are available in the market at discount rate. You can find these kind of shares alot in the market. In value investing, the more important thing you have to do is to find out good shares which are undervalued. But unfortunately there are very few people who can take advantage of value investing. Because sometimes a share looks undervalued/the share is available at discount rate but fundamental or management of that company is not good. So before analysing whether a share is undervalued or overvalued, you should give more importance to fundamentals of that company first then you have to analyse the management of that company and then at the final stage, you should analyse whether that share is undervalued or overvalued. It is a long process isn’t it? But that’s the bitter truth of long term investment.

Value investing was made famous by investor Benjamin graham. Then Warren buffet used that that method to select the undervalued shares. He has invested his money in those shares which were undervalued and investors were not aware of it. But now these companies are very famous. Normally in the market, i have rarely seen the share of a famous company which is still undervalued for example ITC. During corona, ITC is a undervalued share .ITC has diversified presence across industries.

There are also different ways to identify whether a share is undervalued or overvalued. These are:

1. P/E ratio

Here P/E refers to price to earning ratio. With the help of this ratio, you can analyse you can analyse whether that share is undervalued or overvalued. If the P/E ratio of a company is high, then you can consider that company as overvalued. But if the P/E ratio of that company is low, then that company is undervalued. The formula for calculating this ratio is price per share(current market price)divided by earning per share. PE ratio is useful for those industries which are service providers like IT industry. If the P/E ratio of a company is high it doesn’t mean that you should not purchase that company just because it is overvalued. If a P/E of a company is very high, then you should consider other factors like whether the profit of that company is increasing year by year or not and what is the roe and roce of a company etc. If all of things are in stable or in increasing trend, then you can purchase the shares. Similarly if the P/E ratio of a share is low, then it doesn’t mean that you should purchase it just because of the so called attractive valuation. You should also consider other factors like i mentioned the other

2.P/B ratio

Another type of ratio is P/B ratio. It’s full form is price to book value. Normally, i have seen that this ratio is very useful for the asset heavy industries i.e. the industry where asset is more important like infrastructure, Energy etc. Like P/B ratio, if the P/B ratio is high, then that company is overvalued. Similarly, if the PB ratio is very low, it means that the company is undervalued. In my opinion, if the P/B ratio is more than 1.0, then it is overvalued. Similarly,. if P/B ratio is less than 1.0, let’s say 0.5 , then it is undervalued.

3. Price to cash flow ratio

Another type of valuation method is price to cash flow ratio. Sometimes, it can be also written as P/CF ratio. In this ratio, more importance will be given to the operating cash flow. You can see operating cash flow in the cash flow statement of a company. While calculating this ratio, you have to keep operating cash flow in the denominator . Now a days, most of the investors prefer to calculate P/CF ratio rathe than P/E ratio. Because- in P/E ratio, earnings are more important and the company can manipulate the earnings whereas in P/CF ratio, you can not manipulate the cash flow. There are actually two ways of calculating price to cash flow ratio

i. P/CF ratio can be calculated by dividing the market capitalisation of a company with the operating cash flow of a company.

ii. Another way of calculating this ratio is to divide the share price of a company with its operating cash flow. (Remember that here also, you have to keep operating cash flow in the denominator

Now if the P/CF ratio is more than 10, then i have considered it as undervalued. But if the P/CF ratio is more than 10, then it is slightly overvalued.

4. PEG ratio

Another type of ratio is PEG ratio. It’s full form is Price to Earning ratio. The demand of this ratio is getting increased day by day. There is a very easy formula to calculate this ratio. The formula to calculate this ratio is that you have to divide the price to earnings ratio with the earnings growth ratio. In earnings growth ratio, you have to analyse how much percentage the company’s profit will increase or decrease in future. For example- the P/E ratio of a company is 17 and you think that next year, the income of that company will grow at 10%. Now just divide the pe ratio with your earning growth ratio and the answer will be 1.7. Normally, PEG ratio of more than 1 is overvalued . But sometimes this calculation may be wrong because here you have to analyse the earnings which has not been published yet.