How to Know whether the shares are over or under valued???

First A disclaimer : - Here we are just going to tell you the way (simplest) to know whether the shares are overvalued or undervalued, well there are other ways too, but the method discussed here is the simplest way.

So, here we will be discussing two important ratios which give an idea about whether a share is over or undervalued, they are:

A)    P/E Ratio

B)    Earning Yield

A)    P/E Ratio

Price Earning Ratio (P/E Ratio) just tells that a share is trading at how many times of earnings.

Now suppose, a stock is priced at Rs. 50 and Earning Per Share is Rs. 2, then P/E ratio will be 50/2 = 25 i.e. Stock is trading at 25 times of its Earning.

B)    Earning Yield

This is just inverse of P/E ratio and is calculated in percentage terms. So if Earning Yield is low that means company is not doing well. To calculate in the example given above P/E was 25, so Earning Yield will be = 1/25*100 i.e. 4%.

Now main question is how to know whether it is overvalued or undervalued. For this you will have to study the trends of last 5 years P/E or Earning yield which will give an idea, Secondly you can compare company’s P/E ratio and Earning yield with the particular Industry P/E ratio and Earning Yield.

Hope it will help you while picking up the stocks.