Honasa Consumer, the parent company of Mamaearth has filed a DRHP with SEBI and proposed an IPO of ₹400 crore, whose valuation targeted by the company is ₹24,000 crore or $3 billion.
But, as an investor, how would you know that such a valuation is insanely overpriced? Before making an investment it is essential to know whether a stock is expensive or cheap, here is the formula to calculate on your own.
P/E Ratio
It is a widely used investment analysis tool to determine whether a company is suitable and sustainable to buy or not. It measures the company’s earning power in comparison to what they are paying for the stock.
The formula for calculating P/E Ratio is:
Market share price/EPS
For example- The market price per share is ₹100 and the EPS of the company is 10
P/E Ratio would be 100/10= ₹10
Where EPS means earning per share and it is calculated as:
Profit after tax/outstanding shares
Ideally, a high PE Ratio mainly refers to the stock price that you are willing to pay is more than what the company has the potential to earn as of now. Typically, a low PE Ratio is considered suitable to buy a stock. However, PE Ratio can also be looked at as a measurement of the market’s confidence in its growth potential. Before making any investment, always look at the true growth potential of the company by their recent corporate decisions and nearby vision.
Price-to-book ratio
In this ratio, you will get to understand how much a company’s market share price is far from its book value. If the share price of the company is higher than its book value it means the company is inflated.
The formula for calculating PB Ratio:
Share price as per book value/market share price
The higher the PB Ratio the more the inflated share price is and vice versa. In other words, a lower PB Ratio means the company has more potential to grow among its peers. This ratio is the best for comparing other companies before making an investment.
Price-to-sales ratio
It is the most common ratio you must look at before entering into any stock investment. It helps you to determine how much a company’s stock is inflated or deflated in comparison to its sales. It is a much more reliable ratio to use as manipulation of the revenue data is more difficult than other financial data of the company.
The formula to calculate the PS ratio is:
Market price per share/sales of the previous 12 months
A high PS ratio indicates an inflated valuation of the stock and vice versa. It is easy to calculate and denote a growth rate of revenue.
When we particularly talk about Mamaearth, every ratio suggests that the company is hyperinflated in its valuation. The PE ratio of the company is 1,714x. Its return on advertising spend is severely low, ranging between 2.4-2.6 times. Also, the company has reported only ₹14 cr of net profits against the demand of ₹24,000 cr valuation, which is more than 1000 times its profits.
As an investor, the above mentioned ratios help you in making the right investment decisions in growing companies rather than investing in companies at high prices that might never recover after the IPO launch.
Anushka Trivedi is a freelance financial content writer. She can be reached at anushkatrivedi.com
