SBI or HDFC Bank: Learn Stock Picking with Sector-Specific Valuation Metrics

Stock valuation is the cornerstone of investing, helping investors determine whether a stock is overvalued, undervalued, or fairly priced. Each valuation metric has its strengths, ideal use cases, and limitations. Here, we dive into four key valuation metrics—Price-to-Earnings (P/E), Price-to-Book Value (P/B), EV to EBITDA, and the PEG Ratio—and include stock examples for better understanding.

1. Price-to-Earnings (P/E)

• Definition: The P/E ratio compares a stock’s price to its earnings per share (EPS), showing how much investors are willing to pay for each rupee of earnings.
• Best Used For:
  • Companies with stable earnings, such as FMCG and utility sectors.
• Stock Examples:
  • Hindustan Unilever (HUL): A mature FMCG giant with stable earnings.
  • NTPC: A utility company with predictable cash flows and consistent profitability.
• Key Insights:
  • A high P/E can be justified for companies with strong growth potential.
  • Vulnerable to manipulation since EPS can be impacted by accounting practices.

2. Price-to-Book Value (P/B)

• Definition: The P/B ratio compares a stock’s price to its book value (assets minus liabilities).
• Best Used For:
  • Banks, NBFCs, real estate, and insurance firms where tangible assets dominate.
• Stock Examples:
  • State Bank of India (SBI): A bank with tangible assets that can be evaluated using P/B.
  • HDFC Ltd: An NBFC with significant real estate exposure, making P/B relevant.
• Key Insights:
  • High ROE with low P/B: Indicates undervaluation.
  • Low ROE with high P/B: Signals potential overvaluation.
• Limitations:
  • Misleading for companies like TCS or Infosys due to their intangible-heavy balance sheets.

Real estate company, stagnant book value can overstate valuation.

3. EV to EBITDA

• Definition: This metric measures a company’s valuation based on its enterprise value (EV) relative to earnings before interest, taxes, depreciation, and amortization (EBITDA).
• Best Used For:
  • Capital-intensive industries like infrastructure, manufacturing, telecom, and utilities.
• Stock Examples:
  • Tata Steel: A manufacturing giant with significant debt, where EV/EBITDA neutralizes the debt effect.
  • Bharti Airtel: A telecom company with high capex requirements and varying capital structure.
• Key Insights:
  • Suitable for companies with high debt or negative earnings.
  • More reliable than P/E for evaluating operating performance.
• Limitations:
  • Ignores capital expenditures (CapEx) and growth rates.

4. PEG Ratio

• Definition: The PEG ratio adjusts the P/E ratio by factoring in the company’s earnings growth, offering a better perspective on valuation.
• Best Used For:
  • High-growth companies in sectors like technology, pharmaceuticals, and other new-age businesses.
• Stock Examples:
  • Infosys: A high-growth IT stock, where PEG ratio helps justify its valuation.
  • Divi’s Laboratories: A pharma stock with strong earnings growth potential.
• Key Insights:
  • A PEG ratio below 1 often suggests undervaluation relative to growth.

Choosing the Right Metric: A Sector-Based View

Conclusion

The choice of valuation metric depends on the nature of the business, its financial structure, and growth trajectory. For example, PEG is ideal for high-growth companies, while P/B suits asset-heavy industries like banking and real estate. Investors should combine these metrics to form a holistic view of a company’s value before making decisions.