How to find valuation of a company or stock

Finding the valuation of any company or stock is the most important part of fundamental analysis. In order to get good returns we should buy good stocks at a good price.

So we have to estimate the actual value of the stock in order to determine if the price of the stock is undervalued or overvalued or at a fair value. But there is no fixed formula to estimate the actual value of a business. Different investors and analysts adopt different methods to calculate the valuation of a company. We are trying to briefly discuss about them in this chapter.

Table of Contents

• What is Book Value of a stock
• What is Intrinsic Value of a stock
• Relative Value Method to find Intrinsic Value of a stock
• Market Value or Market Capitalization of a stock
• What is Large Cap Stock
• What is Mid Cap Stock
• What is Small Cap Stock
• What is Micro Cap Stock
• What is Blue Chip stock
• What is Penny Stock
• Conclusion

There are basically three methods of valuation of a company those are commonly used.

• Book Value
• Intrinsic Value
• Market Value

What is Book Value of a stock

Book Value is the value of the company as per its books of accounts or balance sheet. It is the net worth of the company. In financial terms if we deduct the total liabilities (here liabilities means the total debts or liabilities excluding shareholders equity) of the company from its total assets, we will get the book value of the company. We can say it is the value which we get if the company would be liquidated. 

Book Value = Total assets – Total Liabilities

We cannot say if a company is undervalued or fairly valued or overvalued considering its book value only. We have to compare it with its peers or with its sector to get a clear picture about its valuation. For which we have to calculate its Price to Book ratio (P/B ratio) and compare it with P/B ratio of its peers and sector.

Book Value Per Share (BVPS) =Book Value / Total number of outstanding shares

P/B Ratio = Per share market price / Per share Book value

Value investors generally prefer stocks with P/B Ratio of less than 1 as good for long term investment.

For Example –

What is Intrinsic Value of a stock

Intrinsic Value is the real value of the stock based on its earnings and growth potentials. Benjamin Graham, who is known as the father of value investing and teacher of legendary investor Warren Buffet, first developed the formula to calculate the intrinsic value of a stock. As per him the formula of Intrinsic Value of a stock is

Where, EPS = Earnings per share 

8.5 = Basic P/E of a non growth company

G = Expected growth percentage of the company in the next 10 years as per past three years performance 

4.4 = Average bond yield or Fixed Deposit return percentage 

Y = Current Yield of a good AAA Bond or Fixed Deposit return percentage 

For Example if we calculate the Intrinsic Value of Reliance Industries share –

Relative Value Method to find Intrinsic Value of a stock

There are various other ways to find the intrinsic value of any stock. This is one of them which many investors and analysts use to calculate the Intrinsic Value in a simple way.

Intrinsic Value = Stock PE X Stock EPS

While selecting stock on the basic of intrinsic value Legendary investor Warren Buffet recommends at least a margin of safety of 25 per cent should be maintained by the investor. Here the difference between the intrinsic value and the current market price is called the margin of safety. With more margin of safety we can expect more safe investment and better returns.

Market Value or Market Capitalization of a stock

Market Valueis the valuation of the company in the stock market. It is also known as Market Capitalisation. If we multiply the total number of outstanding shares with the per share market price of the company we will get the market capitalisation of the company.

Market Capitalization = Per Share market price X Total number of outstanding shares

Market Cap is an important factor while selecting stocks to invest because it decide the risk involved due to price volatility.

Basically there are four types of companies based on their market capitalization; they are Large Cap, Mid Cap, Small Cap & Micro Cap. Indian market regulator SEBI has given a basic definition of Large Cap, Mid Cap & Small Cap stocks in its 2017 circular for reference of the mutual funds while selecting stocks for different types of mutual fund schemes like Large Cap funds, Mid Cap funds, Multi Cap funds etc. As per that the Association of Mutual Funds in India (AMFI) publishes category wise list of stocks. NSE Indices data also provide the category wise list of stocks.

What is Large Cap Stock

The top 100 listed companies of the market as per their full market capitalization comes under the Large Cap Stock category. As per the list published by AMFI in 2021 the 100^th company’s market cap is Rs.37,746. Crore. Hence we can say companies with market cap of more than rupees 37 thousand Crore come under Large Cap Stocks category.

