Q&A: Plotting Share Price with Earnings, Margin of Safety, Using Current Ratio instead of comparing CFO & PAT

Modified: 01-Jul-20

The current article in this series provides responses related to:

  • Plotting share price with earnings on a Chart to assess valuation
  • Queries on margin of safety
  • Finding increase in market capitalization and retained earnings for last 10 years

 

Plotting share price with earnings on a Chart to assess valuation

Dr. Malik,

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.

Regards

Author’s Response:

Hi,

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:

How to do Valuation Analysis of a Company

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.

Regards,

Vijay

 

Margin of Safety in a Stock

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.

Regards.

Author’s Response:

Hi,

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: 3 Simple Steps to Assess “Margin of Safety” of a Stock

Regards,

Vijay

 

Can we look at current ratio instead of comparing CFO and PAT

Dear Dr Vijay,

I wanted to know the cases in which CFO>PAT could be considered as healthy sign? Whether we need to have current ratio for last ten year or preceding year and quarter is enough?

Author’s Response:

Hi,

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.

Read: How to do Financial Analysis of a Company

Regards,

Vijay

 

Finding increase in market capitalization and retained earnings for last 10 years

Hi Dr Vijay,

  1. Please let me know how you obtain the total retained profit in case of Vinati Organics Limited and Tata Steel Limited.
  2. Are Reserves the same as the amount retained by company? Or it should be Reserves – Dividend?
  3. Also how to obtain total increase in market capitalization?

Regards

Author’s Response:

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.

Read: Understanding Annual Report of a Company

Hope it helps!

Regards,

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 except Vinati Organics, mentioned above in my portfolio.

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