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Valuating the Fair Price of Shares with Financial Ratios

The value of a company's shares always moves dynamically with macro and micro economic conditions. So, how do investors know if a stock is cheap, fair or expensive? This is important to determine when to buy and sell stocks.


A fair price is a share price that is fairly valued based on an analysis of the issuer's financial performance. The assessment can be done by comparing financial ratios between issuers in similar industry sectors.


Financial ratios used to assess the fair price of a stock include PER, PBV, and DY.


Financial ratio

1. Price to Earnings Ratio (PER)


Price to Earnings is the ratio of the stock price to the company's earnings per number of outstanding shares (EPS). The PER can be formulated as follows.

PER formula

Example 1


Manufacturing company A's stock is currently at Rp5,000. The net profit for the previous quarter was Rp750,000,000 while the number of outstanding shares is 1,500,000.


PER = 5,000 / (750,000,000 ÷ 1,500,000) = 10


If other manufacturing companies have a PER in the range of 0.86-43.45 with an average of 14.82*, it can be concluded that the share price of company A tends to be undervalued (cheap) because its PER is below average.


*Based on the journal article Price earning ratio, ukuran dan nilai perusahaan pada perusahaan manufaktur di Indonesia” (Wiratno & Yustrianthe, 2022).


2. Price to Book Value (PBV)


Price to Book Value is the ratio of stock price to the company's book value or net assets per number of outstanding shares (BVPS). The PBV can be formulated as follows.

PBV formula

Example 2


Manufacturing company X's stock is currently at Rp10,500. The book value of the previous quarter was Rp5,000,000,000 while the number of outstanding shares was 1,000,000.


PBV = 10,500 / (5,000,000,000 ÷ 1,000,000) = 2.1


If other manufacturing companies have a PBV in the range of 0.17-7.45 with an average of 1.86*, it can be concluded that the share price of company X tends to be overvalued (expensive) because its PBV is above average.

*Based on the journal article “Price earning ratio, ukuran dan nilai perusahaan pada perusahaan manufaktur di Indonesia” (Wiratno & Yustrianthe, 2022).


3. Dividend Yield (DY)


Dividend Yield is the ratio of dividend per share to stock price. The DY can be formulated as follows.

Dividend yield (DY) formula

Example 3


Financial company B paid a dividend of Rp350 per share in certain period. Its stock price at that time was Rp5,000.


DY = (350 / 5,000) × 100% = 7%


The higher the DY of a stock compared to other issuers in similar industry sectors, the better the performance of an issuer and the fairness of its price. DY is also expected to increase every dividend period.


 

Disclaimer: The content is made for educational purposes, not a recommendation to buy or sell a particular stock. PT KAF Sekuritas Indonesia is licensed and supervised by the Financial Services Authority (OJK).



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