Showing posts with label Price to Earnings Ratio. Show all posts
Showing posts with label Price to Earnings Ratio. Show all posts

Wednesday, September 21, 2016

Tuesday, September 6, 2016

Thursday, September 1, 2016

What is US Federal Reserve and How will a Fed Rate Hike Affect the Indian Stock Market?

Every country has a central bank akin to our own the ‘Reserve Bank of India (RBI)’ to regulate the commercial banks and craft and implement the the country’s monetary policy. The ‘US Federal Reserve’ is the central bank of the US.
Central banks world over usually discharge following functions:
  1. Regulate functioning of commercial banks in various ways.
  2. Monitor and control liquidity in the economy by mopping of excess liquidity in the system (by borrowing, raising limits of compulsory reserves like CRR and SLR) and creating liquidity where there is a shortage (recent Quantitative Easing measures of the US is an example).
  3. Determining the Interest Rates through the ‘Repo and Reverse Repo Rates’.
  4. Monitoring and controlling ‘Inflation’ or ‘Price Rise’ through the different monetary measures discussed above.

Although stagnant or on a slight decline for a decade perhaps, the US still is a great nation. Even though her economy is not in great shape (the US today carries the highest external debt in the world), in the absence of a credible alternative, its currency remains the last resort in an increasingly turbulent global economy.
In an effort to revive her sagging economy, the successive US governments, aided by the Federal Reserve, have been implementing following stimulus measures:
  1. Enhancing liquidity in the system through the most controversial and undesirable ‘Quantitative Easing’ or in plain words ‘Printing of Money’.
  2. In order to boost investment, maintaining negative or ridiculously low interest rates.
Since fortunately or unfortunately the US continues to be the dominant global power, her actions, including those of the Federal Reserve impact the world economies and financial markets, including the Indian stock market as follows:
  1. Excess Liquidity: Though meant for boosting domestic investment, cash invariably flows out and floods world markets. This results in a lot of money chasing a small number of stocks and other financial instruments. As per the latest study published by ‘Value Research’ an incredible 40% of the free floating shares of the Indian stock market is held by Foreign Institutional Investors or FIIs. This in-turn drives up valuations to absurdly high levels, making many goos stocks unaffordable to value investors.
  2. Maintaining low interest rates for long periods of time adversely impact the interest incomes of majority of common population - ultimately affecting internal savings and investments, which was the goal of the measure in the first place! Additionally it aids the flow of money from the US to global markets, especially emerging economies like India, in search of better interest rates and other investment returns.

In this overall scenario, in the light of signals emerging from the the US economy that it is strengthening and realising in hind sight that the stimulus measures are hurting the economy the Federal Reserve is attempting a course correction by restoring healthy interest rates gradually.
Having covered the basics and understanding the background let us now address your question in the following paragraphs.
  1. An increase in interest rates by the US Federal Reserve will have the impact of reversing the outward flow of liquidity. The FIIs will find it little more attractive to invest in their own home country. As a result they start selling their holdings in the world markets, causing a fall in stock prices globally.
  2. In addition, an increase in interest rates at home will make the Dollar stronger and conversely the other countries currencies, including the Indian Rupee, weaker. This will force the hands of FIIs to sell immediately, as otherwise they will face a double loss:

  • loss on sale that is certain to arise by selling latter in a falling market.
  • The currency exchange loss; when the Indian rupee depreciates, rupees 68 will fetch one dollar today will fetch less than a dollar after a week.
In the end, when the Fed increases rates, global markets will fall and liquidity in the global markets will reduce drastically. There is no doubt abiout this.
Real impact of market correction 
Is such a steep fall or deep correction of the Indian Stock Market good? Yes, it is really very good for the investors. Please note that excess liquidity chasing the small available floating stock has driven-up the valuations to unreasonable levels. While prudent investment guidelines prescribe a PE Ratio of 10 based on past five years earnings, the market today is trading at over 15 of expected, future earnings of the financial year 2016–17. As a result, real investors like you and I are unable to afford to buy shares at these levels.
In conclusion, the Indian stock market will correct on the back of the US Fed increasing interest rates, as and when it happens, and I as a value investor is eagerly looking forward to that day when I will be able to afford to buy many great Indian companies’ stocks like 'Infosys Ltd.', which I cannot afford presently.
Please Note: This is almost a reproduction of the question I had answered on the website ‘Quora’, which I thought could be useful to the visitors to this blog site also.


Tuesday, July 26, 2016

How to Calculate ‘Price to Earnings Ratio’?

