NISM-Series-X-A: Investment Adviser (Level 1) · Investing in Stocks

Valuation Ratios and Equity Valuation Models for NISM

Updated 11 October 2026 · Fact-checked

Valuation ratios compare a share's price with earnings, book value or dividends to judge if it is cheap or dear. Models like the dividend discount model and DCF estimate intrinsic value as the present value of future cash flows. Compute the inputs, apply the formula, then compare value with market price.

Understand Valuation Ratios and Equity Valuation Models

A share's market price tells you what people pay. Valuation asks what the share is worth. If worth is above price, the share looks undervalued. If worth is below price, it looks overvalued.

There are two families of tools. Relative valuation uses ratios such as P/E, P/B and dividend yield. You compare them with the company's own history, its peers or the market. Absolute (intrinsic) valuation uses models such as the dividend discount model (DDM) and discounted cash flow (DCF). These add up the present value of expected future cash flows.

EPS is the profit available to equity shareholders per share. P/E shows how many rupees you pay for ₹1 of earnings. P/B compares price with the net worth per share. ROE shows how well the company earns on shareholders' money. DuPont analysis splits ROE into margin, asset turnover and leverage, so you see what drives it.

The discount rate in DDM and DCF is the return investors require. A higher required return or a lower growth rate gives a lower value. Ratios are quick but crude. Models are rigorous but very sensitive to inputs.

Key formulas to remember

Earnings per share (EPS): EPS = (Net profit after tax − Preference dividend) ÷ Weighted average number of equity shares; Only profit belonging to equity holders is used.
Price-earnings ratio: P/E = Market price per share ÷ EPS; Earnings yield = EPS ÷ Price, the inverse of P/E.
Price-to-book ratio: P/B = Market price per share ÷ Book value per share; Book value per share = Net worth ÷ Number of equity shares.
Return on equity: ROE = Net profit ÷ Average shareholders' equity × 100; Some questions use closing equity. Follow the data given.
DuPont identity: ROE = Net profit margin × Asset turnover × Equity multiplier; Margin = Net profit ÷ Sales. Turnover = Sales ÷ Total assets. Multiplier = Total assets ÷ Equity.
Dividend yield: Dividend yield = Annual dividend per share ÷ Market price × 100; Uses dividend per share, not EPS.
Dividend payout and retention: Payout = DPS ÷ EPS; Retention = 1 − Payout; Sustainable growth g = ROE × Retention.
Zero-growth DDM: V = D ÷ r; A perpetuity of a constant dividend.
Constant-growth DDM (Gordon): V₀ = D₁ ÷ (r − g), where D₁ = D₀ × (1 + g); Valid only if r > g. Value is today's price from next year's dividend.
DCF value: Value = Σ CFₜ ÷ (1 + r)ᵗ; Includes a terminal value at the end of the forecast period.

How to solve Valuation Ratios and Equity Valuation Models questions

Use this method for any numerical or conceptual question on valuation.

1Read what is asked: a ratio, a value, or a judgement (cheap or dear).
2List the data given and spot traps: preference dividend, face value, D₀ versus D₁, average versus closing equity.
3Write the formula before putting in numbers.
4Compute the base items first, such as EPS or book value per share, then the ratio.
5For DDM, confirm r > g and convert D₀ to D₁ if the question gives the last dividend.
6Check units: per share versus total, percent versus decimal.
7Compare the result with the market price or a benchmark and match it to the option wording.

Quickest way: Shortcut: rearrange the ratio

When to use it: Use when the question gives two of price, EPS and P/E, or asks for a value from a constant-growth dividend.

Price = P/E × EPS. EPS = Price ÷ P/E.
Book value per share = Price ÷ P/B.
ROE from DuPont: multiply the three given factors directly.
For Gordon, compute D₁ first, then divide by (r − g) written as a decimal.
Eliminate options that are off by a factor of (1 + g) or by a percent error.

Common mistakes in Valuation Ratios and Equity Valuation Models

Using D₀ instead of D₁ in the Gordon formula.
The question quotes the dividend just paid, and students plug it straight in.
Fix: If the dividend is 'just paid' or 'last', multiply by (1 + g) first. If 'expected next year', use it as given.
Using total profit instead of profit to equity holders for EPS.
Preference dividend is mentioned in a side line.
Fix: Subtract the preference dividend before dividing by equity shares.
Applying the Gordon model when g ≥ r.
Students compute blindly.
Fix: The model needs r > g. Otherwise it gives no meaningful value.
Confusing P/E with P/B.
Both have price on top.
Fix: P/E divides by earnings per share. P/B divides by book value per share, from the balance sheet.
Treating a low P/E as always a bargain.
Rule of thumb is overstated.
Fix: A low P/E may reflect low growth or high risk. Compare only with similar companies.
Dividing dividend yield by EPS or mixing percent and decimal.
Rushing under time pressure.
Fix: Yield uses price in the denominator. Convert 8% to 0.08 before computing.

Worked examples

Example 1

A company has net profit of ₹60 crore, preference dividend of ₹5 crore and 11 crore equity shares. The share trades at ₹100. Find EPS and P/E.

Show the solution

Profit to equity holders = 60 − 5 = ₹55 crore.
EPS = 55 ÷ 11 = ₹5.
P/E = 100 ÷ 5 = 20.

Answer: EPS is ₹5 and P/E is 20 times.

Example 2

A share paid a dividend of ₹10 per share last year. Dividends are expected to grow at 5% a year for ever. The required return is 15%. Find the intrinsic value.

Show the solution

D₀ = ₹10, g = 5%, r = 15%.
D₁ = 10 × 1.05 = ₹10.50.
V₀ = D₁ ÷ (r − g) = 10.50 ÷ (0.15 − 0.05) = 10.50 ÷ 0.10.
V₀ = ₹105.

Answer: Intrinsic value is ₹105 per share.

Exam tips

Read whether the dividend given is D₀ or D₁. This is the most common trap in DDM questions.
Memorise the DuPont three-part split and what each part measures.
Expect short numerical items on EPS, P/E and dividend yield. Write the formula and compute quickly.
On a 2-mark caselet question a wrong answer costs more, so recheck the arithmetic before you mark it.
Know which ratios are relative valuation and which models are intrinsic valuation.

Practice questions from Investing in Stocks

Valuation Ratios and Equity Valuation Models in other exams

The same ground in other exams, if you are preparing for more than one or want another angle on it.

Valuation Ratios and Equity Valuation Models: frequently asked questions

How do I calculate P/E ratio and EPS with an example?

EPS is profit to equity holders divided by the number of equity shares. P/E is price divided by EPS. If profit is ₹50 crore on 10 crore shares, EPS is ₹5. At a price of ₹75, P/E is 15.

What is the difference between P/E and P/B ratio?

P/E compares price with earnings per share and reflects profit. P/B compares price with book value per share and reflects net worth. P/B is often used for asset-heavy firms such as banks.

What is the dividend discount model formula?

For constant growth, V₀ = D₁ ÷ (r − g). Here D₁ is next year's dividend, r is the required return and g is the growth rate. It needs r to be greater than g.

How does DuPont analysis explain ROE?

It splits ROE into net profit margin, asset turnover and equity multiplier. Multiplying the three gives ROE. It shows whether returns come from profitability, efficiency or leverage.