Warren Buffett’s partner, Charlie Munger, once said, "A great business at a fair price is superior to a fair business at a great price." But how do we know if a price is "fair"?
This is the final stage of Fundamental Analysis. In previous modules, we found companies with great moats, honest management, and strong cash flows. But even the best company in the world is a bad investment if you pay too much for it. If you buy a dollar for two dollars, you lose money, no matter how shiny that dollar is.
Market Valuation Meter
Currently analyzing Price vs. Intrinsic Value...
1. Relative Valuation: The Multiples
Relative valuation compares a company's price to a specific financial metric (like earnings or sales) and then compares that "multiple" to its history or its competitors.
| Ratio | Formula & Explanation | Best Used For |
|---|---|---|
| Price to Earnings (P/E) | Market Price per Share / Earnings per Share (EPS) Tells you how many dollars investors are willing to pay for $1 of profit. A P/E of 20 means you pay 20 years of current profits to own the stock. | Stable, profitable companies (FMCG, IT, Pharma). |
| Price to Book (P/B) | Market Price / Book Value per Share Compares the market's value to the company's net assets. A P/B < 1 means you're buying the assets for less than their accounting value. | Banks, NBFCs, and asset-heavy industries (Steel, Cement). |
| EV / EBITDA | Enterprise Value / EBITDA The "Real" valuation. It includes the company's debt and subtracts its cash. It's how an acquisition expert looks at a company. | Comparing companies with different debt levels. |
| PEG Ratio | P/E Ratio / Annual EPS Growth Adjusts the P/E for growth. A PEG < 1 is often considered a "Growth at a Reasonable Price" (GARP) opportunity. | High-growth tech or startup-style firms. |
2. The Margin of Safety (MoS)
The Margin of Safety is the most important concept in value investing. It is the difference between the Intrinsic Value (what the business is truly worth) and the Market Price (what you pay).
The Bridge Analogy
If you build a bridge that can hold 10,000 pounds, you only let 6,000-pound trucks drive on it. That 4,000-pound gap is your Margin of Safety. If you are wrong about the truck's weight, the bridge still stands.
3. Intrinsic Valuation: The DCF
Discounted Cash Flow (DCF) is a method used to estimate the value of an investment based on its future cash flows. It is based on the principle: "A bird in the hand is worth two in the bush."
Since money today is worth more than money tomorrow (due to inflation and opportunity cost), we "discount" future cash flows back to the present. If the sum of all future cash flows (discounted) is higher than the current stock price, the stock is undervalued.
4. Common Valuation Traps
Avoid these two common mistakes that beginners make:
- The Value Trap: A stock with a P/E of 5 looks "cheap." But if the industry is dying or the management is stealing money, the earnings will disappear, and the stock will go to zero. "Cheap" is not always "Value."
- Growth at Any Price: A company growing at 50% sounds amazing. But if you pay a P/E of 200 for it, the company has to grow perfectly for 20 years just for you to break even. Any slight mistake will cause the stock to crash 80%.
Always look at the "10-year Median P/E" of a stock. If a stock usually trades at a P/E of 20 but is currently at 40, it is historically expensive, even if its competitors are at 50. Markets eventually return to their long-term averages.
Conclusion: Putting it All Together
You have now completed the Fundamental Analysis course at StocKart University. You have the tools to:
- Analyze the Economy and Industry (EIC).
- Verify the quality of Management and the Moat.
- Read and dissect the three Financial Statements.
- Calculate Profitability, Liquidity, and Solvency.
- Determine a Fair Value to ensure a Margin of Safety.