Synopsis
How do you value a stock? Which has a high valuation, and which is cheap? It all depends on the ratio you use to ascertain value. Consider this example: Twelve years back, the stock of an MNC FMCG company was quoting at a PE multiple of 44. At that time, the Nifty’s PE was at 25. Since then, the market capitalization of the stock has grown 10 times and its PE ratio today stands at 65. On the other hand, there was a construction company quoting at a PE multiple less than 15 around the same time, but its market capitalization today is half of what it was 12 years ago. See how relying solely on the PE ratio creates hurdles in the way of wealth creation?
One of the most important things that investors need to do in the stock market is to make a difference between what has value and what looks cheap due to one financial ratio. More often than not, relying on PE may lead to wrong investment decisions. Use the PEG ratio instead. This is determined by dividing a company’s PE multiple with its growth rate. By focusing on the PEG ratio, investors will be able to better differentiate between genuinely
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