### What are the Valuation Ratios in Financial Analysis

A financial ratio is a relative magnitude of two selected numerical values taken from an enterprise's financial statements. Often used in accounting, there are many standard ratios used to try to evaluate the overall financial condition of a corporation or other organization.

Financial ratios are useful tools that help business managers and investors analyse and compare financial relationships between the accounts on the firm's financial statements.

__Valuation Ratios:__A valuation ratio shows the relationship between the market value of a company or its equity and some fundamental financial metric (for example - earnings). The point of a valuation ratio is to show the price the investor is willing to pay for some stream of earnings, revenue, or cash flow (or other financial metric).

__Enterprise Value (EV)__- Enterprise Value is: (a) intrinsic value of the organization either calculated as discounted net cash flow in future / other valuation techniques or market cap of the organization (called as the
**“Equity Value”**)

**Add:**(b) Debt, Preference Share Capital

**Less:**(c) Cash and Cash Equivalent - EV is most widely used in the investment decision or business takeover deals. This is the value paid by the investor while taking over the business in proportion to the stake of investment.

- Enterprise Value is: (a) intrinsic value of the organization either calculated as discounted net cash flow in future / other valuation techniques or market cap of the organization (called as the
__Equity Value__- Equity Value is the intrinsic value of the organization either calculated as discounted net cash flow in future / other valuation techniques or market cap of the organization.
- The investor, for a business takeover, would cut a cheque for the Equity Value (in proportion of their stake) which is derived as below
**Equity Value = Enterprise Value - Debt, Preference Share Capital + Cash and Cash Equivalent**

__Book Value / Net Worth__- Books Value of an organization is equal to total tangible assets minus accumulated depreciation and all external liabilities.
- Alternatively, it is Total Equity (as per books of accounts) as on a given date, reduced by intangible (Goodwill, Customer Contract, License Fees yet to be amortized, etc.) and fictitious assets (Preliminary Expenses, Deferred Tax Assets, etc.).
**Total Equity = Equity Share Capital + Reserves & Surplus** - As the accounting value of a firm, book value has two main uses:
- It serves as the total value of the company's assets that shareholders would theoretically receive if a company was liquidated.
- When compared to the company's market value, book value can indicate whether a stock is under or over-priced.

__Net Present Value (NPV)__- Net present value (NPV) is the difference between the present value of cash inflows and the present value of cash outflows over a period of time. NPV is used in capital budgeting and investment planning to analyse the profitability of a projected investment or project.
**NPV = Sum of “Discounted Net Cashflow” over a period range.** - Discounted Net Cashflow = (Cash Inflow – Cash Outflow) / (1+r)^n

r = Discount rate or return that could be earned in alternate investments

n = Number of time period (year number from the zero / start date) - Money in the present is worth more than the same amount in the future due to inflation and to earnings from alternative investments that could be made during the intervening time. In other words, a rupee earned in the future won’t be worth as much as one earned in the present. The discount rate element of the NPV formula is a way to account for this.

- Net present value (NPV) is the difference between the present value of cash inflows and the present value of cash outflows over a period of time. NPV is used in capital budgeting and investment planning to analyse the profitability of a projected investment or project.
__Price Earnings Ratio (PE)__- The price-earnings ratio, also known as P/E ratio, P/E, or PER, is the ratio of a company's share (stock) price to the company's earnings per share. The ratio is used for valuing companies and to find out whether they are overvalued or undervalued.
**P/E Ratio = Share Price / Earnings Per Share**

Earnings Per Share = “Profit After Tax” (PAT) per Equity Share- P/E Ratio is also called as
**“PAT Multiple”**which means how many times the company is valued (Equity Value or Market Cap) of its Profit After Tax (PAT). **"Trailing P/E"**uses the weighted average share price of common shares in issue divided by the net income (PAT) for the most recent 12-months period.**"Forward P/E":**Instead of historical net income (PAT), this uses estimated net earnings over next 12 months.

