Valuation of shares
- Whether you do simple valuation process or very complicated methods, remember that value is a relative measure. What you’re trying to find is a bargain. Opportunity to buy shares at a bargain generally arises when something is out of favor.
- Always look for moderately undervalued shares rather than trying to find out grossly undervalued shares. If a share is grossly undervalued, it means that there is something terribly wrong with that company.
- You should be able to justify why you bought a share and before buying, make sure you know what would make you sell the stock.
- Never compare your decisions with others. If you are ready to buy a stock at a particular rate for a reason, there’s someone equally ready to sell that stock for some other reason. So, it’s natural; for others to think contrary to your views.
This is an alternative to the valuation method we discussed in our earlier post. Let’s value an imaginary company which is trading at Rs. 33.50, Earnings Per share of Rs. 2.12 and an average 10 year dividend payout of 4.2%. You assume that the stock will be having the average P/E and dividend payout of the past, in the future 10 years also. The average P/E of 10 years is assumed to be 18.7. The expected annual return is 12%. You want to invest in this company with a target of 10 years.
CASH EPS GROWTH RATE
From the historical analysis, you estimate that the stock will continue to grow at 13 % per year for the next ten years. Instead of estimating normal EPS growth rate, you can use cash EPS.
- Cash EPS = (Profit after tax + Depreciation + Other non-cash charges) / Number of equity shares. The logic behind cash earnings per share is, that the depreciation charge is merely an accounting adjustment devoid of any real expenditure on the part of the company
The advantage of using cash EPS is that it is a more realistic figure than normal earnings figure. The higher a company’s cash EPS, the better it is considered to have performed over the period. You need not calculate cash EPS separately since the data is available in most financial web sties.
In this article I am suggesting a very simple method to find intrinsic value. Any novice can do this valuation. It’s not a fool proof method and may have downsides, but this method does give a reasonable down target to buy stocks.
- Do the ground work. You have to pick a target based on historical analysis, future potential, qualitative aspects etc..
• The first step is to find the EPS-GR.
• Based on the EPS growth rate, calculate the expected EPS.
• Estimate the future P/E
• Calculate the estimated future price by : EPS x P/E
One of the main figures that an investor should estimate in the process of valuation is the PE of the company. The details regarding a company’s past P/E ratio is available on many financial web sites. All these are real, past data.The question is how to arrive at the future P/E ratio of the company.
For that, the simplest method is historical analysis – Given below- in a two step format.
The historical P/E ratio of the company is taken and a reasonable present day price-earning ratio is computed.
For example – let’s say the price-earning ratio for ‘A Ltd’ for the past 3 years was 9.00, 7.80 and 8.56. Then, the average price-earning ratio for the company would be (9.00+ 7.80 + 8.56) / 3 = 8.45. We may safely assume that the average price-earning ratio for the past three years is applicable in the immediate future also. In the example I have used 3 but, it’s safe to take 5 or even 10 year average P/E of the company. By taking a long-term average, you smooth out the noise and bumps.
- Point Blank
- Financial Discipline for all.
- Investing Basics
- Shares & Stock Markets
- Introduction to Financial Statements
- Financial ratios.
- Stock investing strategies
- Technical Analysis I
- Technical analysis II
- Before Picking up stocks..
- Choosing a Broker and opening Demat Accounts
- Make your debut !!
- More ... from stock markets.
- Valuation of shares
- Futures and Options - The basics.
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