If you want to make sure that your Investment stays effective in the future, you’ll need to adapt some strategies to snatch maximum profit. So, in this new blogpost I’ll show you how to examine financial statements to find out the qualitative aspect of company.
A quick example :- Which share do you buy if I give a choice between ~ HDFC or SBBJ?
Absolutely HDFC. It is also ranked under top 3 brand of India.
But if you a look over their financial books, your decision may change. SBBJ is quoted around 500 and its yearly profit per share is around 130 INR whereas HDFC is quoted around 1030 and its profit per share is around 50 INR.
Don’t you get astonished? SBBJ is earning 80 INR more than HDFC then too HDFC is more than double the price of SBBJ.
Now think again, what will your decision?
Before starting this blogpost let me assume that you invested your 50,000 bucks in REC @ 193 price per share.
Then most possibly you’ve bought this share at January end or February start as it was quoted around 193 at that time.
And its current price is around 167.
If you sell it now then you will lose 25 per share (192 – 167). As per the statistics you bought 260 (50,000/192) shares. In short you’ll lose 6,500 INR (260*25).
Ques) What if the price of share continue dropping?
If you are seeking capital gain and that too in short term then you should sell but REC is fundamentally strong business, so in long term it will cherish your wealth. Just put your money and forget it. Let the stock grow your wealth.
Ques) How can you say that REC is a Good Quality company?
I’m not saying, company’s financial statements are saying. Let us try to value this company through its financial statements. We will value the stock with some different approach like EPS, DPR, PBV etc. So that we can conclude whether this share is valuable enough to invest or not.
- EPS – Earning per share
- DPR – Dividend payout ratio
- AV – Actual Value
- MV – Market Value
- ROI – Return on investment
- MOS – Margin of safety
- PBV – price to book value
(You can easily find there meanings on Google. So let me not expand this answer)
It is assumed that the we are expecting 20% ROI. It is the minimum return one seeks from equity considering all the margins. You can change this assumption as per your need. If you’re greedy and want 30% return then you do your valuation on the base of 30%. It may change person to person. Here the we took the lowest but more than any other investment vehicle like Mutual fund (15%), Debt (12%), FD (10%) etc.
1) Earning Approach (EPS)
Company is having a growth trend in EPS from past 5 years as you can see above. So let us assume that it will have a EPS of 60 in the year ended 2016. Now lets do some calculation.
60 is ROI and if we are assuming 20% as return then it depicts that 60 is 20%. And if 60 is 20% then 100% will be the actual investment that should be done to earn 60. So, the investment that should be done is ~ 60 ÷ 20% = 300.
So, 300 is the actual value (as per our assumption) and the market value is 167.
Actual value > Market value
This means that you can buy this share at discounted price i.e. difference between AV & MV ~ 300 – 167 = 133 discount. It is undervalued by 133 INR.
Don’t you think it a good opportunity, you can buy a share at almost near to half rate.
2) Dividend Approach (DPR)
Company is paying out around 20% of its earning as dividends and is consistently its shareholder from past 5 years. This shows a good attribute of company.
3) Book Value (PBV)
It is also a good measure to value a company. Book value refers to the total amount a company would be worth if it liquidated its assets and paid back all its liabilities. So it shows the creditworthiness of the company. As you can see below company have a increasing book value year by year, so it is reliable company. And even its book value is much higher than its current price. (251 > 167)
4) PE Approach
PE ratio is also very low as compare to any other companies of same genre. It PE depicts that you have to invest 3 to get 1 in return. Its a 33% return.
And also its PE is smaller than industry PE. It shows its cheapness.
And why am I saying to buy more shares of REC is because it will decrease your average cost. Let me clear it out. You bought shares @193 INR and now if you buy more share at 167 INR then it will decrease your average cost to 180 i.e (193+167/2). More you buy the share more there will be decrease in the average price per share.
Instead of selling your existing share buy more share of the same company to make your investment less costly and more profitable.
The answer you are looking for is completed here but if you want more clarification then read further.
I would also like to highlight one more crucial aspect of investing which is out by Benjamin Grahem 65 years back in mid 20 century but not even a 10% trend of his method was seen in last few decades.
MARGIN OF SAFETY
Margin of safety (safety margin) is the difference between the intrinsic value (AV) of a stock and its market price. More the difference between them, less will be the risk and more will be the profit.
Here’s a quick example:-
The Rural Electrification Corporation Ltd. on 5 Jan 2016 was selling for INR 227 per share in the market. At the time, that day, you could have sold the assets to any one of ten buyers for not less than 300 INR (as we calculated above), probably appreciably more. The company is giving a good return with upward trend. So the person who would have paid 227 rupees per share would not have been crazy. It is traded at 73 discount.
Now, the stock had declined even further to a price that made the valuation 167 instead of 227, its beta would have been greater. And to people that think beta measures risk, the cheaper price would have made it look riskier. This is truly Alice in Wonderland. I have never been able to figure out why it’s riskier to buy 280 worth of properties for 167 million than 227.
