1. Can I in one sentence say exactly what the company does?
2. Is operating cash flow higher than earnings per share?
3. Is Free Cash Flow/Share higher than dividends paid?
4. Debt to equity below 35%?
5. Debt less than book value?
6. Long Term debt less than 2 times working capital?
7. Is the debt to EBITDA ratio less than 5?
8. What are the debt covenants?
9. When is the debt due?
10. Are Pre-tax margins higher than 15%?
11. Is the Free Cash Flow Margin higher than 10%?
12. Is the current asset ratio greater than 1.5?
13. Is the quick ratio greater than 1?
14. Is there growth in Earnings Per Share?
15. Is management shareholding > 10%?
16. Is the Altman Z score > 3?
17. Does the company have a Piotroski F-Score of more than 7?
18. Is there substantial dilution?
19. What is the Flow ratio (Good < 1.25, Bad > 3)
20. What are management’s incentives?
21. Are management’s salaries too high?
22. What is the bargaining power of suppliers?
23. Is there heavy insider buying?
24. Is there heavy insider selling?
25. Any net share buybacks?
26. Is it a low risk business?
27. Is there high uncertainty?
28. Is it in my circle of competence?
29. Is it a good business?
30. Do I like the management? (Operators, capital allocators, integrity)
31. Is the stock screaming cheap?
32. How capital intensive is the business?
33. Does management have the ability to naturally re-invest in the business at a high return?
34. Is the company highly profitable?
35. Has it got a high return on capital?
36. Has the business got an enormous moat?
37. Is there room for future growth?
38. Does the business have strong cash flow?
39. What has management done with the cash?
40. Where has the Free Cash Flow been invested?
40.a. Share buybacks
40.b. Dividends
40.c. Reinvested in the business
Thursday, September 29, 2011
Wednesday, September 28, 2011
The American Business Model
It is raining, and the little town looks totally deserted.It is tough times, everybody is in debt, and everybody lives on credit.
Suddenly, a rich tourist comes to town. He enters the only hotel, lays a 100 Euro note on the reception counter, and goes to inspect the rooms upstairs in order to choose one. The hotel proprietor takes the 100 Euro note and runs to pay his debt to the butcher. The butcher takes the 100 Euro note, and runs to pay his debt to the pig grower. The pig grower takes the 100 Euro note, and runs to pay his debt to the supplier of his feed and fuel. The supplier of feed and fuel takes the 100 Euro note and runs to pay his debt to the town's prostitute that in these hard times, gave her "services" on credit. The hooker runs to the hotel, and pays off her debt with the 100 Euro note to the hotel proprietor to pay for the rooms that she rented when she brought her clients there. The hotel proprietor then lays the 100 Euro note back on the counter so that the rich tourist will not suspect anything.
At that moment, the tourist comes down after inspecting the rooms, and takes his 100 Euro note, after saying that he did not like any of the rooms, and leaves town. No one earned anything....!!
However, the whole town is now without debt, and looks to the future with a lot of optimism. And that, ladies and gentlemen, is how the United States is doing business today....!!!
Suddenly, a rich tourist comes to town. He enters the only hotel, lays a 100 Euro note on the reception counter, and goes to inspect the rooms upstairs in order to choose one. The hotel proprietor takes the 100 Euro note and runs to pay his debt to the butcher. The butcher takes the 100 Euro note, and runs to pay his debt to the pig grower. The pig grower takes the 100 Euro note, and runs to pay his debt to the supplier of his feed and fuel. The supplier of feed and fuel takes the 100 Euro note and runs to pay his debt to the town's prostitute that in these hard times, gave her "services" on credit. The hooker runs to the hotel, and pays off her debt with the 100 Euro note to the hotel proprietor to pay for the rooms that she rented when she brought her clients there. The hotel proprietor then lays the 100 Euro note back on the counter so that the rich tourist will not suspect anything.
At that moment, the tourist comes down after inspecting the rooms, and takes his 100 Euro note, after saying that he did not like any of the rooms, and leaves town. No one earned anything....!!
However, the whole town is now without debt, and looks to the future with a lot of optimism. And that, ladies and gentlemen, is how the United States is doing business today....!!!
Friday, September 16, 2011
How Kingfisher and Jet made a hash of their business models
Running an airline in India is a mugs’ game. Once defined as the simple business of “getting bums on seats”—more “bums” means better bottomline—the way the Indian industry is being run, one wonders if the “bums” are paying enough for the seats they sit on.
