Every company tells two stories – one through its profits and the other through its worth or value.
The profit story builds your EPS ( Earning Per Share) and PE ratio ( Price Earning ratio); the worth story builds your Book Value and PB ratio (Price to book).
Smart investors learn to read both – because a company earns fast but erodes its value is like a runner who sprints without stamina. The value here means the company’s productive resources like land and buildings, plant and machinery, patents, inventories, manpower, cash and bank balances etc. If you have more values or resources, you have more ability to create more revenue and profit.
The price earning ratio is a widely used financial ratio. The PE ratio shows how much you are willing to pay for a stock as against its earnings.
The PE Ratio
= Market Price of Share/EPS
A high PE means you are ready to pay a premium for the stock as you feel that there is potential for growth in the future and the price of stock would go up further. On the other hand, low PE indicates that the stock is undervalued, and you are pessimistic about the company’s future.
So, what we learned so far, you have the twin lenses – PE for Growth, PB for Value.
When you look at a balance sheet, there are two ways to analyse a company:
Earning Growth View – focus on EPS and PE.
Value Growth View – focus on Book Value and PB.
A healthy company usually shows steady growth in both – its profits (EPS) and its net worth (Book Value). If one grows without the other, the story is incomplete.
Example: Suppose company A doubles its EPS in 3 years, but its Book Value barely moves – that means profits are not being retained or reinvested.
Company B shows EPS growth as well as rising reserves and surplus– that’s long term wealth creation.
I thought of covering both the concepts in today’s blog, but as I’ve started writing, I think I won’t be able to complete both the approaches in one blog. That would be too lengthy. To keep things light and simple, today l will focus on Income or earnings model only.
So, through the Income Approach, we try to value a company based on its earnings potential. When you buy a share, you are actually buying a small part of a business. So, before investing, you must ask – how much am I paying for every rupee of profit this company earns?
As I’ve shared with you,PE = CMP/EPS
Let’s say, EPS = ₹10 and CMP( current market price) of share is ₹200, then the PE =200/10, ie, 20
This means, as an investor you are ready to pay ₹20 for every ₹1 of current earnings.
EPS is calculated by dividing a company’s net income (Profit) by the total number of outstanding shares. Outstanding shares are the shares currently held by investors – including the public, institutions and the promoters( company insiders).
EPS indicates how much the company earns against each share or stock.
A higher EPS shows greater value. In general the stock price goes up if EPS keeps increasing QOQ or YOY. But, please remember, if your company misses the target EPS that you or the market expects from it, its share price can crash.
There is also a concept of diluted EPS. Easy example for you : Say the company has 1 crore shares as on today. But after 2 months due to Convertible Debentures (whether Partly Convertible or Fully Convertible) getting due for conversion, there would be increase in the number of shares. So, now , the profit would be divided amongst more shareholders. However, the interest burden will reduce to some extent. But, overall, the EPS will be less, meaning it’s getting diluted.
PEG Ratio
The PEG ratio gives a finer and more realistic picture of a company’s value. It connects the PE ratio with the company’s earnings growth rate. The formula is simple.
PEG = PE / Earnings Growth Rate
For example, if a company’s PE is 20 and its earnings grow @20% per year, PEG =1.
A PEG of 1 means the stock is fairly valued. Below 1 may indicate, the stock is undervalued or attractive, and above 1 means could be overvalued or expensive.
PEG helps investors compare companies better especially when growth rates differ. It tells us whether a high PE is justified by high growth or just market excitement –making it a more balanced tool for stock analysis. PEG gives you a 3D view of the financial value of your stock.
Let’s pick up 2 stocks: HDFC Bank and SBI.
HDFC Bank PE ratio is 21.39 and PEG 0.93 as against SBI’s 10.54 and 0.35 as I sourced from Screener.
We will try to analyse it and find which is better for investing.
HDFC Bank:
PE = 21.39, PEG = 0.93
SBI:
PE = 10.54, PEG = 0.35
Let’s read the message.
SBI’s PEG of 0.35 is much lower than HDFC’s 0.93.
This indicates SBI’s earnings are growing faster relative to its price, or in other words , the stock might be undervalued considering its growth.
However, HDFC’s higher PE of 21.39 reflects the market’s premium for stability, strong management, and consistent long-term performance.
Which is better to invest in – SBI or HDFC?
PEG suggests SBI is undervalued, but remember, public sector banks are cyclical and their growth may not stay consistent.
HDFC, with near-1 PEG, trades at fair value for its quality.
In short:
SBI = Value + Momentum Play
HDFC = Quality + Stability Play
A Smart investor could hold both – SBI for growth and HDFC for long-term strength.
One more insight:
The PE of Petronet LNG, Indraprastha Gas, Gujarat Gas and Mahanagar Gas is 11.37, 17.46, 25.19 and 11.70 respectively as against the Adani Total Gas’s PE of 105.85. This is the market perception. The collective sentiments feel there is greater potential for growth of Adani Total Gas. But, personally, I may not find this stock attractive to buy. It appears costly to me. You need to check the average PE of this sector and examine the extent to which an Adani stock can command a higher market price.
Numbers help us see patterns, but insights come from understanding why those numbers exist – management quality, growth visibility and company’s ability to create lasting value.
In the next blog, we’ll go a step deeper into the world of Value Investing – where we explore how price and value often tell two different stories, and how recognizing that difference can make all the difference.
Stay tuned – the real discovery begins when you learn to see beyond the price tag.
Disclaimer: The information provided in the blog is for educational and informational purposes only and should not be construed as financial advice. Readers are encouraged to consult a qualified financial advisor before making any financial decisions. All views expressed are personal.
