How To Valuate If A Company Share Price Is Overvalue Or Undervalue (Part 3)

Industry P/E Ratio Comparison

Although it might not be a an accurate way to use P/E Ratio to valuate a company. It does has its own advantage. This is done by using it to do a quick comparison of the company against other companies within the same industry.

For example, let’s do a comparison below:

Company Share Price P/E Ratio Market Capitalization
Company A 20 21 1.5 Billion
Company B 30 14 2 Billion
Company C 10 18 1 Billion
Company D 5 99 100 Millions
Company E 23 200 1.3 Billion

From the table, it looks like Company E is overvalued. Its market capitalization is comparable to the rest of its peers, yet its P/E ratio is almost as 10 times higher to its peers. I probably would not be interested in looking at Company E.

Company D looks overvalue, but its market capitalization is almost 10 times smaller. I would research more into Company D as it could have higher potential growth.

Price to Book Ratio

If the company is to go bankrupt and liquidated, investors/shareholders will be paid with the proceed from the liquidation. The proceed is known as book value.

By comparing the company’s stock price to its book value, we are able to gauge if the company is undervalue.

If the ratio is more than 1, it is not necessary that it is overvalue, because the company could have good growth and intangible assets such as special patents or technology.

If the ratio is less than 1, it is an indication that the company is undervalue.

However, this can also mean that this is a distressed company. You should find out more in depth about what has happened to the company.

You have to ask yourself, if it is going to cost you a lot lesser to buy out all the outstanding shares than the physical assets. You might as well buy over all the physical assets and sell it for profit. Why should you still bother to invest with the company?

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