The current article in this series provides responses related to:
- Impact of macroeconomic factors on stock selection
- Clarification about assessing accuracy of reported earnings
- Queries on margin of safety
- Books for learning fundamental investing
I have been made to understand that a good barometer for analyzing the value of a stock is to plot its historical price trend against its earnings. I tried to navigate some sites where this could be done however, was unsuccessful.
Question, do you know of any websites that can plot this for Indian stocks?
Peter Lynch used this tool for selecting his 10 baggers. He used a multiple of 15 to do this. Is it good in the context of India or should be take a higher multiple?
I am associating your comments that the P/E multiple is more a function of interest rates than an individual stock. Please comment on this.
It would be nice if you can write an article to highlight this investing idea.
Thanks for writing to me!
Once an investor becomes habitual of conducting her own stock research, then she starts using her own criteria for stock analysis. This is common place as analysing more & more stocks gives her insights about companies’ behavior. She is able to feel the characteristics of good companies and define new parameters of “Value”.
The method you mentioned has been used apparently by Peter Lynch. I do not use it. Do I have anything against using this parameter? No. However, once you do stock analysis, you start to realize that there are many parameters to judge value, which can be used to analyse value. An investor may use any one or more of them.
I use the following parameters to gauze the valuation levels of a stock:
It’s good that you are trying out different methods to judge value.
I do not know of any website, which can plot price trends against earnings. You may create this chart yourself by getting data from various public sources.
Thanks for the idea of an article on this topic. I have not yet thought about it. I might touch this topic in future. However, that might take some time.
Query on Vinati Organics Limited: with crude oil being sustained below $60 for more than one year, EOR (enhanced oil recovery) due to high cost could slow down. Vinati Organics Limited has more than 40% sales coming from ATBS which has EOR has one of key customer segment.
Do you think it can slow down sales growth in ATBS and thus the company?
Thanks for writing to me!
I do not have any views on such changing business environments. Such changes will keep on coming in future as well. It is the job of management to deal with such scenarios.
An investor should first decide whether the management is competent enough to deal with changing scenarios. Analysis of past performance over a decade or so will help the investor assess the management better.
If the investor finds that the management is competent and have steered the company well in the past, then the investor should relax and let the management deal with these challenges.
However, if the investor finds that the management has not shown enough competence in the past, then she should exit the company immediately.
Looks like you are a classic value investor and a follower of Graham.
A few more questions:
- how will you keep in check if the earnings are manipulated or not as if you are investing on the basis of PE, earnings has to be precise?
- Also what is your opinion on stocks which are low in PE and have a good business record like J&K Bank
It is the role of the investor to assess whether the financials are genuine or manipulated. Usually a comparative analysis of financial statements (B/S & P&L and CF) would give signs. E.g. if sales are increasing but cash not getting collected and resulting in increasing receivables days. Cumulative CFO over the years being much less than cumulative PAT over the years. Cumulative Tax shown in P&L being much higher than actual cumulative tax paid as per CF.
There are many signs, which if an investor keeps an eye on, then she can get an idea about the genuineness of financials. You may get further information about the common tricks managements deploy to manipulate earnings and the steps investors should follow to detect them in the following article:
I do not analyse banking stock as the information shown in annual reports is not sufficient to get an idea about the actual situation.
Thanks for your answer. I understood the way you calculate the margin of safety. I mean that if you do not measure the safety margin, for example, a publicly company traded at ₹80 and is worth ₹100, therefore, it has a safety margin of 20%.
You measure the difference between the dividend yield and the G-SEC yield and then say that it has “more or less” margin of safety, but not 20%, 30%, 40% etc. safety margin, a specific number.
You got it right that I do not assign any value (say fair value) to the stock and therefore, do not find margin of safety by comparing how current market price stands vis-a-vis the fair value.
As rightly mentioned by you, I look at how attractive the earnings yield is in relation to the fixed income returns.
Having said that I do not mean that every stock with high earnings yield (i.e. low P/E) is a good stock to invest. An investor needs to analyse low P/E stocks carefully, to avoid investing poorly performing companies, which deserve low P/E ratios.
You may read more about margin of safety in the following article:
Dear Dr Vijay,
Looking at current ratio and CFO>PAT, both is important. They are not replacement for each other.
High current ratio and CFO>PAT, both are healthy signs of good companies. For any parameter, I prefer using historical trend to assess the performance of any company rather than recent performance like last quarter or year.
Hi Dr Vijay,
- Please let me know how you obtain the total retained profit in case of Vinati Organics Limited and Tata Steel Limited.
- Are Reserves the same as the amount retained by company? Or it should be Reserves – Dividend?
- Also how to obtain total increase in market capitalization?
Thanks for writing to me!
Retained profit for one year: Net Profit after tax – Dividend Paid.
I calculate increase in total market capitalization by deducting 2005 market cap from current market cap. All the required data for calculating these is present in publically available information including annual reports.
Hope it helps!
Thanks for the Super Post Vijay,
Lately I started reading articles on stock market investing and I came across with this fantastic blog. I am completely newbie in this field and I do not have any background in economics or money management.
I am software engineer. I think that is the reason I could not able to understand Intelligent Investor book (have read only first 50 pages).
I want to know the basics that we have to know to start learning fundamental analysis.
Are there any books which gives complete basic idea about fundamental analysis, so that I can understand when I start reading Intelligent Investor again?
Thank you for your time
Thanks for writing to me!
It’s great that you have started reading and learning about investing on your own. I believe that a person does not need to have a background in finance for becoming a successful stock market investor provided he/she is willing to put in the required time and effort for learning about stock analysis.
Intelligent investor is a great book. However, many readers find it bit technical for its use of accounting terms. Nevertheless, it provides one of the most elaborate and detailed description of accounting from the perspective of an amateur stock investor. It is highly recommended that an investor should complete this book.
If you want a book, which is easier to read than Intelligent Investor, then you should read “One Up on the Wall Street” by Peter Lynch. Both the books, “One up on the Wall Street” and “Intelligent Investor”, are recommended reading for stock investors. Therefore you may read One up on the Wall Street first.
You may read my review about One Up on the Wall Street here:
You would already be using google to find out more about the accounting terms being discussed in the Intelligent Investor. You should keep doing it.
All the best for your investing journey.
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- 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 except Vinati Organics, mentioned above in my portfolio.