Investing with target price in mind, parameters to screen stocks, interpreting high current ratio (Q&A)

Modified on July 14, 2018

The current article in this series provides responses related to:

  • Should we invest in stocks with a target price in mind?
  • Which parameters should be focused while screening stocks?
  • What is the difference between debt to equity and debt to profit ratios?
  • Is P/B ratio with adjustments for market value of assets a better parameter?
  • How to analyse high current ratio of companies?

 

Should we invest in stocks with a target price in mind?

Dear sir, your articles are very helpful for beginners like me. I did my investments without proper knowledge and based on tips. However, after losing my money, I have started studying.

I have a doubt. Is it wrong to stick to the expected returns?

I have my investment in Bliss GVS Pharma Limited, where I’m currently getting nearly 45% profit. But, as I was expecting 100% profit, I didn’t sell it when it reached nearly 65% profit. I’ve never got 100% profit in my investments. At least, I expect this counter to hit 100% profit. My average pricing is ₹73. Holding it from nearly 6 months.

Thanks in advance.

Author’s Response:

Thanks for you feedback.

I do not believe in buying a company with a target price in mind. It is a losing strategy that leads an investor to sell her winning positions with limited profits and whereas she ends up holding losing investments longer awaiting to achieve breakeven.

If an investor keeps a target price in mind, she would never be able to get multibaggers in her portfolio.

Warren Buffett acknowledges that most of his wealth is a result of about 8-10 good investment decisions like Coca Cola, Gillette, Wells Fargo, Washington Post etc. If he had kept a target price in mind, his wealth would have been languishing at few hundred million dollars and not billions which he owns today.

Read: Warren Buffett’s 2014 Letter: A Complete Book for Investors

Therefore, I would suggest you not to keep an expected return in mind and stay invested till the time business strength of the company is intact.

Bliss GVS Pharma Limited:

I glanced through the financial numbers of Bliss GVS Pharma Limited. The numbers though looking attractive at the first look, are hiding some significant developments concerning the business operations of the company.

You may read about my views on Bliss GVS Pharma Limited in the following article:

Analysis: Bliss GVS Pharma Limited

Hope it helps to resolve your query.

 

Which parameters should be focused while screening stocks?

Dear sir, your post & blog is very useful to all learners of fundamental stock investing. I want to know, as a learner when I scan stocks in screener.in, which critical parameters should be focused like p/e ,debt to profit, debt to equity, PB x PE etc.

Author’s Response:

Thanks for your feedback! I am happy that you liked the article and the website.

Before using the stock filtering feature of screener, you need to decide what parameters of the stocks that you consider, are the best indicators for a fundamentally good stock. Once you have identified those parameters, then you can set the objective values in the filtering tool of screener to find out the stocks that meet your parameters. Such objective parameters can be PE, D/E etc. as mentioned by you.

I have written dedicated articles on the website about financial analysis, valuation analysis, business analysis and management analysis. In each of these articles, I have explained the vital parameters to judge the fundamental position of any company. Many of these parameters are objective in nature where an investor can assign a threshold value like P/E <10, D/e <0.5, sales growth rate >15% etc.

You can find a compiled list containing all these parameters at a single page here:

Final Checklist for Buying Stocks

Ideally, I would prefer to invest a stock which meets all the parameters. So I would set filter levels at the threshold value of each of these parameters and then analyse the resultant stocks presented by screener.

You should go through the articles on “Selecting Top Stocks To Buy” and you would find detailed step by step process about the way an investor should approach stock investing.

Selecting Top Stocks to Buy – A Step by Step Process of Finding Multibagger Stocks

I believe that the links I have shared above would give you a good insight about stock selection. Take your time to understand each concept discussed in these articles. I am sure by the time you would finish reading them, you would have decided your own checklist of parameters.

Regards,

 

What is the difference between debt to equity and debt to profit ratios?

Premier Explosives Limited:

  • Market Cap: ₹247.11 Crores
  • Current Price: ₹278.90
  • Book Value: ₹66.31
  • Stock P/E: 36.66
  • Dividend Yield: 0.76%
  • Stock is ₹10.00 paid up
  • Listed on BSE
  • 52 Week High/Low: ₹329.70 / ₹64.30
  • Sales growth 7Years: 11.73%
  • Price to Earning: 36.66
  • Debt to equity: 0.18
  • Debt to Profit: 1.92%
  • PB X PE: 154.34

Sir, I am learner and I want to know about

  1. Difference between Debt to Equity & Debt to profit
  2. PB*PE is 154.34 more than 22.5

How do all these parameters impact the stocks?

