Value pick, valuation
gaps, fundamental analysis, etc. So many words for finding investment stocks.
Many times I hear people saying that company is fundamentally strong, or good
ratios. But if I ask u what should be good for you if you wanna buy shares for
earning??? Of course its stock for which there is potential to rise. Stocks for
which value is not yet realized. Such stocks where people are not yet buying
aggressively to take it to new highs or rather stagnant and range bound for
long time or in downtrend. I call them sleeping tigers. I have the habit of
finding such stocks which are not yet in focus but soon it will be in news or
people will buy in madness.
People are scared
about fundamental analysis as they think they are poor in understanding balance
sheet, income statement, etc. But layman can adopt basic things to identify
their own value picks without much knowing finance terms. One can easily
understand what is net profit, operating profit margin, sales, etc. This much
basics are okay. First let us understand basics terms in this session required
for analysis. Then in next session, we will switch to method of finding stocks
for investment.
Brush up on basic Sales related terms:
Don't consider sell of
scraps, or income from rent/lease to the company or even income from
investments. Sales consider revenue from core business for which the company is
established. Rest just comes under other incomes. So beware when company
posting huge profit but major portion is other income. Example as follows
Suzlon
Just check June 2015
quarter results
Sales
-
2605.81
Expenses
- 2415.46
operating profit
- 227.62
so operating profit
margin (OPM) comes out to
227.62 divide by
2605.81 multiplied by 100 equals 8.74%
layman generally have
the habit of calculating profit divide by cost/expense. but let me clarify here
that profit divide by cost is return on investment or profit percentage. to
calculate profit margin, we need to check how much margin is there for company
of sales value, that's why checking OPM is important.
But if you check net
profit, it is shown as 1047.41 because net profit also includes 1329.83.
Suzlon’s return to
profitability in the quarter ended June 30, 2015, is attributed to a windfall
gain of about INR 13.14 billion related to its disposal of German sector player
Senvion to Centerbridge Partners LP. The Indian group noted that the particular
transaction was completed at the end of April 2015, which means that its
consolidated financial results for Q1 fiscal 2015/16 are not comparable with
the prior period presented.
so if we deduct other
income from net profit to remove the effect of windfall gains, we get net loss.
But market actually cheered this huge net profit after this result was out
without even noticing this other income concept and many retail investors might
have got trapped by buying it at higher price and waiting for that price to
come again.
Sales is steady but
net profit showed huge growth. Reason was other income. Common people tend to
see net profits growth directly and specially when they have stock in study in
their portfolio. It makes person biased and they see only positive things. But
we should be cautious enough as other income surge is not good sign as
its not sustainable. It generally implies windfall gains. Our main focus should
be how much company is earning with its core business which is showed only in
sales heading.
OPM also called as
operating profit margin denotes how efficiently company is working. To know
what percentage OPM is good , we should have idea of business. You may also see
OPM more than 100% which is practically impossible. But its just accounting method.
Here a person should just focus on how company is earning money and what is
ideal OPM. It may happen that other companies in that industry are having more
OPM and stock under study is having less OPM then our stock under study is not
good. It may be improving its profit margin quarter on quarter, maybe company
is in expansion mode or any constructive reason. One can take efforts to find
the reason. Thumb rule is don't just stick to numbers on financial statements.
Try to built story as what company might be doing and how company might be
utilizing its resources. It doesn't need big shot finance knowledge. A person
can just select stock of the industry he understands better. And check whatever
company has published on financial statements is in sync with what information
is available to you???
Bottom line is select
the stock from the business a person understands better. Try to built the
company story with available numbers. How to use this will be explained in
further write ups. 2 most important technical that I would like to elaborate
here are PE and EPS
PE and EPS at glance
EPS is earnings per
share. It indicates how much a company is earning for shareholders. Like 10 EPS
is company is earning 10 Rs for each share after paying all expenses and taxes.
Even dividend issued will reduce EPS as its an outflow for the company and that
much amount has already been realised to the shareholders. Its like earlier it
was 10 EPS. Means company should pay 10 Rs to each shareholders per share. But
it pays only 1 Rs as dividend and retains 9 Rs for business. So revised EPS
should be 9. This should actually reduce the stock price as EPS is considered
in final stock value. So whenever you focus on financial statement, focus on
EPS growth rather than net profit. And observe reason for EPS growth if its
because of core sales or other income.
