The Concept of Investing.
Valuation is an important metric in Equity Investing. We invest in various equities based on its favorable valuations. Undervalued stocks define those stocks that are relatively valued as per their earnings capabilities. When we value any stock, we are valuing the future earnings capability of the company. Hence I say, “Company that earn, is worth the yearn”.
Valuation is not the market price, valuation is not the amount the stock quote in the market. Valuation is the intrinsic worth and can be momentary in nature. Yes, momentary for the value of a company can change in a matter of days. And those that are consistent in optimum valuation are those that lead the sector. We call them Blue chip companies, one that is usually suggested for Long-term holdings.
A company share price quoting at CMP Rs.100 per share.
Outstanding shares = 1,00,000 in number.
Market Cap of the company = Rs.1,00,00,000 (Rs.100*1,00,000)
Earnings Per Share = Rs.10
Company earings = Rs.10,00,000 (Rs.10*1,00,000)
Intrinsic worth – ??
In the above case, How well can we decide whether to invest or not? How to evaluate the company just by the earnings figure?
To find the value of the company share. We need to know the Intrinsic price per share, the actual worth of the company. Fair value is just the price agreed between the buyer and sellers upon any given time. Intrinsic worth is the actual worth the company ought to be sold for. To know the intrinsic worth is to know the valuations.
Techniques used for Stock valuation.
Stock valuation is a complicated process. There is no defined set of rules to value a stock, Each of us have our own set of strategies. The Strategies used by veteran investors are unlimited. Investors value a stock based on the financial numbers, the economic certainty, and other aspects that directly or indirectly influence the company and finally the share price. Hence, to value a company. The investor has to have a set of defined strategies and relevant pieces of information.
Stock Valuation types:
- Absolute method – A pure Fundamental Analysis based technique of Investing. In this method, an investor primarily relies on the Company valuation that is Financial centric. The analysis of Annual, Half-Yearly, Quarterly Financials is done from time-to-time to arrive at such a decision that allows an investor to invest in the script.
- Relative method – In this method, an investor not only analyzes the script based on financials. He\She does a back end testing know as ‘peer comparison’. One that allows an investor to know more about the sectoral advantages an investment hold and based on the information, he\she will make the investments accordingly.
Stock valuation methods.
Comparable Company Analysis
There are sufficient tools available to the investor to compare the company with its peer in the same sector or industry. This approach allows an investor to arrive at such a decision that’s favorable and easily achievable. To compare the stock with its peer companies via ratio analysis (discussed in the latter part of this article), and select the best-quoted share amongst the peer company. However, the issue is with what ratio to be considered whilst comparing a company. Know more about Company valuation.
Discounted Cash Flow Model (DCF)
One of the most used valuation methods. Under the DCF approach, an investor arrives at the intrinsic worth of the company based on discounted cash flow to its present value. This method is most favorable for two reasons.
- It takes the time value of money into consideration.
- The return expected in not nominal, hence inflation-adjusted.
Example: ITC Ltd
Earnings Per Share (TTM) – Rs.11.50 (Will vary accordingly)
Sales Growth rate – 5 Years Average – 4.95%
Minimum Rate of Return (Expected) – 15%
The margin of safety – 50% (Suggested, Safe and reliable)
Enterprise Value to Earnings – Rs. 12.10 (Will vary accordingly)
For the given information, the Future Price, the Fair Value, and the Margin of safety shall be calculated based on Discounted Cash Flow Model as follows;
(Pease note: The figures arrived are as per the assumption of future earnings cash flow for 10 Years).
- Future Price = EPS*(1+growth)^10*EV
- Fair Value = Future Price/(1.15)^10
- The margin of Safety = Future Price – 50%
= 225.58 – 50%
Please note: The above-mentioned technique is the one that I use to arrive at the solution for the required query. An investor can do required changes as applicable.
Dividend Discount Model (DDM)
A Dividend based investing model. A quantitative valuation technique, The DDT model is under the assumption that the current price (Fair value) of the company share is equal to the company’s dividend earnings in the future date when discounted back at the present value.
In this method, we value the dividend earnings (in future date) and compare it with the stock price that we pay today. It is used to value the price of the stock based on the Net Present Value (NPV) of the future dividend we earn.
Top 20 Best stocks to buy for Long-term & Short-term in India (2020)
|Sl.No.||Company Name||Price per share (In Rs.)||ROCE (In %)||ROE (In %)||ROIC (In %)||ROA 12M (In %)||ROCE 5Yr (In %)||ROE 5Yr (In %)||5Yr OPM (In %)||P/E (In %)||EV / EBITDA (In Rs.)||PB X PE (In %)||PEG (In %)||Int Coverage (In %)||Debt to Eq (In %)||Enterprise Value (In Crore Rs.)||Market Cap (In Crore Rs.)|
|7||Dr Reddy's Labs||4,322.50||11.11||13.64||16.66||11.20||11.89||12.60||18.26||36.97||23.26||170.43||-15.47||21.88||0.14||73,868.62||71,863.72|
|13||Kotak Mahindra Bank||1,380.05||7.35||13.67||32.60||2.14||8.02||13.46||34.80||29.86||19.32||121.53||1.29||1.78||4.86||5,35,009.22||2,73,112.14|
|15||P & G Hygiene||10,076.60||58.05||41.91||46.93||39.23||61.94||41.27||24.04||75.53||49.10||2,133.72||18.29||98.84||-||31,806.89||32,709.39|
|18||Sun Pharma Industries||512.45||10.53||9.10||11.55||6.86||14.28||12.10||24.97||28.38||16.83||77.19||-9.59||21.24||0.18||1,24,781.25||1,22,953.92|
|19||Tata Consultancy Service||2,288.80||47.76||37.21||57.12||34.93||45.74||34.95||27.12||27.51||18.77||280.88||2.54||51.82||0.08||8,56,085.81||8,58,845.81|
Please note: The rates mentioned may change over time. Investors are advised to cross-check the provided information and show due diligence before investing.
As you can see, all the recommended stocks are of ‘Blue chip Companies’. Known for being market leaders. These are those companies that rule the sector they be in. Hence, it is a safe and reliable investment for a retail investor. This way, one can assure that his/her investment is in such a company that is market leaders. Companies that have a higher chance to grow out of this COVID based recession.
We are in one such phase of the market where the chances of the situation turning from bad to worse are more likely. The US dollar-based Monetary system is at the brink of collapse. None can predict what we ought to see hereon. But, as an Investor and an Economist. I surely see major changes happening in the global level and the same to have a major impact on the Indian Market.
Hence, we have drafted this article. Remember, As much as it is important to invest. Asset allocation stands a major role in wealth creation. Invest in such well-established companies. And have trust in Indian Capitalistic Democracy.
Disclaimer: All the information on this website is published in good faith and for general information purpose only.