Author’s Response: 

Thanks for writing to me!

Debt to Equity:

It is a ratio which indicates out of money invested in total assets of a company, how much is put in by the shareholders and how much is taken as loan from outsiders like banks. If a company as assets of ₹100 and shareholders have put in ₹50 and balance ₹50 is taken as loan from bank, then debt to equity ratio would be 1 (i.e. 50/50).

Higher debt to equity means that company has taken high amount of loans than their own money to fund the assets. It increases risk, as lenders will ask their repayment as per schedule even if the company does not do well in any year. Then the company might have to sell assets to pay its lenders.

You may read more about debt to equity ratio here:

How to do Financial Analysis of a Company

Debt to Profit:

This ratio tell you how much is the debt level when compared to profits. As a company has to pay its debt from its profits, therefore, higher debt to profit levels indicate high risk due to the same reasons as discussed in debt to equity ratio section.

The debt to profit ratio calculated above seems to have an error. The debt of Premier Explosives Ltd (PEL) at March 31, 2014 was ₹10cr. and profit was ₹9 cr. So the ratio would have been 10/9 = 11.11

P/E*P/B of 154.34 indicates that the stock is very highly priced, and therefore, is very costly. Benjamin Graham has suggested that an investor should not buy stocks which have P/E*P/B more than 22.5.

You should read Benjamin Graham’s book “The Intelligent Investor”. It is a very good book and advisable to read for all the investors.

You may read my review of The Intelligent Investor here:

Book Review: The Intelligent Investor

Hope it helps to answer your query.

 

Is P/B ratio with adjustments for market value of assets a better parameter?

This is very useful information, Vijay. Thank you for putting it together in an easy to understand the manner and highlighting the important valuation metrics. I just found out about your blog and there is so much to explore.

On P/B ratio, you mentioned that you don’t consider it (except for financial firms) since the book value of assets is measured on historical cost basis (I think it is as per accounting rules) and it may not represent the current market value of the assets. However, if P/B ratio is at an attractive level, say ~1 then if we adjust the book value of assets to reflect the current market value than isn’t it even better?

Author’s Response: 

Thanks for your feedback! I am happy that you liked the article.

You are right that if by any metric, we are able to adjust the book value to reflect current market value, then it would be better.

Every investor uses her own judgment to assess the current market value of the assets of a company. In effect, the current market capitalization is the judgment of entire market for current market value of the net assets of a company.

I do not use P/B as an important metric because I have not come across any reliable methodology to find current market value of company’s assets. In case you use any such methodology then it would be great if you can share it with us. It would be a good learning for me as well as other readers of the website.

Regards,

 

How to analyse high current ratio of companies?

Hi Vijay,

While analyzing a company, the current ratios were found to be within 4 to 8 for the past 5 years. Does it mean that the company is having too much inventory or they were not properly investing their excess cash to get more out of the business?If yes, is it a red flag for investing in that company? Your valuable advice will be helpful.

Thanks,

Author’s Response: 

Thanks for writing to me.

It can be any of the two situations mentioned by you.

To find out the real cause of higher current assets, you should see the breakup of current assets in the annual report of the company and then try to analyse the trend in different components of current assets (e.g. inventories, current investments, trade receivables, short term loans & advances etc.).

Only upon the granular analysis of current assets, you would be able to find out the real reason. It can be that the company is selling goods but not able to collect money from buyers, therefore, trade receivables would be increasing year on year in relations to sales amount.

I suggest that you should study the annual reports and analyse composition of current assets year on year.

The following article on analysing operating performance of companies would help you in your analysis:

How to Analyse Operating Performance of Companies

Hope it helps.

P.S.

 

DISCLAIMER

  • The above discussion is only for educational purpose to help the readers improve their stock analysis skills. It is not a buy/sell/hold recommendation for the discussed stocks.
  • I am registered with SEBI as an Investment Adviser under SEBI (Investment Advisers) Regulations, 2013.
  • Currently, I do not own stocks of the companies mentioned above in my portfolio.

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