How to Value Stocks: Sector-wise KPIs Beyond Just PE Ratio

Summary

This video explains why the P/E ratio, though widely used, doesn't accurately reflect the value of companies in certain sectors. It breaks down sector-specific metrics like Price to Book for banks, EV/EBITDA for healthcare, and market cap to embedded value for insurance, showing that different industries require different valuation methods. By examining real-world examples across sectors like banking, hospitals, FMCG, insurance, and retail, the video provides valuable insights on how to assess company value more effectively, helping investors avoid common pitfalls when evaluating stock potential.

Takeaways

• 😀 P/E ratio is a commonly used metric but may not reflect the true valuation of certain sectors like banks, hospitals, and retail.
• 🏦 For banks and NBFCs, the price-to-book ratio is a more accurate measure of valuation than the P/E ratio due to their unique business models based on interest spreads and balance sheets.
• 📊 When analyzing banks, key factors to consider include Return on Equity (ROE), asset quality, and the overall lending history of the institution.
• 🏥 In the healthcare sector, P/E ratios can be misleading due to high capital expenditures and debt. Instead, EV/EBITDA is a better metric for assessing profitability.
• 💉 For hospitals, track occupancy rate, ARPOB (average revenue per occupied bed), EV/EBITDA margin, and expansion strategy to assess their true value.
• 🍫 FMCG companies, despite their high P/E ratios, can justify the valuation through consistent earnings growth, strong brand loyalty, and high cash flow generation.
• 📈 In FMCG, P/E is useful but should be paired with metrics like ROCE (Return on Capital Employed) and free cash flow to assess long-term stability.
• 💡 The insurance sector requires focusing on market cap to embedded value (EV) rather than P/E, due to the long-term nature of the earnings.
• 🔐 For insurance companies, track the value of new business (VNB margin), annualized premium equivalent (AP growth), and persistency ratio to gauge growth potential.
• 🛍️ In retail, P/E ratios can be misleading during expansion phases, and metrics like EV/EBITDA, same-store sales growth, and revenue per square foot are more useful to assess operational efficiency and growth.
• 🧮 The key to effective valuation is understanding the unique characteristics and business models of each sector and choosing the right metrics accordingly, such as price-to-book for banks or market cap to embedded value for insurance companies.

Q & A

Why is the P/E ratio not the best valuation metric for certain sectors, like banking and healthcare?

The P/E ratio might not reflect the true value in sectors like banking and healthcare because these businesses operate differently. Banks earn money through interest spread, not just revenue or margins, and healthcare businesses are capital-intensive with significant depreciation and interest expenses that can distort profit figures.

What is a better metric for valuing banks compared to the P/E ratio?

The Price to Book (P/B) ratio is a more appropriate metric for valuing banks. It compares the market price of the bank to its book value per share, giving an idea of how much you're paying for each rupee of equity in the bank.

What role does Return on Equity (ROE) play in valuing banks and NBFCs?

ROE is crucial for valuing banks and NBFCs because it helps assess how efficiently the company is using its equity to generate profits. A high ROE, combined with strong asset quality and consistent earnings growth, can justify a higher P/B ratio.

Why is the P/E ratio misleading for the valuation of hospitals and healthcare services?

The P/E ratio is misleading for hospitals because their capital-intensive nature, with heavy investments in infrastructure and equipment, leads to significant depreciation and interest expenses. These costs can depress profits, even if the business is fundamentally healthy.

Which valuation metric is recommended for valuing hospitals and healthcare services?

EV/EBITDA is recommended for valuing hospitals and healthcare services. This metric strips out non-operating expenses like depreciation and interest, offering a clearer picture of the core operating profitability.

What are the key performance indicators (KPIs) to track when analyzing hospital stocks?

The key KPIs to track include occupancy rate (ideally above 60-65%), Average Revenue Per Occupied Bed (ARPOB), EBITDA margin (target of 20-25%), and the expansion strategy to assess the company's growth and profitability.

What makes the P/E ratio relevant for the FMCG sector?

The P/E ratio works well for FMCG companies because these companies are typically asset-light, with high cash flow and strong brand loyalty. They don't require heavy reinvestment in capital expenditure and often enjoy high return on capital and steady profit growth.

What additional metrics should be considered alongside the P/E ratio when evaluating FMCG companies?

In addition to the P/E ratio, it's important to consider Return on Capital Employed (ROCE), earning consistency, and free cash flow generation when evaluating FMCG companies.

Why is the market cap to embedded value ratio crucial for valuing life insurance companies?

The market cap to embedded value ratio is important because it compares the market's valuation of the insurance company to its existing business value, which includes both the current net asset value and the future profits from existing policies. It reflects how much premium investors are willing to pay for the company's future growth potential.

What should investors track when analyzing life insurance companies?

Investors should track the market cap to embedded value ratio, value of new business (VNB) margin, annualized premium equivalent (AP) growth, and persistency ratio to assess the company's long-term growth prospects and profitability.