Next very common term
being discussed is PE. You may find many people discussing low PE stocks. There
are few amateurs who always focus low PE stocks as undervalued stocks. But
remember, Nifty with 22 PE was recently said to be overbought. Same Nifty at 22
PE was said to be oversold just 4 months back. So PE is actually a matter of
perception of investors to be considered overbought or oversold. PE is simply
price per earnings
It simply means how
much price you are ready to pay to earn 1 Rs in that company. Like 20 PE
indicates, an investor is paying 20 Rs to earn just 1 Rs from that company. It
may look strange but its a fact. Why should we pay higher price to earn lower
money. So basically it just denotes expectations. Expectations that company
earning 1 Rs today will earn 20 Rs in future. It is only the expectations of
the people from the company that makes stocks move up and down. Technical
analysis call this demand and supply. If stock is expected to earn more in
future then it will be in demand and price will surge. Bear in mind that EPS
remains constant unless company has declared fresh results. Once results are
out, new EPS will be considered and that should factor in stock price. One may
think this as a simple trading opportunity. But experienced traders might have
observed that results are mostly factored in stock price before it is out. Or
many cases when results are outstanding, stock locks in upper ciruict with no
sellers or vice versa with bad results. So nothing comes easy
People always compare
company PE with industry PE or with PE of other companies. And many layman
considers it as valuation gap for investment. But one should bear in mind that
people should consider PE only as future expectations of earnings. Let me give
1 classic example
Experienced investors
might have seen rally of kitex. It quadrupled ( 250 to 1000) within just 1
year. Kitex was trading around 20 PE when it was 250. In that case, kitex
should have been considered fairly priced. But still it made excellent rally in
a year to make it 4 digits stock. Suddenly what could have happened that even
with 20 PE, kitex rallied to give 300% returns. If one goes through company
presentations or google few analyst coverage or report then it can be found
that Kitex has planned for expanding its capacity to double their sales with
just 20% increase in cost. Now doubling the sales means doubling the earnings.
But without much increase in cost means improvement in profitability thereby
more than triple increase in net profits. So this statement from management
increased its earnings expectations, which ultimately reflected in stock price.
But today financial statements indicates sales are not doubled but 70-80% surge
in 2 years with increase on OPM from 20% to approx 34%. It means management
really took efforts in increasing their sales while making sure not to increase
their cost proportionately. But couldnt achieve their target as promised. So
even if for a layman, results are consistently good, it is not as per
expectations for which, stock price took rally from 200 levels to 4 digits. And
stock price fall which is now trading below 700 Rs. Many people are curius
about stock price behaviour after results. Its difficult for layman to
understand that why stock fall inspite of good results and why stock surged
inspite of bad results. So they should just keep in mind that company
performance is already discounted. So again bottom line is that stock price is
the factor of expectations which is indicated by PE. So many investors have
basic question like why few stocks are trading at high PE or few trading at low
PE. So i guess they might have got answer.
Kitex is a past story.
Now its obvious to know that readers are curious to know upcoming story. Its
simple now. Just keep surfing through management commetries on their company
performance. And also test the credibility of management commitments from their
past performance. If you feel that management does what they says and they have
made bullish statement on their growth then grab it for long term. 1 stock that
I can suggest will be Vakrangee. I am personally invested in Vakrangee long
back when it was trading at 132. I grabbed it because promoters are increasing
there stakes and it was sleeping tiger since long. Management had set their
vision upto 2020 and are aggressively approaching to complete their targets on
time. recent announcement of strategic alliance in Ricoh India will improve
their network and help vakrangee to achieve sales growth of 30-35% CAGR for
next 5 years. Those who want to understand importance of 30-35% CAGR, they
should divide 72 by 30 to see in how much time frame will the sales double.
72/30=2.4
Means sales will
double in max 2 years 5 months as per company expectations.
Now thinking about
cost??? Of course doubling the sales requires expense to be proportional. But
let's understand vakrangee business model. If you open their website, you will
see invitation of franchise and amazon advert on top(vakrangee also have strategic
tie up with amazon). Right now vakrangee is aggressively focussing on selling
franchise. For franchise they are asking franchise owner to invest and
vakrangee will give all back office support. For these support, vakrangee will
get 20% share of the revenue earned by franchise. Now back office already
exists. Infrastructure is already set up. Apparently Vakrangee don't need to
put up additional cost for these revenue growth. Rather more the franchise,
more will be the cash inflow without marginally increasing the cost. Sounds
like kitex situation??? Kitex vision was just for for 1-2 year and vakrangees
vision is for 5 years. Do your own research before investing and reading these
numbers.
A glance at CAGR
CAGR stands for
compounded annual growth rate. Means 100 Rs invested today at 10% CAGR will
increase as follows
1st year
110
2nd year
121 (10% increase over 110)
3rd year
133.1 (10% increase over 121)
4th year
146.41(10% increase over 133.1)
5th Year
161.051(10% increase over 146.41)
6th Year
177.1561(10% increase over 161.051)
7th Year
194.87(10% increase over 177.1561)
and so on.
Now its easy for us to
understand that, with simple interest, money doubles in 10 years with 10% rate.
but it takes only 7 years and few days to double with 10% CAGR. Now applying
formula of 72.
72 divide by 10 equals
7.2.
so, instead of
calculating, when our money will get double with defined rate, we can directly
find out dividing 72 by our expected CAGR. That's the magic of compounding and
number 72.
Finally combining EPS and PE
EPS multiplied by PE
gives current market stock price.
EPS X PE = CMP
As discussed before,
EPS will be constant till fresh EPS out with results and PE changes according
to stock price.
Hope I am able to
explain basic points with investing point of view. This terms may not be new to
investors traders or even layman who never traded. But my aim was to make
readers think same term with respect to value investing. This session was just
introduction to the basics of terms. In next part, will introduce you one
method by which you can select which stocks to select for investment.
I call them sleeping tigers
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