Voyaging the exciting field of value investing requires scholarship of some central yet simple financial metrics of which ‘Price to Earnings Ratio’, also christened ‘PE Ratio’, is a key member. In the present essay, let us discover it.

As the title indicates, the proportion has two components, Price and Earnings. Price is the current market price of the stock and earnings is ‘Earnings Per Share’ or ‘EPS’, the meaning and the mode of computation of which are published in separate articles, elsewhere on this site.

Continuing with the example of NMDC Ltd. used in the other essay, summarized information assembled from the audited financial statements of NMDC Ltd., for the financial year 2014-15 show: Operating revenue 12356.41, total expenses 4740.29, non operating income 2265.40, exceptional items of charge 113.01, corporation tax 396.47 and miscellaneous debits 0.44. All numbers are expressed in Indian Rupees (Rs.) in crores  (10 millions) and the company has an equity capital of Rs.396.47 crores of nominal value of Rs.1 each, that is 396.47 crore shares.

On drawing up the profits and loss statement, the results will be as follows:


Rs. In crores (one crore = 10 millions)
Total Operating Revenues
12,356.41
Total Expenses
4,740.29
Operating Profits
7,616.12
Non Operating Revenues
2,265.40
Profit Before Exceptional Items
9,881.52
Exceptional Items
113.01
Corporate Income Tax
3,346.21
Miscellaneous Charges
0.44
Net Profit for the year
6,421.86
Number of Equity Shares (In crores (10 millions) of nominal value of Rs.1 each
396.47
Applying the formula EPS = Net Profit ÷ number of equity shares
Earnings Per Share – Rs. Per share
16.20

The current market price (CMP) of the scrip on the website of the popular financial newspaper ‘The Economic Times’ today, 26th July, 2016, is Indian ‘Rupees’ 100.25.

‘Price to Earnings’ is obtained by dividing the CMP by the EPS. 

Therefore, PE = 100.25 ÷ 16.20 = 6.19.

Recommended PE multiple for making a purchasing decision is a number below 10, and this scrip meets the criterion.


Wednesday, July 6, 2016

It is Far Better to Buy A Wonderful Company at a Fair Price than a Fair Company at Wonderful Price

When Warren Buffett said, “It is far better to buy a wonderful company at a fair price than a fair company at wonderful price”, he is clearly stating that the investor should only buy excellent companies’ shares and pay a reasonable price for them. 

So there are two distinct caveats in his advice – Excellent Company and Reasonable Price.

What is an Excellent Company?  Buffett has given ample clarity.  It should not only have had a long and successful existence, but should also be capable of thriving for a long time in future, and its products or business should be such that people will need them for foreseeable future. Mere longevity is insufficient, the business should have been profitable for a long time into the future and should be capable of generating profits and “”Free Cash Flows” well into foreseeable future.  The company should stick to its core business, never or insignificantly borrow, and shall possess the culture of rewarding the shareholders with handsome, regular and uninterrupted dividends.  Let us take the example of Gillette.   It produces excellent razors.  One can never foresee a replacement for razors or people not needing a shave, thus endowing permanence to the company’s business.  Thus, Gillette satisfies all the qualifications of an “Excellent Company”.

Now let us examine the price element.  We should not pay a fancy or unrealistic price.  If we do so the “Return On Investment” or “ROI” for the money we have invested will be poor.  However, this is easier said than done.  Today, on 7th July 2016, Gillette India Ltd. Shares are trading at an unrealistic, “Price-to-Earnings” or “PE” multiple of 63.76 as against the acceptable 10, and a “Price-to-Book Value” or “P2BV” of 20.44 as against the recommended 1.5.  Under such impractical market conditions what can we do? 

No reason to despair.  One can always find a handful of excellent companies whom the market is disfavoring at that time.  We should invest in those companies.  We should also make a list of the other excellent companies but which are expensive.  We should revisit them during large market crashes like the post “Lehman Brothers”.  My own experience shows that even during such extremely depressing times, companies like Gillette will not be available at the idealistic PE of 10 and P2BV of 1.5.  You may find them at a PE of 25 and a P2BV of five to ten, at that time you should BUY.  If you hesitate, you will never get the opportunity to own such companies.  I had vacillated, and let me admit, I do not own any of these good companies.

On the other hand, when people buy shares based on “Tips”, usually given by brokers and the So-Called-Experts, they end up doing the opposite of what Warren Buffett has warned, Buying Fair Companies At Wonderful Price, instead of Wonderful companies At Fair Price.