Absolute PE: How to Estimate Intrinsic Value Of A Company?

The world of fundamental analysis is a dynamic one. Formulas, methods, strategies, tools, and technologies are regularly introduced across the world to add more accuracy to the analysis process. But while most such new introductions stay around for some time before getting replaced by something new, a few have retained their position.One such popular method of analysing stocks is absolute PE. Let us have a quick look at what it is and how it works-

The absolute PE (Price-to-Earnings) model was first introduced by VitaliyKatsenelson in his book Active Value Investing in 2007. Since then, investors have used this model to fundamentally analyse individual companies and compare them with others.It derives the intrinsic value of the stocks based on the company’s Dividend Yield, Earnings Growth Rate, Financial Risk, Business Risk, and Earnings Visibility. The intrinsic value of a company is determined with the help of the following formula- Intrinsic Value= Absolute PE x EPS (Earnings Per Share) Here, the EPS can be easily found on the company’s website or online financial portals. You only need to figure out Absolute PE.

To calculate absolute PE, you are required to follow six different steps that are divided into two categories- Adjusted PE and Risk Multipliers.

Adjusted PE involves-

1. Base PE
2. EPSG (EPS Growth)
3. DY (Dividend Yield)

Risk Multipliers are as follows-

1. Business Risk
2. Financial Risk
3. Earnings Visibility Risk

To calculate Absolute PE, you first need to find the Adjusted PE that is Base PE, adjusted for EPSG and DY. Once you have the Base PE, Absolute PE can be calculated with the help of the following formula- Absolute PE= Adjusted PE x Risk Multipliers (BR, FR, and EVR) Once you have absolute PE, it can be multiplied with EPS to find the intrinsic value of a stock.

Like all the different stock valuation methods, absolute PE is also subjective. It requires you to understand the industry a company is involved in and estimate the risk level. It is not always easy to estimate the business risk or whether you should assign a discount or premium to the value. However, there are other strategies to help improve the accuracy of this method.If you are new to the stock market and want to analyse companies and stocks fundamentally, mastering the absolute PE method is sure to enhance your investment journey.

The information contained herein is generic in nature and is meant for educational purposes only. Nothing here is to be construed as an investment or financial or taxation advice nor to be considered as an invitation or solicitation or advertisement for any financial product. Readers are advised to exercise discretion and should seek independent professional advice prior to making any investment decision in relation to any financial product. Aditya Birla Capital Group is not liable for any decision arising out of the use of this information.