Chapter 10 carries 16 marks — the highest of any chapter in NISM Series XV. Master P/E, P/B, DCF, EV/EBITDA, and DDM with exam-focused explanations and practice questions.
Why Valuation Principles Is the Most Important Chapter in NISM Series XV
Chapter 10 carries 16 out of 100 marks in the NISM Series XV (Research Analyst) exam — more than any other single chapter. If you score well here, you have a meaningful head start. If you lose marks here, no other chapter can compensate. The chapter tests your ability to apply valuation models, interpret multiples, and identify overvalued or undervalued securities.
What Is Intrinsic Value and Why Does It Matter?
Intrinsic value is the true or fundamental value of a security, calculated by analysing its underlying financials — independent of what the market currently prices it at. A research analyst's job is to estimate intrinsic value and compare it to the market price. If intrinsic value > market price, the stock is undervalued (potential buy). If intrinsic value < market price, the stock is overvalued (potential sell).
Relative Valuation: P/E, P/B, and EV/EBITDA Explained
Relative valuation compares a company's multiples to peers or historical averages rather than calculating an absolute intrinsic value. It is faster and widely used by equity analysts. NISM XV tests all three major relative valuation multiples in depth.
Price-to-Earnings (P/E) Ratio
The P/E ratio compares a company's share price to its earnings per share (EPS). It tells you how much investors are willing to pay per rupee of earnings.
Key exam points on P/E: it cannot be used for companies with negative earnings; it varies significantly across sectors (technology companies trade at higher P/E than utilities); trailing P/E uses historical EPS, forward P/E uses estimated future EPS. The exam frequently tests which variant is used and when.
Price-to-Book (P/B) Ratio
The P/B ratio compares market capitalisation to book value (net assets). It is particularly useful for valuing banks, NBFCs, and asset-heavy businesses where book value is meaningful.
The exam tests P/B in the context of banks (where P/B is the primary valuation metric) and compares it to P/E. Know when each is more appropriate.
Enterprise Value to EBITDA (EV/EBITDA)
EV/EBITDA is a capital-structure-neutral multiple, making it ideal for comparing companies with different debt levels.
Absolute Valuation: Discounted Cash Flow (DCF)
DCF is the most rigorous valuation method. It calculates the present value of all future free cash flows a company is expected to generate, discounted back to today at the weighted average cost of capital (WACC).
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The exam tests DCF conceptually: understanding that a higher discount rate lowers the DCF value, that terminal value often accounts for 60–80% of total DCF value, and the limitations of DCF (sensitivity to assumptions, requires detailed forecasting).
Dividend Discount Model (DDM)
The DDM values a stock as the present value of all future dividends. It is most appropriate for mature, dividend-paying companies with stable growth.
NISM XV tests DDM in scenarios: given a dividend of ₹5, growth rate of 6%, and required return of 12%, the intrinsic value = 5 × (1.06) ÷ (0.12 − 0.06) = ₹88.33. Practice these calculations — numerical questions on DDM appear regularly.
Chapter 10 Practice Questions
Q1. A company has EPS of ₹20 and a market price of ₹400. What is its P/E ratio?
Answer: 20x. P/E = 400 ÷ 20 = 20. This means investors pay ₹20 for every ₹1 of annual earnings.
Q2. Why is EV/EBITDA preferred over P/E when comparing companies with different debt levels?
Answer: EV includes both equity and debt in the numerator, while EBITDA is pre-interest and pre-tax. This makes EV/EBITDA independent of capital structure — a highly leveraged company is not artificially penalised or favoured. P/E is distorted by interest expenses, making comparison across leverage levels misleading.
Q3. A stock pays a dividend of ₹8 next year. The required return is 14% and dividends are expected to grow at 6% forever. What is the intrinsic value?
Answer: ₹100. Using Gordon Growth Model: P = 8 ÷ (0.14 − 0.06) = 8 ÷ 0.08 = ₹100.
Q4. Which valuation multiple is most appropriate for valuing a bank?
Answer: P/B (Price-to-Book). Banks are valued on their net asset quality. EV/EBITDA is not meaningful for banks (interest is their core revenue, not a financing cost). P/E can be used but P/B is the primary metric.
Q5. What does a DCF terminal value represent?
Answer: Terminal value represents the present value of all cash flows beyond the explicit forecast period (typically 5–10 years), assuming a stable, perpetual growth rate. It often accounts for 60–80% of total DCF value, making it the most sensitive component of the model.
What to Study Next
Valuation connects directly to the chapters before and after it. Read our Chapter 12: Fundamentals of Risk and Return guide (10 marks) next — risk-adjusted returns are central to comparing valuations. Or go directly to the NISM Series XV complete exam guide for the full syllabus overview.