Company Evaluation:Company Evaluation?
Whenever there is a discussion about funding a company or an entrepreneur and company financing, it always turns into a topic of company valuation.
Figuring out the worth of your company is almost like determining the value of a child. Though it is not exactly the same, a company can be seen as a child in the eyes of an entrepreneur, something that needs constant nurturing and care to grow.
What is a Company Evaluation & Why is it important?
- Company Evaluation is a process where the economic value of a company is determined. With the help of the Evaluation, you would be able to determine the fair value of a company. These include determining the sales value, establishing partner ownership and also closings deals. The owner of a company usually visits professional business Evaluators for getting an objective estimate of the business’ value.
- There are numerous reasons as to why a company Evaluation is needed, but one of the leading reasons is when a business wants to sell a portion or all of its operations. Another reason is when a company wants to acquire a company or merge with another company. The process of finding the value of a business involves Evaluating all aspects of the business and using objective measures.
Stock investing requires careful analysis of financial data to find out the company's true worth. This is generally done by examining the company's profit and loss account, balance sheet and cash flow statement. This can be time-consuming and cumbersome. An easier way to find out about a company's performance is to look at its financial ratios, most of which are freely available on the internet.
Though this is not a foolproof method, it is a good way to run a fast check on a company's health.
"Ratio analysis is crucial for investment decisions. It not only helps in knowing how the company has been performing but also makes it easy for investors to compare companies in the same industry and zero in on the best investment option,"
We have Brought you Nine financial Factors that one should look at before investing in a Company stock .
- 1. P/E Ratio
The price-to-earnings, or P/E, ratio shows how much stock investors are paying for each rupee of earnings. It shows if the market is overvaluing or undervaluing the company.
One can know the ideal P/E ratio by comparing the current P/E with the company's historical P/E, the average industry P/E and the market P/E. For instance, a company with a P/E of 15 may seem expensive when compared to its historical P/E, but may be a good buy if the industry P/E is 18 and the market average is 20.
A high P/E ratio may indicate that the stock is overpriced. A stock with a low P/E may have greater potential for rising. P/E ratios should be used in combination with other financial ratios for informed decision making.
P/E ratio is usually used to value mature and stable companies that earn profits. A high PE indicates that the stock is either overvalued (with respect to history and/or peers) or the company's earnings are expected to grow at a fast pace. But one must keep in mind that companies can boost their P/E ratio by adding debt (thereby constricting equity capital). Also, as future earnings estimates are subjective, it's better to use past earnings for calculating P/E ratios,
- 2. Debt to Equity Ratio
It shows how much a company is leveraged, that is, how much debt is involved in the business vis-a-vis promoters capital (equity). A low figure is usually considered better. But it must not be seen in isolation.
If the company's returns are higher than its interest cost, the debt will enhance value. However, if it is not, shareholders will lose
Also, a company with low debt-to-equity ratio can be assumed to have a lot of scope for expansion due to more fund-raising options,
But it is not that simple. "It is industry-specific with capital intensive industries such as automobiles and manufacturing showing a higher figure than others. A high debt-to-equity ratio may indicate unusual leverage and, hence, higher risk of credit default, though it could also signal to the market that the company has invested in many high-NPV projects, NPV, or net present value, is the present value of future cash flow.
- 3.Return On Equity
The ultimate aim of any investment is returns. Return on equity, or ROE, measures the return that shareholders get from the business and overall earnings. It helps investors compare profitability of companies in the same industry. A figure is always better. The ratio highlights the capability of the management. ROE is net income divided by shareholder equity.
ROE of 15-20% is generally considered good, though high-growth companies should have a higher ROE. The main benefit comes when earnings are reinvested to generate a still higher ROE, which in turn produces a higher growth rate. However, a rise in debt will also reflect in a higher ROE, which should be carefully noted,
One would expect leveraged companies (such as those in capital intensive businesses) to exhibit inflated ROEs as a major part of capital on which they generate returns is accounted for by debt,
- 4. Price - Book Value Ratio
The price to book value ratio, or PBV ratio, compares the market and book value of the company. Imagine a company is about to be liquidated. It sells of all its assets, and pays off all its debts. Whatever is left over is the book value of the company. The PBV ratio is the market price per share divided by the book value per share. For example, a stock with a PBV ratio of 2 means that we pay 2$ for every 1$of book value. The higher the PBV, the more expensive the stock.
Most companies have a PBV greater than one. This means that its market value is higher than its book value.
Why is this the case? There are two reasons:
First, investors will pay a premium above the book value if the company is expected to generate enough earnings in the future. These earnings justify a market value above the book value.