Large Cap stocks are generally well known and big companies with large market reach & customer base. So they can efficiently survive in the worst economic conditions and may give a stable and consistent return in long term. They have sufficient market liquidity and hardly show 10% to 20% correction in the bearish market. Hence large cap stocks are considered as safer investment bets. But these companies generally don’t have much more space for expansion because they have been already captured a big market share. Therefore these companies may not show multi fold returns in future. But there is no fixed rule in the market and anything can happen in future which no one can predict.

What is Mid Cap Stock

101 to 250^th company (total 150 companies) as per market capitalization comes under the Mid Cap Stock category. Hence companies with market cap of less than Rs.37,000. Crore and more than Rs.11,800. Crore come under Mid Cap Stocks category.

Mid Cap stocks are generally growing companies with an average market reach. These companies have more space for business expansion and higher growth potentials. Hence mid cap stocks can give a multi fold return in long term. But these companies have less competitive strength to survive in tough conditions and can easily show 20% to 40% corrections in bearish trend. Therefore aggressive and strategic investors having more risk taking ability generally focus on the mid cap stocks to invest for long term.

What is Small Cap Stock

251 to 500^th companies (as per NSE Indices data) comes under the Small Cap Stock category. Companies with market cap of less than Rs.11,800. Crore and more than Rs.3,250. Crore comes under Small Cap Stocks category.

Small cap stocks are mostly small companies or new companies with lesser market reach. These companies generally don’t have very strong financials and business fundamentals. Some of the small cap companies with good business growth can give multi bagger returns within very short period of time and some of them may not have enough resources to face worst conditions. They have less market liquidity and in case of any negative sentiment they can easily correct more than 50%. These stocks are very volatile in nature and considered as highly risky investment bets. We have to deeply analyse their business before making investment decision.

What is Micro Cap Stock

As per NSE Indices data, companies below the 500^th rank listed company are known as Micro Cap stocks. These are very small companies and most of them are generally unknown companies, we may get very little information about the company. Generally these companies don’t have enough market liquidity and shows extreme volatile price movements. Many of these stocks are operator driven and most of the time runs in upper circuits and lower circuits. Highly aggressive and speculative traders bet on these stocks for short term gains.

There are two other popular categories of stocks on the basis of their market value we often here in the market.  Those are Blue Chip Stock and Penny stock. There is no fixed definition to categorised stocks in these categories but we use these names most of the times.

What is Blue Chip stock

The term Blue Chip has been derived from the Poker Game where Blue Chips are the most expensive chips. Similarly in stock market Blue Chip Stocks are referred to the sector leaders or the largest companies of the market. Most of the popular and top companies of various sectors are known as blue chip companies. There is no certain limit of market cap for blue chip stocks but generally companies of more than 1 Lakh Crore market caps are considered in this category. These companies have good brand value and are fundamentally strong large cap companies with good and stable earnings & financial history.

As these are very large companies hence may not have huge growth potentials in future and may not give multi fold returns but could survive in the worst economic conditions and ups and downs of the market and will give consistent regular returns in a long run. Safe investors generally focus on these companies to invest huge amounts for long term, because blue chip stocks are considered as safe bets.

Some Examples of Blue chip stocks are – Reliance Industries, TCS, Infosys, HDFC Bank etc.

What is Penny Stock

There are no actual definition of Penny stocks but in Indian stock market generally small cap or micro cap stocks with market capitalization of less than 200 Cr. with share price of less than Rs.10 are considered as Penny stocks. Some market researchers also consider micro cap stocks with price in two digits as Penny stocks.

These are mostly very small companies with not so good fundamentals or financial histories, most of them are loss making with huge debts or bankrupt companies hence considered as very risky for investment. At any time these companies may become insolvent or liquidate and we may lose all our capital. Generally traders focus on these types of stocks for speculating. Most of the penny stocks don’t have enough market liquidity (don’t have enough numbers of buyers and sellers) and runs on upper circuits and lower circuits. Before investing in these stocks we should check their financials, history, past and present business performance and future growth prospects.

Conclusion

In current days we don’t have to make all these calculations to find out the financial ratios, values or information about the stocks, there are many stock analysis apps and web platforms available in the market from which we can easily get all this information. To know more about them and which app we prefer most, you can check this article. Thanks for visiting us.

Disclaimer : This article is for information and educational purposes only and based on our research only. We are not registered advisor and we are not giving any advice to anyone to invest in stock market or to make any investing decision. Please consult your financial advisor before making any decisions.