Thursday’s newspapers said Kingfisher’s auditor was tut-tutting about the poor state of its balance-sheet. Without owner Vijay Mallya putting in more equity, the airline is on a crash course, with accumulated losses eroding more than “50 percent of its net worth.”
Look at the carnage. Kingfisher hasn’t seen black since 2005. Market leader Jet Airways hasn’t sniffed profits since 2007-08. SpiceJet has got a whiff, but has accumulated sackfuls of losses (Rs 720 crore) in the past. In the first quarter of 2011-12, Jet made a loss of Rs 123 crore after many accounting adjustments, Kingfisher lost a whopping Rs 264 crore, and SpiceJet Rs 72 crore.
One figure tells it all. Between last year and now, the three listed companies – Jet, Kingfisher and SpiceJet – destroyed Rs 6,600 crore of shareholder wealth, a drop of 59 percent when the overall market (as measured by the Nifty index) fell only 13.48 percent.
As for Air India, the less said the better. When last heard of, it had racked up losses of Rs 22,000 crore against a shrinking market share – and its management is accumulating frequent flier miles to-ing and fro-ing between Delhi and Mumbai, trying to wangle thousands of crores in equity infusion. What it needs is an infusion of cyanide.
The airline business is clearly a value destroyer. And it’s doing it all by itself, without help from Praful Patel.
Or is it? In India, there is clear line dividing successful (or near successful) airlines from the rest. And that line is drawn in sand. It divides the pure low-cost carriers (LCCs) with a clear business model (SpiceJet, Indigo) from the ones who operate both full-service and low-cost carriers (Jet, Kingfisher, Air India).
It’s the full-service carriers (FSCs) that are bleeding profusely for they have a confused business model. They have fallen between two stools.
The world over, there are five keys to airline success: costs, costs, costs, costs, costs. This is where the LCCs score over the FSCs.
The first cost in this bums-on-seats business is a four-letter word – CASK, or the cost per available seat kilometre. It helps to have more bums on seats, but the critical thing is to have the lowest possible seat cost per possible bum. CASK is a metric that measures what it costs to fly every seat for each km of distance.
Indigo and SpiceJet are the industry champs in CASK, though clearly comparable figures are not available. A Forbes India report quotes.
Citibank’s airline industry analysts Jamshed Dadabhoy and Arvind Sharma as saying that “the capital costs per passenger for full service airlines have jumped several fold over the last few years, while those of budget airlines have remained stable or moved up very little. SpiceJet, for instance, has a CASK of between Rs 2.30-2.40 while the number for Jet Airways is around Rs 3.60.”
The second cost to control is debt. Debt brought Air India down, with some help from Praful Patel, who was the Civil Aviation Minister when the airline suddenly ordered 50 medium and long-range aircraft for $7.2 billion when the management thought 18 would do. The resulting debt laid the airline low. It current debt: a crippling Rs 42,570 crore.
Contrast that with what Indigo and SpiceJet have cannily done. Both take aircraft only on lease. Even if they buy them, the aircraft are resold to financiers and leased back. Says Antique Stock Broking, which put a buy on SpiceJet in July: “The company has used an asset light model for business growth with sale and leaseback strategy. Its entire fleet is currently leased and the strategy has helped the airline to keep its debt levels to minimum, avoiding debt burden. This strategy has paid off SpiceJet very well and it stands out distinctly amongst its competitors. The company has managed to survive the downturn and grow, while competing players are finding it difficult to expand the fleet due to heavy debt burden.”
Jet is better off compared to Air India, but it is still tottering under debt. In a recent interview, Jet’s Senior Vice-President (Finance) Mahalingam Shivkumar agreed that debt exceeded its airline assets. He said: “We have a debt of about Rs 13,400 crore, out of which Rs 9,000 crore is our acquired aircraft. Against that, we have an asset worth Rs 9,000 crore and we have a balance of Rs 4,000 crore.”
The market agrees. Rs 4,300 crore is the value of Jet’s drop in market capitalisation over the last one year.
The third cost is fuel. Thanks to rising fuel prices over the last one year, SpiceJet’s fuel costs as a percentage of sales have moved up from 37 percent to 56 percent of sales, but if its balance-sheet is looking prettier than its competitors’, its not because it is able to drive better bargains with the oil companies. Aviation fuel costs the same for everybody. So what makes the difference?
