Valuation Basics
You already know how to buy a stock or a fund. This chapter answers the harder question: is the price you're being asked to pay actually fair? A great company can be a terrible investment if you overpay for it, and a mediocre company can be a fine one if you buy it cheap enough. Learning to tell price from value is the single skill that separates investing from gambling.
Don't worry — there's no heavy math here. We'll build everything from one idea up.
The one idea everything rests on
A business is worth all the cash it will ever hand back to its owners over its lifetime — adjusted for the fact that cash arriving in the future is worth less than cash in your hand today.
- Cash flow
- The actual money a business generates and could pay out to owners (not an accounting figure — real rupees).
- Discounting
- Shrinking a future rupee to its "today" value, because waiting has a cost (you lose the chance to earn elsewhere) and a risk (the rupee might not arrive).
- Intrinsic value
- Your honest estimate of what the business is fundamentally worth, based on those future cash flows. It is a range and a judgment, never an exact fact.
Price vs earnings — the confusion that traps beginners
People say a stock "went up" and assume the company got better. Often it didn't.
- Price = the market's current quote per share. Driven by mood, demand, and news. Moves all day.
- Earnings = the actual net profit the business made. Measured per share as EPS (Earnings Per Share) = net profit ÷ number of shares. Moves slowly — once a quarter.
If the price rises while earnings stay flat, the market is simply paying more rupees for each rupee of profit. The business is no better; it's just more expensive. That's called multiple expansion, and it's a warning sign as often as a good sign.
The multiples — quick yardsticks for "expensive or cheap"
A multiple (or ratio) is a shortcut: instead of forecasting decades of cash flows, you compare price to one number (profit, book value, etc.). Fast, useful, and full of traps.
P/E — Price-to-Earnings
P/E = Price ÷ EPS (or Market cap ÷ Net profit). Read it as "how many years of today's earnings you're paying for the company." A P/E of 20 means you pay ₹20 for every ₹1 of annual profit.
As of June 2026, the Nifty 50 trades at a trailing P/E of roughly 20.7–20.8, against a long-run average near 20–21. So the broad Indian market is "fairly valued, with a slight premium." (Nifty P/B is about 3.07 and the dividend yield about 1.20%.)
P/B — Price-to-Book
P/B = Price ÷ Book value per share. Book value is roughly the net assets the company owns on paper. Useful for banks, NBFCs, and asset-heavy firms where those assets are real and measurable. Weak for software/brand businesses, where the real value (code, IP, reputation) barely shows on the balance sheet. P/B below 1 can mean a bargain — or that the assets are impaired and not worth their stated value.
EV/EBITDA — the debt-fair comparison
- Enterprise Value (EV)
- Market cap + debt − cash. The price to buy the whole business, debt and all.
- EBITDA
- Earnings Before Interest, Tax, Depreciation and Amortisation — a rough proxy for operating cash generation.
EV/EBITDA is capital-structure-neutral: it doesn't get distorted by how much debt a company carries, so it compares two firms more fairly than P/E. It's the preferred yardstick for capital-intensive, leveraged, or loss-but-cash-generating businesses. Lower = cheaper, all else equal. Indian retail investors lean too hard on P/E and ignore this one (and ignore debt) — a real edge if you don't.
PEG — adjusting P/E for growth
PEG = P/E ÷ annual earnings-growth %. A high P/E is justified if profits are growing fast. Rule of thumb: PEG ≈ 1 = fairly priced; below 1 = potentially cheap for its growth; above 2 = expensive. The catch: it depends on a forecast growth number — garbage in, garbage out.
Dividend yield
Annual dividend per share ÷ price. A measure of income, not growth.
Why a cheap stock stays cheap — the value trap
A statistically cheap stock (low P/E, low P/B) is often cheap for a reason: a dying industry, an eroding competitive moat, weak or self-dealing management, governance problems, a debt overhang, or earnings about to fall. The ratio is low because future cash flows are shrinking. The market is frequently right that it's cheap.
Margin of safety — Graham's seatbelt
Because your intrinsic-value estimate is just an educated guess, only buy when the market price sits meaningfully below it. Pay ₹70 for something you reckon is worth ₹100. That ₹30 buffer protects you from forecasting errors and bad luck. The more uncertain you are, the bigger the discount you should demand.
DCF intuition — without the spreadsheet
DCF (Discounted Cash Flow) is just the core idea made into steps:
- Estimate the free cash the business throws off each year into the future.
- Discount each year's cash back to today (a rupee in year 5 is worth less than a rupee now).
- Add up all those discounted amounts → that sum is your intrinsic value.
Future cash flows Discounted to today (~12%/yr)
Year 1: ₹100 ─────► ₹89
Year 2: ₹110 ─────► ₹88
Year 3: ₹120 ─────► ₹85
... ...
─────────
Intrinsic value = SUM of the right column
Two levers swing the answer hugely: the discount rate (more risk → higher rate → lower value) and the growth assumption. Tweak either slightly and the output moves a lot — which is exactly why you need a margin of safety. Use DCF to sanity-check, never to pretend false precision.
Valuing your own startup — same idea, more fog
As a founder, the logic is identical, but a young SaaS company has little or negative profit, so P/E is useless. So:
- VCs value startups on multiples of revenue or ARR (Annual Recurring Revenue) — e.g. "5× ARR" — instead of earnings.
- Comparables: what similar startups recently raised or sold for.
- VC method: project a future exit value, then work backward applying a target return to reach today's valuation.
India tax — the part that quietly eats your gains
Valuation tells you what to pay; tax decides what you keep. Budget 2024 changed equity capital-gains rules, effective 23 July 2024 (figures below are for FY 2025-26 — older articles citing 10%/15% are now stale):
| Type | What it is | Rate | Key detail |
|---|---|---|---|
| LTCG (Sec 112A) | Listed equity / equity MFs held more than 1 year, STT paid | 12.5% | Only on gains above ₹1.25 lakh/year (exemption raised from ₹1 lakh) |
| STCG (Sec 111A) | Same assets held 1 year or less | 20% | Raised from 15% |
Indexation (adjusting cost for inflation) has been removed for all assets except real estate. STT = Securities Transaction Tax, the small levy you pay on each market trade.
Key Takeaways
- Value = future cash flows discounted to today. Everything else is a shortcut for this one idea.
- Price ≠ value, and earnings ≠ price. A rising price with flat earnings just means you're paying more per rupee of profit.
- Multiples (P/E, P/B, EV/EBITDA, PEG, yield) are fast yardsticks but full of traps — never compare them across sectors, and never buy on a low ratio alone.
- A cheap stock often stays cheap for good reason — demand a durable business and a low price (the value trap).
- Always insist on a margin of safety — buy below your estimate of worth, because your estimate is only a guess.
- For your own startup, value rests on ARR multiples and comparables, not P/E — and dilution matters more than the headline valuation.
- Mind the tax: post-July-2024, equity LTCG is 12.5% above ₹1.25 lakh; STCG is 20%. Holding past one year can roughly third your tax bill.