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When a company should sell all assets and invest money in FDs? Find usage of short term funds for long term purpose. Find historical market capitalization of any company. Who decides the share price of any stock?

Modified on January 9, 2019

www.drvijaymalik.com has a section dedicated to answering queries from readers: “Ask Your Queries”. Over time, many readers have asked their queries related to many aspects of stock analysis and sought clarifications about investing. We have responded to these queries as replies to their comments.

“Q&A” series is an attempt to share the queries & their responses, which have featured on “Ask Your Queries” section, with all the readers. The primary aim of this new feature is to share the knowledge with other readers of the website, who might have similar queries.

The current article in this series provides responses related to the following queries:

  • When a company is better off by selling all its assets and invest the money in Bank’s fixed deposits?
  • How to find out usage of short-term funds for the long-term purpose by companies?
  • How to find historical market capitalization of any company?
  • Who decides the share price of any stock?

 

When a company is better off by selling all its assets and invest the money in Bank’s fixed deposits?

Hi Dr. Vijay,

I was one of the participants of your “Peaceful Investing” workshop in Delhi on May 13, 2018. I had a query while I was going through your ‘Peaceful investing’ e-book.

On page 100, we have a snippet of financials of ‘Atul Auto Ltd’. The sales growth looks good. Good profit growth in absolute numbers. However, my doubt comes from the fact that at the bottom line for the P&L, the business has only 6-8% NPM. Is this a good number to have for any business?

I understand that this is a capital-intensive business. However, at the end of the year, it is still generating only 6-8% for equity holders after repaying the debt, compared to 6-7% return from a fixed deposit. The free cash flows may be good, but shouldn’t the net profit be much better than that.

I think I may be missing something here. To understand it better, I will appreciate your help on this!

Regards,

Author’s Response:

Hi,

Thanks for writing to us! It was great to have you at the workshop!

We believe that comparing the net profit margin (NPM) with fixed deposit (FD) interest rate may not be a like-to-like comparison. Let us illustrate:

Let us assume if we invest ₹100/- in an FD and the interest rate is 7%. Then in one year, we will have interest income (pre-tax) of ₹ 7/-. We will pay about ₹2 as a tax (30%) and therefore, we will have ₹5 as income after tax.

In this example, the NPM is about 70%, which is after-tax income/Total income = 5/7

However, this case represents that the total assets put in the business/FD are ₹100, which provided after-tax net income of ₹5/-. So the total return on assets is 5% i.e. after-tax income/total assets = 5/100

Further advised reading: How to do Financial Analysis of Companies

If in case of companies, we find that the net profit after tax on total amount of assets is less than the net profit after tax earned by investing the same amount in FD, then we may arrive at the conclusion that it is not worthwhile to run the business.

Over time, while analysing companies for readers’ submissions, we have found that many companies are not able to earn a return on their total assets that are higher than fixed deposits. An investor may read some of the examples in the following articles:

Therefore, to conclude, we believe that an investor may compare the cases, where if a company invests all its assets in FD, then what money it would have earned after tax. If that return from FD after tax is higher than the net profit after tax (PAT) from running the business, then it might mean that putting all the effort to run the business may not be worth it.

Hope it answers your queries.

All the best for your investing journey!

Regards,

Dr Vijay Malik

 

Follow up query:

 

Applicability of (net PAT/total assets vs FD) to banking/financial institutions/service sector companies

Sir, a follow up query about comparing (net PAT/assets employed) with fixed deposit (FD) returns. Is there any such way of comparing banking/finance stocks like this manner?

Most of these companies have return on assets of 1-2% and comparing with FD returns of 5% (after tax) I suppose can’t be done.

Regards,

Author’s response:

Hi,

Thanks for writing to us!

In case of financial institutions or other services companies, fixed assets are not the primary determinant of returns. This is because these companies have people oriented businesses. A company can increase its business by hiring more employees (bankers/software developers etc.) within the existing assets (buildings). The company may not need to invest in new physical assets each time it increases the number of employees to increase the business.

Therefore, in case of financial institutions and other services companies, the physical assets are not the primary factor influence the returns/profits. As a result, the parameter of net PAT/assets employed may not be highly relevant for such companies.

Hope it answers your queries.

All the best for your investing journey!

Regards

Dr. Vijay Malik

 

How to find out usage of short-term funds for the long-term purpose by companies?

Hello Sir,

I wanted to know how we could see whether short-term resources have been used for long-term purposes. I understand the sources of both but how can I check whether one is used for the other & vice versa.

Thank you.

Author’s Response:

Hi,

Thanks for writing to us!

