Financial Markets and Investments

Module Introduction to Financial Markets

Session No. IV

Version 1.0
 Financial Markets and Investments

Material from the published or unpublished work of others which is referred to in the Class
Notes is credited to the author in question in the text. The Class Notes prepared is of 868
words in length. Research ethics issues have been considered and handled appropriately
within the Globsyn Business School guidelines and procedures.

FM&I/M4SIV/v1.0/291119 Valuation of Stocks | Session No. IV

 Financial Markets and Investments

Table of Contents

1. Brief about the Company and Relevant Financial Variables............................... 4

1.1. Calculation of EPS ................................................................................................ 4

1.2. Return on Net Worth ............................................................................................. 4

1.3. Net Asset Value .................................................................................................... 5

2. Price Earnings Ratio ................................................................................................. 5

3. Observation in terms of P/E Ratio ........................................................................... 5

4. Recommendation ...................................................................................................... 6

References ..................................................................................................................... 6

List of Figure

Figure 1: Weighted Average Chart of Three Variables ............................................... 4

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 Financial Markets and Investments

1. Brief about the Company and Relevant Financial Variables

Euro Vitrified tiles has been operating in the tiles industry since 2003. It came out with a public
issue of 56.125 lakh shares. The earnings per share (EPS); Return on Net Worth (RONW) and
Net Asset value (NAV) are given through a chart for the preceding three years and the same is
laid down below:
Figure 1: Weighted Average Chart of Three Variables

(Accounting Tools, 2019)

1.1. Calculation of EPS

EPS stands for Earnings Per Share. When the earnings of a firm are divided by outstanding
shares the earning per share is created. Here earnings denote Profit After Tax (PAT). If there is
any preferred dividend it should be deducted from profit after tax (Clear Tax, 2019).

PAT−Preferred Dividend
EPS =
Outstanding shares

Different EPS of the firm should be considered for evaluating the performance of the P/E Ratio.
For this purpose, the investor should check the weighted average EPS of the firm. While
computing the weight the volume of shares is required to be considered. Sometimes new
shares are added up. Sometimes shares are repurchased. These facts should be counted to
ascertain the correct weight of EPS.

1.2. Return on Net Worth

This ratio refers to the efficiency of the shareholders’ capital to generate profit. The investors put
their attention over the ratio as the profitability of the company can be understood through it. It is
calculated by dividing the net income of the firm by stockholders’ equity. The net income covers
its elements – revenue and expenses for the last 12 months. The volume of profit is generated

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 Financial Markets and Investments

by the company to its shareholders from the equity.Moreover, this equation also reveals the
capacity of a firm to create more profit in a certain industry in comparison to the capacity of
other firms belong to the same industry (Borad, 2019).

1.3. Net Asset Value

The net value of a firm is represented by Net Asset Value (NAV), which is a difference between
total value of entity’s asset and total value of its liabilities. In particular, NAV is the ratio of
difference between asset value and liability value by number of units (shares) outstanding. NAV
is often associated with mutual fund (Borad, 2019).

2. Price Earnings Ratio

Price Earnings (PE) ratio is a certain multiplier which is used to measure relative valuation.
Relative valuation is an attempt to find a comparison of an asset with another asset that closely
resembles the asset that an investor needs to value. The PE ratio represents the efficiency of
the market in measuring the level of accuracy of a certain asset in comparison with the
performance of another asset(Clear Tax, 2019).

Market Price
Price Earnings Ratio =
Earning per share

Market price = P0, Earnings per share = E0

In valuing a share Price Earnings ratio (P/E ratio) follows the following relative principles:
• Identify the firm under a certain industry the share of which is required to be valued.
• Find the P/E multiple of the industry.
• Project the relative position of the firm in the industry. There are three states under
relative position. These are good, average, and below average.
• Project the earnings of the firm.
• Project the value of the asset by applying appropriate multiples.

3. Observation in terms of P/E Ratio

RONW; P/E Multiplier NAV are the three parameters which are used for relative valuation. The
results of all these parameters of a certain company are compared with other firms belonging to
similar industry (Damodaran, 2019). Among all relative valuation techniques P/E Multiplier is
considered as one of the best multiplier in stating the value of a firm. In this context the present

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 Financial Markets and Investments

company, Euro Ceramics Ltd. has an EPS in 2005-06 is 17.81. The price of the share is Rs.
165. Therefore, the Price Earnings ratio is 165 / 17.81 = 9.26

This P/E ratio should be compared with other P/E ratios of several companies under ceramic
industry. Whether the current P/E ratio is justified in comparing with other P/E ratios that is
required to check. When this ratio is compared with the highest P/E ratio (22.30) and Lowest
P/E (5.80) ratio under ceramic industry it is observed that the P/E ratio of the present company
lies below average P/E ratio i.e. 15.

4. Recommendation
For the purpose of valuing an equity P/E ratio is used. It is regarded as a simple tool for stock
valuation. The result of this ratio is a reflection of the market’s current consensus on a
company’s future growth prospect. A high ratio indicates that the firm seeks to continue its
earnings opportunities that will eventually be returned as value to its shareholders. Considering
this fact, it is recommended that ceramic ltd should formulate an effective financial policy to
enhance the level of P/E ratio so that it can increase the value of the firm by attracting more
investors to buy its shares who will eventually get benefitted through better earnings. The
company should issue more shares whenever it is required to procure capital from the market
for business purpose. When more shares are issued EPS falls. Such slump in EPS helps to
increase the level of P/E ratio. It is assumed that share price remains unchanged.

References
Accounting Tools, 2019. What is the weighted average of shares outstanding?. [Online]

Available at: https://www.accountingtools.com/articles/what-is-the-weighted-average-of-shares-

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outstanding.html

[Accessed 27 11 2019].

Borad, S. B., 2019. Return on Net Worth. [Online]

Available at: https://efinancemanagement.com/financial-analysis/return-on-net-worth

[Accessed 29 11 2019].

Clear Tax, 2019. PE / Price to Earnings Ratio : Basics, How to calculate and More. [Online]

Available at: https://cleartax.in/s/price-earnings-ratio

[Accessed 29 11 2019].

Damodaran, A., 2019. Relative Valuation. [Online]

Available at: http://people.stern.nyu.edu/adamodar/pdfiles/execval/relval.pdf

[Accessed 29 11 2019].

FM&I/M4SIV/v1.0/291119 Valuation of Stocks | Session No. IV