Stock comparison is a viable method to analyse the actual value of a stock. Financial ratios, such as P/E (price-to-earnings) ratio, D/E (debt-to-equity) ratio etc., offer a sneak peek into the stock’s performance. Comparing a company’s stock fundamentals with its peers within the same sector is necessary to make an informed investment decision to buy stocks.

Analysts and investors perform equity analysis by comparing stocks of the same sector. The equity analysis technique can help them filter overvalued and undervalued stocks quickly and efficiently.

Comparable valuation

A straightforward approach for comparing a company’s stocks within a sector is putting its fundamental values vis-à-vis its peers. 

• Select a financial ratio viz. price-to-earnings (P/E), debt-to-equity (D/E), Return on Equity (ROE), or any other
• Note its value associated with the company in which you want to invest
• List down the peers, i.e., companies from the same sector
• Note down the peers’ ratios as well—the one you selected in the first step and calculated in the second
• Arrange them in a definite order for easy comparison

Now, before comparing the stocks, it is crucial to understand what each ratio indicates.

P/E ratio

If the P/E ratio is high compared to the average P/E ratio for that sector, it affirms the probability of an overvalued stock because investors are willing to pay high share prices in return for profits. On the contrary, if the P/E ratio is low, it means the stock performs below par or trades at a price well below its potential. Studying long-term prospects while understanding the P/E ratio is advisable.

P/S (price-to-sales) ratio

A higher-than-average value means a stock’s value is higher than it should be. If the P/S ratio is high, investors are ready to shell out more money per unit of sale for a stock. On the flip side, if the P/S ratio is low, it means the stock is undervalued and could be a great investment opportunity.

D/E ratio

If the D/E ratio is high, it suggests the funding of a company is majorly through debt. As a result, it becomes critical while evaluating stock’s performance because it could have high obligations.

Other metrics to consider

• Check and compare the expected annual earnings growth of a company within the sector. It is always better to invest in a company with high expected yearly earnings
• Also, you can invest in a company with a higher ROE than the median value of a sector. It indicates that the company is good at making profits from its equity capital
• Skim through the financial statements of the companies to assess the management quality and stability. It is advisable to go for a company with stable management

Comparing stocks to make prudent investment decisions

Analysing a company’s financial strength is one aspect, but you need to keep an eye on qualitative and competitive elements. Everything associated with a company adds to its value in the market; hence, comparing the stocks on various parameters is advisable before making an stock market investment.