There are a few finer nuances in the assessment of usage of short-term resources for the long-term purpose. However, as a thumb rule, the investor may compare non-current assets (i.e. Total assets – current assets) with non-current liabilities (i.e. total liabilities – current liabilities).

If the non-current assets are greater than non-current liabilities, then it is highly likely that short-term resources (i.e. current liabilities) have been used to fund long-term assets/purposes (i.e. non-current assets).

Further advised reading: Understanding the Annual Report of a Company

Please note that this general rule works in most cases. However, various kinds of grouping/reclassification of items in the balance sheet may require finer details like reading notes/schedules to financial statements to have any definitive opinion.

Moreover, auditors also point out the usage of short-term resources for long-term purpose in their report in the annual report.

All the best for your investing journey!

Regards

Dr Vijay Malik

 

How to find historical market capitalization of any company?

Hello Sir,

Can you please advise me on how to find the historical market capitalization for a company? For example, if I need to find what is the market cap for a company 10 years ago?, then can I get it only from that year annual report alone, or is there any site which provides that info handy?

Author’s Response:

Hi,

Thanks for writing to us!

The historical stock price on stock exchanges is available on the stock exchange websites (e.g. historical prices of stocks on BSE Website). This share price data is usually bonus/split adjusted. Therefore, an investor may simply multiply the current number of stocks with the share price on any historical date to have an idea about the market cap of the company on that particular historical date.

We do not know about any website, which provides the auto-calculated market capitalization of stocks on such different dates.

All the best for your investing journey!

Regards

Dr. Vijay Malik

Follow up query:

Thanks for the explanation sir. One small confusion, do we need to multiply the historical price with the current number of stocks or the outstanding stocks at that point in time?

Regards

Author’s Response:

Hi,

Thanks for writing to us!

In case, the historical share price data is adjusted for splits/bonuses, then we need to multiply the historical share price with the current number of shares.

However, if the historical share price data is not adjusted for split/bonuses, then we need to multiply the historical share price with the number of shares at that particular date.

Please note if an investor needs to prefer any one of the above two approaches, then the second approach will give a better result as it will also exclude the influence of additional share issuances due to ESOPs/preferential allotment etc.

Hope it answers your queries.

All the best for your investing journey!

Regards

Dr. Vijay Malik

 

Who decides the share price of any stock?

Respected sir,

Suppose a person has purchased 100 stocks of MRF Ltd at ₹500 and then another person Mr. Y purchased 200 shares of MRF at ₹500. After that, another person does the same. After some time the price of MRF has changed from ₹500 to ₹600. It cannot change automatically. Someone has to be there to change it depending on the demand and supply of MRF.

My question is who is that someone and on what formula he changes the price of the stock? Please help clear my doubt, Sir.

Author’s Response:

Hi,

Thanks for writing to us!

It is the investors like you, me etc. who influence the price. The current price of any stock disclosed by the stock exchange is the price of the last transaction done by any investor.

To understand the impact that any investor has on stock price, it is advised to see the trading in the stock with very low liquidity on stock exchanges. There are many stocks listed on BSE where there are only a few trades in the entire day. Many times, there is not even a single trade in those shares in the entire day.

When an investor sees the bid/ask data for these stocks, then she notices that a few buyers and a few sellers have put in their bids at different prices. It may be that the highest buyer has put in a buy price of ₹100/- and the lowest seller has put in a selling price of ₹105/-

They simply put their bids and then wait until any buyer agrees with the lowest seller’s price or any seller agrees with the highest buyer’s price. If the buyer has urgent need to buy stocks, then she will increase her buy price and buy the shares at ₹105/- and the stock exchange will show the current price of the stock as ₹105/-. On the contrary, if the buyer is patient and the seller is in urgent need of funds, then she may lower her sell price and sell her shares at ₹100/-. In this case, the stock exchange will show the current share price as ₹100/-.

The same mechanism plays out in highly liquid stocks including large caps where millions of shares are traded every day. However, as the trades in large caps happen frequently, therefore, any single buyer/seller is not able to see her influence on the stock price. On the contrary, any buyer/seller is able to see the impact on the share price that any single person/investor may have in the illiquid/low liquidity stocks.

Request you to observe the trading in low liquidity stocks on BSE to see it in action.

All the best for your investing journey!

Regards

Dr. Vijay Malik

P.S.

 

DISCLAIMER

Registration Status with SEBI:

I am registered with SEBI as an Investment Adviser under SEBI (Investment Advisers) Regulations, 2013

Details of Financial Interest in the Subject Company:

Currently, I do not own stocks of any of the companies discussed above

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