Value is a magic word.
Ears stand up.
Where is value?
Big, big question.
Medium term investors look for growth.
Long-termers invariably look for value.
How do you value a stock?
There are many ways to do that.
Here, we are just going to talk about basics today.
For example, price divided by earnings allows us to compare Company A to Company B, irrespective of their pricing.
Why isn’t the price enough for such a comparison?
Meaning, why can’t you just compare the price of an Infosys to that of a Geometric and conclude whatever you have to conclude?
That would be like comparing an apple with an orange.
Reason is, that the number of shares outstanding for each company are different. Thus, the value of anything per share is gotten by dividing the grand total of this anything-entity by the number of outstanding shares that the company has issued. For example, one talks of earnings per share in the markets. One divides the total earnings of a company by the total number of outstanding shares to arrive at earnings per share, or EPS.
Now, we get investor perception and discovery into the game. How does the public perceive the prospects of the company? How high or low do they bid it? How much have they discovered it? Or not discovered it? This information is contained in the price.
So, we take all this information contained in the price, and divide it by the earnings per share, and we arrive at the price to earnings ratio, or P/E, or just PE.
Yeah, we now have a scale to judge the value of stocks.
Is this scale flawed?
A stock with a high PE could have massive discovery and investor confidence behind it, or, it could just have very low earnings. When the denominator of a fraction is low, the value of the fraction is “high”. You have to use your common-sense and see what is applying.
A stock with a low PE could have low price, high earnings, or both. It could have a high price and high earnings. The low PE could also just be a result of lack of discovery, reflected in a low price despite healthy earnings. Or, the low PE could be because of a low price due to rejection. What is applying? That’s for you to know.
At best, the PE is ambiguous. Your senses have to be sharp. You have to dig deeper to gauge value. The PE alone is not enough.
Now let’s add a technical consideration. One sees strong fundamental value in a company, let’s say. For whatever reason. How does one gauge discovery, rejection or what have you in one snapshot? Look at the 5-year chart of the stock, for heaven’s sake.
You’ll see rejection, if it is there. You’ll understand when it is not rejection, because rejection goes with sell-offs. Lack of discovery means low volumes and less pumping up of the price despite strong fundamentals. You’ll see buying pressure in the chart. That’s smart money making the inroads. Selling pressure means rejection. You’ll be able to gauge all this from the chart.
Here are some avenues to look for value :
– price divided by earnings per share,
– price divided by book-value per share,
– price divided by cash-flow per share,
– price divided by dividend-yield per share,
– in today’s world, accomplishment along with low-debt is a high-value commodity, so look for a low debt to equity ratio,
– look for high return on equity coupled with low debt – one wants a company that performs well without needing to borrow, that’s high value,
– absence of red-flags are high value, so you’re looking for the absence of factors like pledging by the promoters, creative accounting, flambuoyance,
– you are looking for value in the 5-year chart, by gauging the chart-structure for lack of discovery in the face of strong fundamentals.
We can go on, but then we won’t remain basic any more. Basically, look for margin of safety in any form.
Yeah, you don’t buy a stock just like that for the long-term. There’s lots that goes with your purchase. Ample and diligent research is one thing.
Patience to see the chart correct so that you have your proper valuations is another.
Here’s wishing you both!