Second, the book value of the firm may not be up to date. For example, the value of an asset on a company's balance sheet often reflects what the firm paid for the asset. This is not necessarily what the asset is currently worth. The best example of this is property, which typically increases in value over time. In this case, the true book value is higher than what the financial statements imply.
The PBV is most relevant for firms that are close to liquidation or bankruptcy. If a firm is liquidated, shareholders receive the book value. Once caveat here is that the bankruptcy process is costly. There is no guarantee that shareholders receive the entire book value for a liquidated firm.
The PBV ratio is more useful for firms that hold assets of tangible value. Manufacturing firms are a good example. They hold property, machinery, plants, etc. For firms with few tangible assets, the book value is less relevant. For example, companies that consists solely of employees, computers, and office space, don't have a meaningful book value.
- The Price - Book Value Ratio Formula: The PBV ratio is the market price per share divided by the book value per share. The market price per share is simply the stock price. The book value per share is a firm's assets minus its liabilities, divided by the total number of shares.
- PBV ratio = market price per share / book value per share
- 5. Operating Profit Margin (OPM)
Operating Profit Margin is a profitability or performance ratio that reflects the percentage of profit a company produces from its operations before subtracting taxes and interest charges. It is calculated by dividing the operating profit by total revenue and expressing it as a percentage. The margin is also known as EBIT (Earnings Before Interest and Tax) Margin.
Operating Profit Margin differs from Net Profit Margin as a measure of a company’s ability to be profitable. The difference is that the former is based solely on its operations by excluding the financing cost of interest payments and taxes.
An example of how this profit metric can be used is the situation of an acquirer considering a leveraged buyout. When the acquirer is analyzing the target company, they would be looking at potential improvements that they can bring into the operations.
The operating profit margin provides an insight into how well the target company performs in comparison to its peers, in particular, how efficiently a company manages its expenses so as to maximize profitability. The omission of interest and taxes is helpful because a leveraged buyout would inject a company with completely new debt, which would then make historical interest expense irrelevant.
A company’s operating profit margin is indicative of how well it is managed because operating expenses such as salaries, rent, and equipment leases are variable costs rather than fixed expenses. A company may have little control over direct production costs, such as the cost of raw materials required to produce the company’s products.
However, the company’s management has a great deal of discretion in areas such as how much they choose to spend on office rent, equipment, and staffing. Therefore, a company’s operating profit margin is usually seen as a superior indicator of the strength of a company’s management team, as compared to gross or net profit margin.
- 6. Interest Coverage Ratio
It is earnings before interest and tax, or EBIT, divided by interest expense. It indicates how solvent a business is and gives an idea about the number of interest payments the business can service solely from operations.
One can also use EBITDA in place of EBIT to compare companies in sectors whose depreciation and amortisation expenses differ a lot. Or, one can use earnings before interest but after tax if one wants a more accurate idea about a company's solvency.
- 7. Price/Earnings Growth Ratio
- Example of the PEG Ratio Calculation
Using the example shown in the table at the top of this guide, there are three companies we can compare Fast Co, Moderate Co, and Slow Co.
Fast Co has a price of $58.00, 2018 EPS of $2.15, and 2019 EPS of $3.23.
Fast Co, therefore, has a P/E of 27.0x, which divided by its growth rate of 50, results in a PEG ratio of 0.54.
Moderate Co has a price of $146.12, 2018 EPS of $11.43, and 2019 EPS of $13.25.
Moderate Co has a P/E of 12.8x, which divided by growth in EPS of 15.9, results in a PEG of 0.80.
Slow Co has a price of $45.31, 2018 EPS of $8.11, and 2019 EPS of $8.65.
Slow Co’s P/E is 5.6x, which divided by growth of 6.7, results in a PEG ratio of 0.84.
Based on the above examples, Fast Co has the highest P/E ratio at 27-times, and on the surface, it may look expensive. Slow Co, on the other hand, has a very low PE ratio of only 5.6-times, which may cause investors to think it’s cheap.
There is one major difference between these two companies (all else being equal), which is that Fast Co is growing its earnings per share at a much faster rate than Slow Co. Given how quickly Fast Co is growing, it seems reasonable to pay more for the stock. One way of estimating how much more, is by divided each company’s PE ratio by its growth rate. When we do this, we see that Fast Co may actually be “cheaper” than Slow Co given its increasing EPS.
- 8.Dividend Yield
Dividends are an essential part of any investor's portfolio. While they are not guaranteed, few companies cut or eliminate dividends so that investors can rely on this income stream.