Aircraft age. Keep your aircraft fleet young, and you get fuel savings. Says the Forbes article on Indigo: “Indigo has six-year sale and leaseback agreements for most of its planes. The lessor takes the planes back after this and the airline can induct a brand new one in its place. Though at a cost, this is effectively like a perpetual elixir of youth. The most important financial implication is that it never has to undertake the ‘D’ check, where the aircraft is completely stripped down and airlines often discover the need to spend on major repairs. This check is usually done when the plane is about eight years old.”
The average age of Indigo’s fleet, as indicated by aviation website www.airfleets.net is 2.4 years. It’s a fleet-footed toddler in Indian airspace. Go Air’s average fleet age is also a stripling 2.5 years. SpiceJet’s birds are a bit older at an average of 4.7 years.
But the three airlines with a mix of full-service and low-cost operations—Kingfisher, Jet and Air India—had the oldest fleet mix. Kingfisher and Kingfisher Red had 4.6 years and 5.9 (making for an above 5 average for the company as a whole), Jet had 5.8, and Air India had a gerontocratic 9.8 years.
Age is beginning to tell on the big boys.
The fourth cost relates to aircraft maintenance. Globally, airlines have to maintain and service airlines to strict safety standards. This is why airlines with a diverse mix of aircraft tend to have higher costs, because they need separate staff to maintain Boeings or Airbuses or whatever.
The low-cost carriers (LCCs) have cannily focused on having only one basic aircraft (or sometimes two, with the second one connecting the smaller towns). SpiceJet uses Boeing 737s (NextGen). And Indigo Airbus 320s. But the big boys use several types. Kingfisher uses many different Airbuses (from A319-321 to 330) and ATRs. Jet uses Airbuses, Boeings and ATRs. Air India uses Airbuses, Boeings and even a Lockheed L-101 Tristar (anyone’s heard of them?)
In this business, diversity is weakness.
The fifth cost is the cost of idling. Getting bums on seats is one half of the challenge, but there’s no point getting them seated till you can fly them. In short, you have to fly more bums more often and for longer – and this means airlines which keep their aircraft flying for longer hours get better revenues. The figure to watch here is the aircraft utilisation rate – the time the aircraft spends in the air in a 24-hour cycle.
Indigo tries to keep the idle time between two journeys to 30 minutes and manages an aircraft utilisation rate of 11.5 hours a day. Air India’s? Don’t ask. It’s 9.1 hours.
Apart from costs, the full-service carriers compounded their problems by making fundamental strategic errors in their desire to scale up and raise market share.
Domestic market shares in 2001 stood at 26 percent for Jet (including JetLite), 19 percent for Kingfisher, 18 percent for Indigo, 16 percent for Air India, 14 percent for SpiceJet and 7 percent for Go Air, according to data from the Directorate General of Civil Aviation.
Two areas are worth mentioning. Mergers and branding.
All the full-service boys messed up their mergers. Coincidentally, all three—Jet, Kingfisher and Air India—went in for acquisitions and mergers in 2007-08. While Jet bought Sahara, Kingfisher bought Air Deccan and Air India merged with Indian Airlines. The traditional logic of mergers is cost savings and synergy, where two and two equals five.
But, surprise, two plus two ended up as three for all of them. While some cost rationalizations did come through from route swapping and capacity and code sharing, all three made branding and HR errors.
Air India never fully consummated the marriage with Indian Airlines as its human resources issues did not get sorted out (pay structures, etc). Jet and Kingfisher committed cardinal branding errors by renaming their low-cast carriers in their own image.
While Jet renamed Sahara as Jet Lite, consumers wondered what the difference was. Kingfisher converted Air Deccan into Kingfisher Red – and duly landed deeper in the red.
The issue is simple: when two brands—one full-service with all the frills of flying, and another, with low fares—are given the same or similar names, how is the consumer to know the difference? It is easy to assume that Kingfisher Red’s service is no different from Kingfisher’s, when the fares of the former are far lower. If Rolex were to buy Titan and name the latter Rolex Lite, will Rolex’s sales go up or Titan’s?
It is more than likely that many air passengers downtraded to the LCCs due to this brand confusion.
The full-service carriers have clearly to rethink their business models and branding. Or else, they can kiss goodbye to profits forever.
The above article is taken from Firstpost.
Thursday’s newspapers said Kingfisher’s auditor was tut-tutting about the poor state of its balance-sheet. Without owner Vijay Mallya putting in more equity, the airline is on a crash course, with accumulated losses eroding more than “50 percent of its net worth.”
