Stock Valuation Simplified: How to Find a Stock's True Worth

Is that stock you’ve been eyeing a future multi-bagger or an overpriced dud? This is the million-rupee question every investor in India asks. The answer lies in stock valuation—the process of determining the intrinsic, or “true,” worth of a company.

It might sound complex, but the core idea is simple: you want to buy a stock for less than its actual value. Think of it like buying a house. You wouldn’t just pay the asking price without checking its condition, location, and the prices of similar houses in the area. Stock valuation is your due diligence on a company before you invest your hard-earned money.

Key Takeaways

• Valuation helps you avoid overpaying. It provides a logical framework to decide if a stock’s market price is fair.
• There are two main approaches: Intrinsic Valuation (what the business is worth on its own) and Relative Valuation (how it’s priced compared to others).
• No single method is perfect. Using a combination of methods provides a more balanced and reliable view of a stock’s worth.

Intrinsic vs. Relative Valuation: Two Sides of the Same Coin

All valuation methods can be broadly split into two camps. Understanding this difference is the first step to becoming a smarter investor.

1. Intrinsic Valuation: This approach calculates the “true” value of a company based on its financial health and future potential. It ignores market noise and focuses purely on the company’s ability to generate cash. The most famous method here is the Discounted Cash Flow (DCF) analysis.

2. Relative Valuation: This is a more straightforward approach. It compares a company’s valuation metrics to those of its competitors or the industry average. If a company is cheaper than its peers based on certain ratios, it might be considered undervalued. The Price-to-Earnings (P/E) ratio is the most common tool for this.

Imagine you’re buying a mango. An intrinsic approach would be to judge its value based on its sweetness, size, and freshness. A relative approach would be to see what other mango sellers are charging for similar-looking mangoes. Both methods help you decide if you’re getting a fair price.

The “Crystal Ball” Method: Discounted Cash Flow (DCF)

The Discounted Cash Flow (DCF) model is considered the gold standard of intrinsic valuation. While it sounds intimidating, the concept is quite logical.

The Core Idea: A company’s value today is the sum of all the cash it’s expected to generate in the future, discounted back to its present value.

Why “discounted”? Because a rupee you receive tomorrow is worth less than a rupee you have today. This is the time value of money—you could invest today’s rupee and earn a return on it. The DCF method accounts for this by using a “discount rate” to calculate the present value of future cash flows.

How It Works (Simplified):

1. Project Future Cash Flows: Estimate the company’s free cash flow over a period, typically 5-10 years.
2. Calculate Terminal Value: Since a company will likely operate beyond the projection period, a “terminal value” is calculated to represent all cash flows after that.
3. Discount Everything: Both the projected cash flows and the terminal value are discounted back to today’s value using the discount rate.
4. Find the Intrinsic Value: The sum of these discounted values gives the company’s intrinsic value per share. If this value is higher than the current stock price, the stock may be undervalued.

Pros:

• It’s based on a company’s fundamentals, not market mood swings.
• It forces you to think critically about a company’s long-term prospects.

Cons:

• It’s highly sensitive to assumptions. A small change in growth or discount rate projections can drastically alter the final valuation.
• It’s less reliable for companies with unpredictable cash flows, like startups or businesses in distress.

The “Neighbour’s Envy” Method: Comparables (Relative Valuation)

This is the most widely used valuation method due to its simplicity. Instead of complex forecasts, you compare a company to its peers.

The Core Idea: Two similar companies in the same industry should trade at similar valuation multiples.

The most popular multiple is the Price-to-Earnings (P/E) Ratio.

P/E Ratio = Current Market Price per Share / Earnings Per Share (EPS)

It tells you how many rupees you are willing to pay for every one rupee of the company’s annual earnings.

How It Works (Example):

1. Calculate the P/E Ratio: Let’s say Company A trades at ₹500 and its EPS is ₹25. Its P/E ratio is 500 / 25 = 20.
2. Find the Industry Average: You find that other similar companies in its sector are trading at an average P/E of 25.
3. Compare: Since Company A’s P/E (20) is lower than the industry average (25), it might be considered relatively undervalued. As of late June 2025, the Nifty 50 index has a P/E ratio of around 23, which can serve as a broad market benchmark.

Other common multiples include:

• Price-to-Book (P/B): Compares the stock price to the company’s book value per share. It’s useful for banks, financial institutions, and manufacturing companies.
• EV/EBITDA: Compares Enterprise Value (Market Cap + Debt - Cash) to Earnings Before Interest, Taxes, Depreciation, and Amortization. This metric is great for comparing companies with different debt levels and tax rates.

Pros:

• Quick and easy to calculate and understand.
• Reflects current market sentiment and provides a good starting point for analysis.

Cons:

• It assumes the market is pricing the peer group correctly, which isn’t always true.
• It doesn’t work for loss-making companies (which have negative earnings).
• Finding truly comparable companies can be challenging.

The “Scrap Value” Method: Asset-Based Valuation

This method values a company based on the net value of its assets. It’s like calculating what would be left if the company shut down, sold all its assets, and paid off all its debts.

The Core Idea: Value = Fair Market Value of Total Assets - Total Liabilities.

This approach is most useful for asset-heavy industries like manufacturing, real estate, or for holding companies. It provides a “floor” value for the stock, as it often doesn’t account for intangible assets like brand value or future growth potential.

Simple Example:

• A manufacturing company has land and machinery worth ₹10 crore (Fair Market Value).
• It has other assets like inventory worth ₹2 crore.
• Its total liabilities (loans, payables) are ₹5 crore.
• Net Asset Value = (₹10 Cr + ₹2 Cr) - ₹5 Cr = ₹7 Crore.

If the company has 1 crore shares outstanding, the asset-based value per share would be ₹70.

Pros:

• Provides a conservative, baseline valuation.
• Useful for companies facing liquidation or in capital-intensive sectors.

Cons:

• Largely ignores the company’s earning power and future growth.
• Determining the fair market value of assets, especially intangible ones, can be subjective and difficult.

Which Method Is Best?

There is no single “best” method. A savvy investor uses a combination of these techniques to build a holistic view.

• Start with the Comparables Method for a quick market snapshot. How is the stock priced relative to its peers?
• Use DCF to form your own opinion on the company’s intrinsic worth based on its future potential.
• Use Asset-Based Valuation to establish a conservative floor price, especially for industrial or holding companies.

By cross-referencing these different values, you can build conviction in your analysis, make more informed decisions, and increase your chances of finding truly valuable investment opportunities in the Indian stock market.

Disclaimer: This article is for informational and educational purposes only and should not be considered investment advice. Please conduct your own research before making any investment decisions.