As an investor, it’s important to compare the value of stocks to determine which stocks are worth investing in. The PSR ratio is one such metric which will help the investor determine high valued stocks.

What is Price-to-Sales Ratio?

Price-to-Sales Ratio is a valuation metric developed by Kenneth L. Fisher, a noteworthy stock market guru. It’s a concept that uses ‘sales’ as a primary parameter to evaluate a company. The PSE metric is based on the fact that sales are far more stable when compared to earnings which keep fluctuating. Similar to the P/E ratio, it is based on the top line rather than earnings per share. The PSE ratio will remain uninfluenced even with a change in the number of shares outstanding from share repurchases.

Why is it important?

The PSR ratio is important for analysing the fundamentals of a company. It helps avoid anomalies which result from arithmetically boosting and suppressing earnings, by manipulating or altering earnings and profits. Since investors may raise expectations to unrealistic levels for companies with strong early growth, a fall in earnings may subsequently result in a fall of stock prices especially when investors sell hurriedly.

Risk is a very real part of stock market investing. While betting on stocks, it is important to identify those stocks that are less susceptible to the fluctuations in the market.

What is Beta?

Beta is a measure of fluctuations in the overall stock market. Indicated by the Greek letter (β), beta shows the relative change in investment against a broader index (e.g., NSE NIFTY). In other words, beta calculates the volatility or risk for an asset. It’s a reflection of a stock’s responsiveness in relation with changes in the overall stock market. Using beta, you can decipher a pattern which reflects a stock’s openness to the market risk. A beta value above 1 indicates a risky stock whereas a beta value below 1 shows a less volatile stock. A positive beta value shows that the stocks and the market are moving in the same direction. If the stock’s beta value is 1.5, this stock will display 50% higher volatility than the market.

What information does it provide to investors?

Beta essentially helps investors’ pin-point how much their portfolio will swing when the market moves. It is also helpful for short-term decision making and lays the susceptibility of an investment on the table. The value of beta is an indicator of whether a particular stock, fund, or even an entire portfolio could go through large swings in the future. Beta is also a key metric in the Capital Asset Price Model (CAPM) which measures stock return.

When the stock price of a company rises, subsequently its revenue soars. However, based solely on these factors, an investor cannot be certain that it is a worthwhile stock to invest in. You need to dive into the growth rates of the company, its challenges and valuations to determine whether the stock is worth buying.

Characteristics of a worthwhile stock

Stock exchanges are riddled with too many listings, and it may be hard for a new investor to identify a worthwhile stock. However, the following characteristics that define a good stock will help you recognise one that’s worth investing in:

• A good stock comes from a company achieving consistently increasing profits. The fundamental indicators of the company will give you this information.
• A good stock comes from a company with low debt. A company with low liabilities will provide higher returns.
• A worthwhile stock comes from a company with a good product. If you observe the stock performance of companies with a popular product, you will realise that innovative product stocks display phenomenal performances.

Value determination methods are used to evaluate the value of an asset or a stock. However, these methods are on equal footing. Any one of these methods are not ultimate and are best used in conjunction. Depending on the risk factor and the type of trade, it’s better to employ one type of value analysis over the other. 

What is Fundamental Analysis?

Fundamental Analysis mainly studies ‘price movement’ to determine stock value. Through this method, the trader measures macro and micro economic factors including supply and demand, economic strength and growth. Fundamental Analysis is used to find out both the long-term as well as short-term value of an asset or stock. 

What is Technical Analysis?

Technical analysis employs the use of elements like patterns, trends, price movement, and volume to analyse trading activity in the stock market. By utilising the two key parameters namely, price movement and volume of a stock, it predicts the future potential of the stock. 

Differences between Fundamental & Technical Analysis

Here is a basic chart to help you understand the fundamental differences between the two

A long-term investor is always on the lookout for the ideal time to invest in profitable companies. When this window of opportunity opens up, usually during events like a market correction, you need to quickly build your portfolio. By building your portfolio at this time, you can dodge market volatility while giving you time to reap in the returns of your investments in the long-term. 

What is an investment portfolio?

Your investment portfolio is a crucial part of your long-term investment strategy. It’s a curated collection of financial asset classes, mainly your stock investments that collectively reflect your personal investment goals. 

Why it’s important to build a solid portfolio

A solid portfolio is a tool that generates long-term profitable returns. It’s a medium through which investors can reap benefits. A solid portfolio helps meet future capital requirements. A strong portfolio is also one that’s diversified which means that your capital is spread across multiple investment categories. By having a stronghold over multiple financial assets, a strong and diversified portfolio will balance out your capital if any one or few of your asset classes aren’t performing. 

Steps for creating a profitable portfolio

Build your goals:

Before picking stocks for your profile, it’s important to clearly define your goals and your risk profile. First, define your goals clearly. What are you trying to achieve with your investment? Nurture realistic goals like ‘raising INR 10 Lakhs in the next 2 years’ rather than investing for vague reasons like ‘I want to become the next Jordan Belfort’ or ‘I want to become rich’. 

Make healthy investments

Healthy investments include a good collection of high-quality stocks. They need not necessarily be cheap but are guaranteed to perform well. Don’t get tempted to purchase a ton of penny stocks. 

Restrict your portfolio to a decent number of stocks

Collect a few high-performing stocks for your portfolio rather than hoarding too many stocks uncontrollably. 

Think in the long-term

Choose stocks backed by strong fundamentals and valuations since these will give you good long-term returns. On the other hand, stocks that are guaranteed to give you short-term returns are unsuitable for long-term returns and are hence not a good choice while building your portfolio.