__Price Earnings / Earnings-to-Growth Ratio (PEG)__- The 'PEG ratio' (Price/ Earnings-to-Growth ratio) is a valuation metric for determining the relative trade-off between the price of a stock, the earnings generated per share (EPS), and the company's expected growth.
- In general, the P/E ratio is higher for a company with a higher growth rate. Thus, using just the P/E ratio would make high-growth companies appear overvalued relative to others. It is assumed that by dividing the P/E ratio by the earnings growth rate, the resulting ratio is better for comparing companies with different growth rates.
**PEG Ratio = (Share Price / Earnings Per Share) / Annual EPS Growth** - The growth rate is expressed as a percent value, and should use real growth only, to correct for inflation. For example, if a company is growing at 30% a year, in real terms, and has a P/E of 30, it would have a PEG of 1. A lower ratio is "better" (cheaper) and a higher ratio is "worse" (expensive).

__Price-to-Cash Flow Ratio (P/CF)__- P/CF Ratio compares a company’s market value to its Cash flows. Since, non-cash expenses like depreciation, amortization, etc. are excluded and capital expenses are included, this is more stable valuation indicator than Earnings Per Share (EPS).
- There is common saying
**“Profit is an Opinion; Cash is Real”.**Hence, using cash instead of EPS, sometimes, provide better view.**P/CF Ratio = Share Price / Cash flow per share** - Lower P/CF means the counter is cheap. Sectors and Companies with higher growth command a higher premium and hence, a higher P/CF.

__EBITDA Multiple - EV/EBITDA ratio__- EBITDA means Earnings Before Interest, Tax, Depreciation and Amortization. It is kind of operating profit excluding finance cost, non-operational earnings, depreciation, taxation etc.
**EBITDA Multiple**represents how much / how many times investor is willing to pay for a stock’s operating margin.**EBITDA Multiple = Enterprise Value / EBITDA**- EV stands for Market Cap – Net Debt and hence, this ratio is useful for companies with large debt. Since, the total capital is used as numerator, this ratio can be used across industries.

__Price-To-Book Value Ratio (P/B Ratio)__- P/B ratio compares a company’s current market value to its Book Value. Low P/B means the counter is cheap.
**P/B Ratio = Share Price / Book Value per share** - More useful in periods when EPS is fluctuating due to external factors or seasonality, non-recurring income in the company, because Book Value is more stable. P/B Ratio is more suited to sectors where the Book Value is marked-to-market on a regular basis and not for companies with high brand value.

- P/B ratio compares a company’s current market value to its Book Value. Low P/B means the counter is cheap.
__Price (Market Cap) -To-Sales Ratios__- Price-to-Sales ratio indicates how much / how many times equity investors need to pay for the stock’s revenue. Lower ratio indicates cheaper stock.
**Price-to-Sales Ratio = Market Cap / Sales or Revenue** - Sometime and in case of some industry, revenue is more stable than earnings, the chance of manipulation is less with this ratio. However, different industries will have different margins and therefore, compare only within the industries.

- Price-to-Sales ratio indicates how much / how many times equity investors need to pay for the stock’s revenue. Lower ratio indicates cheaper stock.
__EV to Sales Ratio (Sales Multiple)__- Sales Multiple compares the total value of company to its sales. Lower ratio means the counter is cheaper.
**Sales Multiple = Enterprise Value / Sales or Revenue** - Since, sales are generated using entire capital, including Debt, this gives better picture than price / sales ratio. Comparison should be within industry.

- Sales Multiple compares the total value of company to its sales. Lower ratio means the counter is cheaper.
__EV / Production Capacity__- EV / Capacity Ratio measures how much market is paying (valuing) per unit of capacity e.g. 1 MW of Power or 1 tonne of Cement capacity etc.
- This ratio needs to be compared within industry with similar manufacturing or customer base.
**EV / Capacity Ratio = Enterprise Value / Total Capacity** - This ratio is generally used by acquirers but can also be used by retail investors to understand high or low value stocks.