However, when it comes to investing in stocks, you must examine the company's ability to pay its dividend. That's where the dividend yield ratio comes into play.
The dividend yield ratio measures a company's dividend payment relative to its share price. Analysts and investors use this ratio to determine whether a stock is undervalued or overvalued. It is also viewed as a general indicator of its financial strength and health. It measures their ability to generate cash flow (through dividends) and pay back their long-term debt (if applicable).
When it comes to dividend stocks, the dividend yield ratio is a good tool and provides an easy way to compare the dividend yields between different companies.
Trying to figure out what a stock is worth can be difficult. The P/E ratio is a popular method of comparing the price of a stock with its earnings (the company's profits).
One problem with the P/E ratio is that it only considers one aspect of a company's valuation. Dividends can also be quite significant especially for income-seeking investors.
The Dividend Yield Ratio compares dividends against stock price. It is calculated by dividing the annual dividend yield by the P/E ratio.
- 9.Asset Turnover Ratio
It shows how efficiently the management is using assets to generate revenue. The higher the ratio, the better it is, as it indicates that the company is generating more revenue per rupee spent on the asset. Experts say the comparison should be made between companies in the same industry. This is because the ratio may vary from industry to industry. In sectors such as power and telecommunication , which are more asset-heavy, the asset turnover ratio is low, while in sectors such as retail, it is high (as the asset base is small).
Primarily company analysis can be segregated into two methods:
1. Top Down Approach: In the top-down approach, the investors start analyzing by looking at the macroeconomic factors like monetary policy, inflation, economic growth, broader events before digging deep into the individual stock.
The investor looks for the factors, events prevailing in the market and tries to understand the opportunity that could be derived from it.
2. Bottom Up Approach: In this approach, we start by analyzing the individual companies and then building a portfolio based on the specific attributes.
Investors tend to focus on the micro-economic factors in this method of investing.
How do we evaluate the company fundamentals?
First we need to have a brief overview about the company’s business model. As discussed earlier, we need to see how the company manufactures and sells its products or services.
From the point of getting the raw materials to selling the products; a series of steps need to be taken.
For example, let’s say in the case of Dabur, first, we need to get an idea about the company from the About
Corporate Profile section.
Then, we can get further details about the company’s business model from the Annual Report which is published annually.
The business model analysis includes getting the information of the raw material as to how it is supplied to the retailers.
This step will help us to get an idea of how are the different products manufactured and are supplied to the various suppliers.
Post getting to know about the business model, we need to check the financials of the company. We will get these from the Profit & Loss Statements. Analyzing the financials and the balance sheet will help us to get an idea of the financial position of the company.
We will get the Financials and Balance Sheet in the Annual Report from where we can analyze the performance of the company compared to the previous fiscal year.
Now, the financial analysis should also be done on a comparable approach, like how is the revenue growth, PAT growth, or the margins expansion/contraction compared to the industry leader i.e HUL.
Only then it is possible for us to conclude whether the company fared well or was average. Balance Sheets can be analyzed on a year-on-year change basis.
Cash Flow Statements should also be analyzed on the basis of three activities: Operating, Investing, and Financing activities.
Finally, we need to compare with these data with the peers which will help us understand about the company from a comparative point of view. This step will help us understand how the company is actually performing compared to the industry players.
For the final comparable analysis, we need to prepare an excel wherein we get the few closest comparable of Dabur which are present in the FMCG industry.
From there we can analyze the revenue growth, PAT growth, margins, and debt levels among others.
We also need to conduct a ratio analysis with the peers which will help us get a fair idea of how does the company operates and also its strengths and weaknesses.
Analysts are trained professionals who do this day in and day out.
But being a retail investor it is not always possible to give so much time for the analysis.
Thus, that basic investing and accounting knowledge is sufficient to generate moderate returns.
Thus to create wealth you need to find out where to collect data from. Learn how to do the fundamental analysis of a company step-by-step.
Frequently Asked Questions
- What’s the difference between company analysis and business analysis?
Company analysis gives the performance of a particular company. It includes all the areas of business in which it is engaged and in all the segments and how they are performing.
On the other hand business analysis is the examination of the business in which the company is engaged and how well it is doing in that context with regard to other companies in a similar business.
- What is Company Analysis?
Company analysis is the process by which investors evaluate securities, the company’s profile, profitability, and its products and services for the investment process.
- What are the factors of company analysis?
Factors affecting company analysis are qualitative factors and quantitative factors. Qualitative factors are business models, competitive advantage, Management, and corporate governance. Quantitative factors deal with company growth and industry growth along with its peers.
Explained too well.👌👌👌
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