You also have to have the knowledge to enable you to make a very general estimate about the value of the underlying businesses. But you do not cut it close. That is what Ben Graham meant by having a margin of safety.
So should we wait to see if there price goes down? I can’t advise you for this thing as prices are unpredictable. Just what can I explain is that the present price is undervalued or overvalued. Nothing more. It is impossible to predict future prices. So, just what you have to do is find the cheap stock and forget about the ups and downs of market.
What are you waiting for? Just call your broker and buy REC. It is highly underrated with growing EPS (check out its balance sheet) Ohh! Your broker/adviser are refusing to buy it. Dammit Always remember a quote stated by world’s 3rd richest man, (who grew his wealth through stock market)
They are not working for making you rich instead they are making themselves rich and pretending as if they are making you rich. More you trade, more they get their fee/brokerage. Most probably, they will not preach you to invest in long term. So, just rely on your brain. Not if others. World is full of greedy and selfish people.
Hey! You (me) are also as a adviser to us, Isn’t it ironical? Why do we rely on you? But the only difference is that I’m not charging anything from you.
[Tweet “Just buy the right share and forget it. Then see your wealth grow with the passage of time. This is what known as value investing.”]
In short, you can rely on this information.
Instead of opening the secret, Why don’t you yourself buy REC? I bought it earlier and don’t worry there’s always opportunity out there in market. What we need to find quality stock is just a curious seeker.
What? You can’t seek any opportunity? Okay, don’t worry just stay connected with me. I’ll update you time to time with this types of precious information. Best way to get notified about it is to get subscribed to this blog. Not joking, I treat my subscribers as inner “caucus”. They are the only one who get notified about my new writings first. Even this answer was first emailed to all of my subscriber then I published it here.
Wrapping It Up.
There’s thousands of stocks available in market and the undervalued shares are very rare which makes it hard (not impossible) to pick up pearls from ocean. So, do your own research and invest your money whenever you find any profitable deal.
Many people are criticizing that there are more valuable ways other than PE ratio like PBV, NPA, NIM to evaluate a bank stock. Below is an extract of comments on one of my writings on Quora.
No doubt, I evaluated this stock (REC) on many other basis too but there’s no need to mess it up. If you don’t have technical knowledge then just concentrate on earning factor i.e EPS and if you are scholar then you can also look over other factor but it doesn’t mean that without “other than earning factor” you can’t invest wisely and profit. Also read how a villager turned his 10,000 bucks into 704 crore ~ , stock market is not much complicated as it looks like.. If he can (without any technical knowledge) then why can’t we? (go on – read it up – I’ll wait)
Well said by Peter Lynch – “Everyone has the power to follow the stock market. Of you made it through fifth grade math, you can do it”Well said by Ben Graham – “Investors should purchase stock like they purchase groceries – not like they purchase perfumes.
Well said by Warren Buffett (3rd Richest Man)
That’s all what great investors says and even if you want some logical explanation then read further.
When value investors buy stocks, they see it as a medium of buying a business, not a product which goes up and down. They are just purchasing a business through the purchase of marketable stocks — I doubt that many are cranking into their purchase decision the day of the week or the month in which the transaction is going to occur. If it doesn’t make any difference whether all of a business is being bought on a Monday or a Friday, I am dazzled why academicians invest extensive time and effort to see whether it makes a difference when buying small pieces of those same businesses. Many professionals talk about beta factor and some other factors. In fact, most of them would have difficulty defining those terms. The value investors simply focus on two variables: price and value.
I always find it extraordinary that so many studies (NPA, NIT, price behavior, movements etc) are made of price and volume behavior, the stuff of chartists. Can you imagine buying an entire business simply because the price of the business had been marked up substantially last week and the week before? Of course, the reason a lot of studies are made of these price and volume variables is that now, in the age of computers, there are almost endless data available about them. It isn’t necessarily because such studies have any utility; it’s simply that the data are there and academicians have [worked] hard to learn the mathematical skills needed to manipulate them. Once these skills are acquired, it seems sinful not to use them, even if the usage has no utility or negative utility. As a friend said, to a man with a hammer, everything looks like a nail.
What I want to point out is that it is not much complex to evaluate a business. As said earlier, even a fifth grade math can do it. No doubt, other evaluating factors like you said NPA, PBV etc can also used to evaluate a stock. It is good to evaluate by as much as ways you can but even without this criteria one can wisely invest in stocks from basis evaluation. Let it be simple, only 2-3 criteria’s are enough to evaluate – PE ratio, DCF and as a retail investor~ Dividend yield ratio. Even the bargain hunter Mr. Buffett evaluates stocks from these criteria’s and he is not a joke, he made his whole wealth by investing in stock market.
PE ratio is primary step to look upon before starting a researching on any stock. If the company pass these criteria then other methods can be overlooked like PBV, NPA etc but if not passed then don’t even give them a shit.
So may I presume you got a great insight into stock market.