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Module 2: Valuation
Two shops each earn ₹10 lakh a year. One is for sale at ₹1 crore, the other at ₹3 crore. Is the second one a worse deal? Not automatically. It depends on how fast it grows, how safe it is, and what you really get for the price. Valuation is the habit of asking that question.
How it connects. In Module 1 · Financial statements you learned to read a company’s profit, debt and cash. Here you use those numbers to check whether a share’s price is fair.
Tap or hover a picture to see what it means.
1. P/E: price to earnings
In plain words. Say a shop earns ₹10 lakh profit a year and you buy it for ₹2 crore. You are paying 20 times its yearly profit. That “20 times” is the P/E. For a share: P/E = share price ÷ profit per share (EPS).
Example. Price ₹200, profit per share ₹10. P/E = 20. You pay ₹20 for every ₹1 the company earns in a year.
Where to find it. The stock screener on the Markets page, or the company’s quote page on NSE or BSE.
How to read it. A P/E alone means little, like a price of ₹50 means little until you know if it is for a cup of tea or a shirt. So compare it with similar companies and with the same company’s own past. High P/E: people expect strong growth. Low P/E: it may be good value, or the business may be in trouble.
Common trap. Comparing a bank’s P/E with an IT company’s. Different sectors have different normal P/Es. Also, a company making a loss has no useful P/E.
2. P/B: price to book
In plain words. Book value is what would be left for owners if the company sold everything and paid all its debts. It is the same as net worth (equity). P/B compares the share price with book value per share.
Example. Net worth ₹1,000 crore, 10 crore shares, so book value is ₹100 per share. If the price is ₹150, P/B = 1.5.
How to read it. It suits banks and other companies that hold lots of money or assets. Look at ROE too. ROE is the yearly profit earned on every ₹100 of the owners’ money. A company with high ROE can fairly have a higher P/B.
Common trap. Book value does not count brands, software or skilled people. So P/B is a poor guide for such businesses.
3. EV/EBITDA
In plain words. If you buy a shop that has a loan, you must repay that loan too. If it has cash in the till, that cash is yours. So the true price of the whole business is: market cap + debt − cash. This is enterprise value (EV). “Net debt” means debt minus cash.
EBITDA is the profit from running the business, before interest, tax and wear-and-tear on equipment (depreciation). A quick way: operating profit + depreciation.
Example. Market cap 80, net debt 20, so EV = 100. EBITDA = 10. EV/EBITDA = 10 times.
Why use it. Two companies with different debt can be compared fairly, because EV counts the debt.
EV is the price of the whole shop: its shares, plus the loans you inherit, minus the cash in the till.
Where to find it. Work it out yourself from the results (operating profit + depreciation) and the balance sheet (borrowings and cash).
Common trap. EBITDA ignores money spent on new machines. A company that must keep buying equipment looks cheaper than it is. It also does not suit banks.
4. A simple DCF
In plain words. A business is worth the cash it will give you in future, but counted in today’s money. DCF means discounted cash flow.
Why future cash is worth less. If you can earn 10% a year, ₹100 today becomes ₹110 next year. So ₹100 promised a year from now is worth only about ₹91 today. At 10% a year, ₹100 three years away is worth about ₹75 today. At 12% it is about ₹71.
The four steps.
- Guess the free cash flow (cash left after running costs and new equipment) for the next few years.
- Choose a discount rate: the yearly return you demand.
- Estimate what the business is worth after those years (terminal value).
- Bring each amount back to today and add them up.
Put ₹90.9 in a 10% deposit and in a year it becomes ₹100. So ₹100 a year away is only worth ₹90.9 today.
Common trap. A DCF is only as good as your guesses. A small change in growth or the discount rate changes the answer a lot. So think in a range of values, not one number.
5. Putting it together
No single ratio gives the answer. Use this simple routine on any company:
- Check the business first. Is profit growing? Is debt low? Is cash flow healthy? This is Module 1 · Financial statements.
- Use two or three tools. For example P/E plus EV/EBITDA, or P/B for a bank.
- Compare. Look at similar companies and the company’s own past.
- Ask what the price expects. A high price assumes high growth. Is that realistic?
- Keep a range. Decide what looks cheap, fair and expensive, not one magic number.
Example. Two shops each earn ₹10 lakh. Shop A costs ₹1 crore (P/E 10), shop B costs ₹3 crore (P/E 30). B is not worse. If B’s profit doubles every few years and A’s is flat, B may be the better buy. If B’s profit is only flat, you are overpaying. Valuation is this question: “what must go right for this price to make sense?”
Valuation tells you what a price implies, not what to do. A good company can be a poor buy at a high price, and a low price can be low for a reason.
← Revisit Module 1: Financial statements
Try it live
Open the screener and compare the P/E of two companies in the same sector.
Practice lab
Do these on the real site. Tick each one when done. 0 of 3 done
Disclaimer: WealthyTrees is for education only. Nothing here is investment advice or a recommendation to buy, sell or hold any share or product. Numbers and examples are made up. WealthyTrees is not a SEBI-registered investment advisor. Please speak to a SEBI-registered advisor before you invest.