Look at the carnage. Kingfisher hasn’t seen black since 2005. Market leader Jet Airways hasn’t sniffed profits since 2007-08. SpiceJet has got a whiff, but has accumulated sackfuls of losses (Rs 720 crore) in the past. In the first quarter of 2011-12, Jet made a loss of Rs 123 crore after many accounting adjustments, Kingfisher lost a whopping Rs 264 crore, and SpiceJet Rs 72 crore.
One figure tells it all. Between last year and now, the three listed companies – Jet, Kingfisher and SpiceJet – destroyed Rs 6,600 crore of shareholder wealth, a drop of 59 percent when the overall market (as measured by the Nifty index) fell only 13.48 percent.
As for Air India, the less said the better. When last heard of, it had racked up losses of Rs 22,000 crore against a shrinking market share – and its management is accumulating frequent flier miles to-ing and fro-ing between Delhi and Mumbai, trying to wangle thousands of crores in equity infusion. What it needs is an infusion of cyanide.
The airline business is clearly a value destroyer. And it’s doing it all by itself, without help from Praful Patel.
Or is it? In India, there is clear line dividing successful (or near successful) airlines from the rest. And that line is drawn in sand. It divides the pure low-cost carriers (LCCs) with a clear business model (SpiceJet, Indigo) from the ones who operate both full-service and low-cost carriers (Jet, Kingfisher, Air India).
It’s the full-service carriers (FSCs) that are bleeding profusely for they have a confused business model. They have fallen between two stools.
The world over, there are five keys to airline success: costs, costs, costs, costs, costs. This is where the LCCs score over the FSCs.
The first cost in this bums-on-seats business is a four-letter word – CASK, or the cost per available seat kilometre. It helps to have more bums on seats, but the critical thing is to have the lowest possible seat cost per possible bum. CASK is a metric that measures what it costs to fly every seat for each km of distance.
Indigo and SpiceJet are the industry champs in CASK, though clearly comparable figures are not available. A Forbes India report quotes.
Citibank’s airline industry analysts Jamshed Dadabhoy and Arvind Sharma as saying that “the capital costs per passenger for full service airlines have jumped several fold over the last few years, while those of budget airlines have remained stable or moved up very little. SpiceJet, for instance, has a CASK of between Rs 2.30-2.40 while the number for Jet Airways is around Rs 3.60.”
The second cost to control is debt. Debt brought Air India down, with some help from Praful Patel, who was the Civil Aviation Minister when the airline suddenly ordered 50 medium and long-range aircraft for $7.2 billion when the management thought 18 would do. The resulting debt laid the airline low. It current debt: a crippling Rs 42,570 crore.
Contrast that with what Indigo and SpiceJet have cannily done. Both take aircraft only on lease. Even if they buy them, the aircraft are resold to financiers and leased back. Says Antique Stock Broking, which put a buy on SpiceJet in July: “The company has used an asset light model for business growth with sale and leaseback strategy. Its entire fleet is currently leased and the strategy has helped the airline to keep its debt levels to minimum, avoiding debt burden. This strategy has paid off SpiceJet very well and it stands out distinctly amongst its competitors. The company has managed to survive the downturn and grow, while competing players are finding it difficult to expand the fleet due to heavy debt burden.”
Jet is better off compared to Air India, but it is still tottering under debt. In a recent interview, Jet’s Senior Vice-President (Finance) Mahalingam Shivkumar agreed that debt exceeded its airline assets. He said: “We have a debt of about Rs 13,400 crore, out of which Rs 9,000 crore is our acquired aircraft. Against that, we have an asset worth Rs 9,000 crore and we have a balance of Rs 4,000 crore.”
The market agrees. Rs 4,300 crore is the value of Jet’s drop in market capitalisation over the last one year.
The third cost is fuel. Thanks to rising fuel prices over the last one year, SpiceJet’s fuel costs as a percentage of sales have moved up from 37 percent to 56 percent of sales, but if its balance-sheet is looking prettier than its competitors’, its not because it is able to drive better bargains with the oil companies. Aviation fuel costs the same for everybody. So what makes the difference?
