Assume the shopkeeper asks you to pay Rs 100 for a ten-rupee pen, which means you will be paying ten times the pen’s original worth. Will you proceed with the transaction? Of course not, you’ll look for another pen that is suitably valued.
The same case goes with stocks, there are certain stocks in the stock market which are overvalued, which means the price of a particular stock is above its intrinsic value. There are also other categories of stocks which are undervalued, which means the price of the stock is below its intrinsic value. There are certain factors which determine the valuation of various stocks such as rise and fall in demand, market fluctuations, unfounded decisions made by investors which inflate the prices of such stocks, etc.
Investors generally prefer investing in those stocks which are below their intrinsic value or undervalued, this concept is known as value investing. Several renowned market experts such as Warren Buffet and Benjamin Graham are mainly focused on value investing.
Elements Determining Overvaluation of Stocks
There are four elements which are being used by every investor in order to determine the valuation of the stock
1. Price-book ratio (P/B)
It generally determines the value the investor could get from the company in the event of it being sold or torn up. It is useful for value investing as many companies falter in their growth but they still have a good P/B ratio which is based on their underlying assets. The book value generally includes building, equipment, land and bonds etc.
Price of Stock/ Book value of all assets
2. Price- Earning ratio (P/E)
P/E ratio is the major determinant required for the valuation of the stocks. It’s the ratio of price of the stock and the earning per share.
P/E ratio = Price / Earning per share.
For instance, if a company P.E. ratio is 15 then it means that an investor is paying Rs 15/ share to earn a rupee on its investment.
Companies having a P/E ratio of 50 or above are considered overvalued by investors and experts.
3. Price-Earning-Growth ratio (PEG)
In order to make their valuation much more accurate, many investors use the price to earnings growth (PEG) ratio because the P/E ratio is insufficient on its own. This ratio in addition to the price and earnings growth it also looks at the historical growth rate of the company’s earnings.
PEG ratio= P/E ratio / Growth rate of company’s EPS
4. Dividend Yield
When a stock’s growth slows, the dividend yield comes for the rescue in the form of a secured return. This is why dividend-paying stocks are alluring to many investors: even if prices fall, you still get paid. The dividend yield indicates how much you’re getting for your money. This rate of return generally defines the valuation of the company.
Let us discuss the 5 most overvalued stocks which are expected to fall in 2023.
Check here to know more fundamental metrics of the stocks
List of Overvalued Stocks
Here are the list of overvalued stocks which you need to cautious for the time being.
1. Adani Transmission
Adani transmission is part of the Adani group company. It has shown an enormous growth of 50% in its share value last year.If we consider the valuation of the company its P/E ratio is 94x. The P/B ratio on the other hand have reduced to 10.31x
Due to the recent Hindenburg report both the P/E and the P/B ratio of Adani Transmission have declined drastically due to a fall in share prices.
Indian Railway Catering and Tourism Corporation Limited (IRCTC) is a public limited company . It is one of India’s largest companies and a subsidiary of Indian Railways. It provides catering, ticketing, and tourism services for the Indian Railways. The company is highly valued as being a public sector undertaking, which guarantees its stability.
3. Godrej Properties
Most real estate stocks have become overvalued following the aftermath of the first wave of the pandemic. Godrej Properties is one of the most overvalued stocks as its current P/E multiple accounts for 92.36x, which is around double the sector P/E. Whereas its book value remained stable.
4. Adani Green Energy
In Dec 2022 P/E and P/BV ratios for the company were 560x and 44.3x, respectively. As of March 31, 2022, the P/E and P/BV ratios were 479x and 89.4x, respectively. Its dominant position in the high-growth renewable energy sector could explain such excessive valuations. At present the company’s P/E ratio stands at 201.16x and P/B ratio at 37.63. This shows that the company valuation has been reduced and that is due to the Hindenburg allegations.
5. Adani Total Gas
Next on the list is again a stock from the Adani Group of companies which have got the largest valuation in the Indian financial market. Shares of the company are currently trading at a price-to- earnings ratio (P/E) of 804.8x, as against 463.9x as on 31 March 2022.
There are multiple reasons why many stocks are valued excessively in the market. One of the main reasons might be due to the company’s high future potential. Companies related to renewable energy, information technology etc. have got enormous valuations due to their future prospects and their need for development.
Now, the question arises whether it is safe to get these overvalued stocks in one’s portfolio. The answer lies in the future potential of the company you have betted on. If a company’s business has large scope in coming decades then these valuations are just in number as the company has the ability to manage it in future.
However, many investors strive for stocks which are undervalued, that is the price is below the intrinsic value. Such stocks have greater probability to provide huge returns by matching the valuation of the company in future.