5.20 Conclusions
By selectively conducting a price ratio analysis of a business,
including comparing price ratios across companies and relative to
the industry, you gain important insights into how the market is
pricing drivers of value.
This provides you with two types of information.
First, it is the market’s scorecard for evaluating
performance along various dimensions of the business strategy and
operational efficiency. Second,
it will provide an initial assessment of whether a stock appears to
be under or overvalued relative to its competitors and immediate
peer group.
In the next chapter, we
move from relative valuation using price ratios to the determining
the intrinsic value of a stock.
The intrinsic value can be used to decide whether a stock is
overpriced or underpriced.
Note that you cannot make such an assessment with price
ratios; the market price is an input into calculating the ratios.
So to decide whether a stock is trading at an appropriate
price, we need to value the company independently of the stock
price.