Every day, the price of a listed company’s shares moves up and down on the NSE and BSE. Valuation is the process of estimating what those shares are really worth — their intrinsic value — so you can judge whether the current price looks expensive, cheap or about right.
No single method gives a perfect answer. Professional analysts combine several approaches and compare the results. Here are the most widely used ones.
1. Relative valuation: comparing with similar companies
Relative valuation uses ratios to compare a company with its own history and with peers in the same industry.
Price-to-earnings (P/E) ratio
P/E = Share price ÷ Earnings per share (EPS)
If a share trades at ₹500 and the company earned ₹25 per share over the last year, its P/E is 20. In other words, investors are paying ₹20 for every ₹1 of annual profit. A P/E is only meaningful in comparison: against the company’s own past P/E, against close competitors, and against its expected growth. Fast-growing companies often trade at higher P/Es than slow-growing ones.
Price-to-book (P/B) ratio
P/B = Share price ÷ Book value per share
Book value is the company’s assets minus its liabilities, as recorded in its balance sheet. P/B is especially useful for banks, financial companies and asset-heavy businesses. It is less useful for software or brand-led businesses whose most valuable assets don’t appear on the balance sheet.
EV/EBITDA
Enterprise value (EV) = Market capitalisation + Debt − Cash
Dividing EV by EBITDA (earnings before interest, tax, depreciation and amortisation) lets you compare companies with very different levels of debt, which the P/E ratio can hide.
PEG ratio
PEG = P/E ÷ Expected annual earnings growth (%)
PEG adjusts the P/E for growth. A company with a P/E of 30 growing earnings at 30% a year has a PEG of 1, which may be more reasonable than a company with a P/E of 15 and no growth.
Dividend yield
Dividend yield = Annual dividend per share ÷ Share price
Helpful for mature, cash-generating companies that pay regular dividends.
2. Absolute valuation: discounted cash flow (DCF)
A DCF model values a business from the ground up, based on the cash it is expected to generate in the future. The idea is simple: a business is worth the cash it will produce, adjusted for the fact that money received later is worth less than money today.
- Forecast free cash flow (FCF) — the cash left after running the business and making necessary investments — for, say, the next five to ten years.
- Choose a discount rate (r), usually the company’s cost of capital, reflecting how risky those future cash flows are.
- Estimate a terminal value for all the years after your forecast. A common formula is TV = FCF in the next year ÷ (r − g), where g is a long-term growth rate below the economy’s growth rate.
- Discount everything back to today and add it up to get the enterprise value. Subtract debt and add cash to get equity value, then divide by the number of shares.
DCF is powerful but sensitive: small changes to growth or the discount rate can change the result a lot. Always test a range of assumptions instead of trusting a single number.
3. Quality checks before you trust any number
A cheap-looking stock can be cheap for a reason. Before relying on a valuation, check the quality of the business:
- Return on equity (ROE) and return on capital employed (ROCE): how efficiently the company turns capital into profit, consistently over several years.
- Debt-to-equity: how much the company relies on borrowed money.
- Cash flow vs profit: operating cash flow should broadly track reported profit over time. Profits that never turn into cash are a warning sign.
- Promoter holding and pledging: in Indian companies, a high or rising share of promoter shares pledged as loan collateral can signal stress.
- Corporate governance: related-party transactions, auditor remarks and how management treats minority shareholders.
4. Build in a margin of safety
Every valuation is an estimate. Many long-term investors only buy when the price is meaningfully below their estimate of intrinsic value, leaving room for error. This gap is called the margin of safety.
Where to find the data
Listed companies publish annual reports, quarterly results and shareholding patterns, which are available through the NSE and BSE websites and the company’s own investor-relations page. These primary sources are the most reliable starting point for any valuation.
Common valuation mistakes
- Looking at P/E alone, without considering growth, debt or industry.
- Comparing companies from different sectors as if they were alike.
- Using unrealistic long-term growth rates in a DCF.
- Ignoring cash flow and focusing only on reported profit.
- Treating a valuation as precise instead of as a range.
Make valuation faster with FairStocks
FairStocks, a Stakespark venture, is a stock valuation analyzer for companies listed on India’s NSE and BSE. It helps investors apply valuation methods like these to Indian stocks without building every model from scratch.