Create a risk profile for yourself

Depending on your age and financial position, determine the amount of risk you are willing to take. For instance, if you are in your late years, you might want to minimise risk. Depending on your risk profile, you can invest in stocks that match your risk appetite. 

Choose an investment strategy

Pick either a conservative or an aggressive investment strategy.

Conservative strategy

This entails investing in safe, large cap stocks. As a conservative investor, you can allocate up to 80% of your investment for large cap, blue chip stocks. 

Aggressive strategy

An aggressive strategy entails investing in high-risk, high-return stocks, mainly small and mid-cap stocks. An aggressive investor must invest 20% of their capital in small caps, 30% in midcaps, and 50% in large cap stocks.

When a company gets listed on stock exchanges through the IPO process, they may not stay listed permanently. Owing to several factors such as internal changes, market, and environmental conditions, or even due to the health of the business, the company may stay listed on one exchange or multiple exchanges or may get delisted. When a company delists, it will no longer be available on the stock market for share purchase and thus its securities get removed. 

What is delisting?

Deslisting is a process in which a company is offboarded from one or more stock exchanges. Such companies go from being public listed companies to private companies once again. 

Reasons why companies delist from a stock exchange

• Companies may choose to voluntarily delist. 
• Regulatory factors could also play a part in the delisting of a company.
• If the company is struggling with their operations, it could get delisted or voluntarily delist. 
• If the business gets impacted due to fluctuating market prices. A good example for this is the sudden drop in petrochemical prices we witnessed last year.
• Project payments getting delayed or stuck in the market. 
• Delayed commissioning of projects. 
• Other factors that could lead to the delisting of the company include bankruptcy, mergers, non-compliance during listing, etc. 
• The need to become a private company once again due to overshooting costs of staying publicly listed. 

What happens to stocks held by shareholders after a company gets delisted?

Suppose shareholders purchase and hold stocks of a company that has been delisted. They will continue to hold ownership in the company based on the number of shares they own. However, the shareholder won’t be able to sell these stocks either on the BSE or the NSE. 

Additionally, he/she is free to approach an over-the-counter market to sell them to a buyer outside the stock exchanges. 

SEBI regulations and guidelines for delisting 

The Securities Exchange Board of India has laid out certain guidelines and regulations for delisting companies. As per Section 5.1 of SEBI’s Delisting of Securities Guidelines, 2003:

• A delisting company removing its securities from a stock exchange can only do so if they have been listed for a minimum period of 3 years on any exchange.
• The delisting company must provide an exit opportunity for its investors. 
• The delisting company shall determine an ‘exit price’ that’s in accordance with the ‘book building process’ mentioned in clauses 7-10 and 13-14.

When a retail investor makes his/her way into the world of stocks, the first factor to be considered is the price of stocks. However, just by looking at a low stock price one cannot tell the story of whether the stock is viable. A stock may have a low price but be high-valued. On the other hand, a stock may also be perceived as ‘expensive’ but may not result in profitable returns in the long-term. A new investor may not be able to tell the difference between a cheap stock and an expensive one. For this reason, you need a deeper understanding about the factors that determine the value of a stock.

Looking beyond share price – Understanding the value of a stock

The value of a stock is determined by whether it’s a good deal for the investor or not. A stock with an attractive valuation is one that comes from a worthy company and that will allow the investor to make handsome gains. 

It is important for a retail investor to look beyond the price of a stock due to the following key reasons:

• A stock’s share price tells very little about its value. For this reason, you shouldn’t make a buying decision based solely on the share price.
• It is not strictly true that a stock with a low price is ‘cheap’ or one costing higher is ‘expensive’.
• The price of a stock does not indicate whether it will go higher or lower in the foreseeable future.
• Very cheap stocks, also known as penny stocks, may seem profitable. But the fact is that penny stocks have the highest risk associated with them. 

A simple example

Let’s consider the simple example of a stock that’s available at an incredibly cheap price. Say the price of the stock was INR 60 and has now fallen to a price of INR 6. Now, the stock is considered a penny stock. But purchasing this stock is not recommended for two reasons:

• The price has fallen drastically which indicates poor stock quality.
• The price may further fall and achieve a INR 0 valuation due to its past performance.

Valuation ratios you need to know

To understand what the value of a stock entails, there are certain parameters called valuation ratios that you need to familiarise with

P/E Ratio (Price to Earnings)

PE Ratio is the ratio of the market price of a stock to its Earnings per Share (EPS). EPS for a stock is derived by dividing the net profit of the listed company by the total number of its outstanding shares. 

P/B Ratio (Price to Book)

This ratio compares a stock’s valuation against its company’s worth or book value. 

PEG Ratio (Price to Earnings Growth)

PEG ratio is obtained by dividing the PE ratio of a stock by the earnings growth rate. 

Stock Price vs. Stock Value – Which matters when?

When stock price matters

Stock price matters only to indicate its current market value to buyers and sellers.

Price matters when you are aware of the company’s potential for growth. 

Stock price matters in relation with the company’s capital cost and equity. If stock price plummets, it could indicate that the company may not sustain the capital market for long or may even shut down.

Price matters only in context of the stock’s market capitalisation and total number of shares allotted by the company.

Price matters for short-term traders rather than long-term investors since traders are more interested in price changes. 

When value matters

The value of a stock matters to decide whether a stock is cheap or expensive.

Stock value will help you gauge whether an investment is worthwhile. 

Judging the value will also give you an idea about whether you should sell or hold on to a stock in the long term.