Q&A: Net Interest Margin and Spread, What determines PE Ratio of a Stock, Operating Leverage, Financial Leverage, Internal Rate of Return (IRR)

Modified on July 2, 2020

The current article in this series provides responses related to:

  • Net Interest Margin and Spread
  • What determines the PE ratio of a stock?
  • Operating Leverage, Financial Leverage and Internal Rate of Return (IRR)

 

Net Interest Margin and Spread

Hello Vijay,

Thank you for valuable time and support beginners like me.

I need your clarification about net interest margin (NIM) and interest spread. I try to understand from internet but I couldn’t. Please confirm my below understanding

  • NIM = (Interest Income – Interest Expense) / Interest earning assets

Spread, on the other hand, is the difference between yield and cost of borrowing, where yield is the interest income earned on interest earning assets and cost of borrowing is interest expense charged on interest bearing liabilities.

  • Spread = (Interest Income/ Interest earning assets) – (Interest Expense/ Interest bearing Liabilities)

E.g.

  • If Interest income = Rs. 150 crore
  • Interest expense = Rs. 80 crore
  • Interest earning assets = Rs. 2,250 crore
  • Interest bearing liabilities = Rs. 3,000 crore
  • NIM = (150 – 80) / 2250= 3.11%
  • Spread = (150 / 2,250) – (80 / 3,000)= 4%

Some websites explains spread = (interest earned – interest expenses)

E.g.: interest expenses= 8%, interest earned = 12% Spread= 4%

Thank you again for your support

Author’s Response:

Hi,

Thanks for writing to me!

I am happy that you are trying to understand different key concepts relevant to understanding stocks of different industries and referring to different resources for them.

Different resources would always define different ratios differently as per their preference. From you calculations, I find that you have understood the basic behind NIM/Spread.

Therefore, the first thing that you need to take care while using NIM &/or spread is that before taking the NIM/spread value mentioned on any website/source for granted, you should calculate it on your own from the annual report data and secondly, you should compare any two stocks for NIM/Spread by calculating their values by similar method.

Regards,

Vijay

 

What determines the PE ratio of a stock?

a} sir, does market’s perception or market price of share increases with increase in eps or is there any other factors involved ?

and

b} can P/E ratio for a company be constant with increase in eps ?

Author’s Response:

Hi,

Thanks for writing to me!

P/E ratio measures how much market is willing to pay for a company. P/E will depend on many factors. Many of these factors are measurable like EPS growth, debt levels etc. how many are subjective like market perception. Therefore, there is no definite answer to your query.

P/E may increase or remain constant with increasing EPS depending upon other factors that influence a company’s performance.

Read: 3 Principles to Decide the Ideal P/E Ratio of a Stock for Value Investors

All the best for your investing journey!

Regards,

Vijay

 

Operating Leverage, Financial Leverage and Internal Rate of Return (IRR)

Dear Sir,

In the web portals, I find the formulas of Degree of operate leverage, degree of financial leverage of degree of total leverage. I simply want to know what is operating leverage and its, formula to compute. And what is financial leverage and its formula.

I also what to know from you on IRR.

IRR is the rate which makes NPV zero. If a project has IRR on 15% for 5 years means, its NPV is zero or say the projects Initial cost is equivalent with discounted value of projected cash flow of first 5 years, isn’t it? If so, the future projected cash flow generated by the project from 6th year are the return for the investors of the project?

Please simply educate me or if you have any links of your article on such, please provide. I would be very grateful with you.

Sincerely

Author’s Response:

Hi,

Operating leverage: when fixed costs are high, then with increasing sales, profits increase faster than sales in % and vice versa.

Financial leverage: company boosts its assets by raising additional resources (debt) over its equity

Read: How to do Financial Analysis of Companies

IRR is compared to cost of funds or risk free rate. The higher is the IRR than cost of funds or risk free rate, the more rewarding is the project.

Regards,

Vijay

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.

Related Posts:

Get free e-book with 20 Companies Analysis

Free Investing Ebook Case Studies Peaceful Investing
  • Get the e-book: “Case Studies: Applying Peaceful Investing Approach”
  • Learn fundamental analysis by reading 20 case studies in this e-book​
  • Get email updates of our articles

Get email updates of our articles

  • Portfolio returns of 16% against Sensex returns of 8.4%.
  • We identified companies, which were later invested by Sanjay Bakshi, Mohnish Pabrai, PE funds, Mutual Funds
  • See details of stocks in our portfolio
  • Get updates of buy/sell transactions in our portfolio by email

"Peaceful Investing": My Stock Investing Approach

“Peaceful Investing” approach is the result of my more than a decade of experience in equity markets. This approach helped me invest even when I had a full-time corporate job and therefore, could not spare a lot of time for stock analysis.

During my investing journey, I have faced almost all the common challenges of the investors; the biggest one being “scarcity of time”. “Peaceful Investing” approach keeps in mind that an investor will have only limited time for stock analysis. 

The objective of “Peaceful Investing” approach is the selection of such stocks, where once an investor has put in her money, then she may sleep peacefully. Therefore, if later on, the stock prices increase, then the investor is happy as she is now wealthier. On the contrary, if the stock prices decline, even then the investor is happy as she can now buy more quantity of the selected fundamentally good stocks.

Watch Balance Sheet Analysis through a Free Sample Video:

Peaceful Investing Video Series Image
Play Video

Please share your comments here:

1. IMPORTANT: You MUST do a search on Google and on our website to find answer to your query before writing it here. It will save your time as well as our time.

2. All comments are moderated. Your comment will be visible after we approve/reply to it.

Get free e-book with 20 Companies Analysis

Free Investing Ebook Case Studies Peaceful Investing
  • Get the e-book: “Case Studies: Applying Peaceful Investing Approach”
  • Learn fundamental analysis by reading 20 case studies in this e-book​
  • Get email updates of our articles

Get email updates of our articles