Aircraft age. Keep your aircraft fleet young, and you get fuel savings. Says the Forbes article on Indigo: “Indigo has six-year sale and leaseback agreements for most of its planes. The lessor takes the planes back after this and the airline can induct a brand new one in its place. Though at a cost, this is effectively like a perpetual elixir of youth. The most important financial implication is that it never has to undertake the ‘D’ check, where the aircraft is completely stripped down and airlines often discover the need to spend on major repairs. This check is usually done when the plane is about eight years old.”
The average age of Indigo’s fleet, as indicated by aviation website www.airfleets.net is 2.4 years. It’s a fleet-footed toddler in Indian airspace. Go Air’s average fleet age is also a stripling 2.5 years. SpiceJet’s birds are a bit older at an average of 4.7 years.
But the three airlines with a mix of full-service and low-cost operations—Kingfisher, Jet and Air India—had the oldest fleet mix. Kingfisher and Kingfisher Red had 4.6 years and 5.9 (making for an above 5 average for the company as a whole), Jet had 5.8, and Air India had a gerontocratic 9.8 years.
Age is beginning to tell on the big boys.
The fourth cost relates to aircraft maintenance. Globally, airlines have to maintain and service airlines to strict safety standards. This is why airlines with a diverse mix of aircraft tend to have higher costs, because they need separate staff to maintain Boeings or Airbuses or whatever.
The low-cost carriers (LCCs) have cannily focused on having only one basic aircraft (or sometimes two, with the second one connecting the smaller towns). SpiceJet uses Boeing 737s (NextGen). And Indigo Airbus 320s. But the big boys use several types. Kingfisher uses many different Airbuses (from A319-321 to 330) and ATRs. Jet uses Airbuses, Boeings and ATRs. Air India uses Airbuses, Boeings and even a Lockheed L-101 Tristar (anyone’s heard of them?)
In this business, diversity is weakness.
The fifth cost is the cost of idling. Getting bums on seats is one half of the challenge, but there’s no point getting them seated till you can fly them. In short, you have to fly more bums more often and for longer – and this means airlines which keep their aircraft flying for longer hours get better revenues. The figure to watch here is the aircraft utilisation rate – the time the aircraft spends in the air in a 24-hour cycle.
Indigo tries to keep the idle time between two journeys to 30 minutes and manages an aircraft utilisation rate of 11.5 hours a day. Air India’s? Don’t ask. It’s 9.1 hours.
Apart from costs, the full-service carriers compounded their problems by making fundamental strategic errors in their desire to scale up and raise market share.
Domestic market shares in 2001 stood at 26 percent for Jet (including JetLite), 19 percent for Kingfisher, 18 percent for Indigo, 16 percent for Air India, 14 percent for SpiceJet and 7 percent for Go Air, according to data from the Directorate General of Civil Aviation.
Two areas are worth mentioning. Mergers and branding.
All the full-service boys messed up their mergers. Coincidentally, all three—Jet, Kingfisher and Air India—went in for acquisitions and mergers in 2007-08. While Jet bought Sahara, Kingfisher bought Air Deccan and Air India merged with Indian Airlines. The traditional logic of mergers is cost savings and synergy, where two and two equals five.
But, surprise, two plus two ended up as three for all of them. While some cost rationalizations did come through from route swapping and capacity and code sharing, all three made branding and HR errors.
Air India never fully consummated the marriage with Indian Airlines as its human resources issues did not get sorted out (pay structures, etc). Jet and Kingfisher committed cardinal branding errors by renaming their low-cast carriers in their own image.
While Jet renamed Sahara as Jet Lite, consumers wondered what the difference was. Kingfisher converted Air Deccan into Kingfisher Red – and duly landed deeper in the red.
The issue is simple: when two brands—one full-service with all the frills of flying, and another, with low fares—are given the same or similar names, how is the consumer to know the difference? It is easy to assume that Kingfisher Red’s service is no different from Kingfisher’s, when the fares of the former are far lower. If Rolex were to buy Titan and name the latter Rolex Lite, will Rolex’s sales go up or Titan’s?
It is more than likely that many air passengers downtraded to the LCCs due to this brand confusion.
The full-service carriers have clearly to rethink their business models and branding. Or else, they can kiss goodbye to profits forever.
The above article is taken from Firstpost.
Wednesday, September 14, 2011
Saturday, September 10, 2011
8 Steps To Financial Analytic Intelligence
The following 8 financial ratios offer terrific insights into the financial health of a company -- and the prospects for a rise in its share price.
1. Ploughback and Reserves
After deduction of all expenses, including taxes, the net profits of a company are split into two parts -- dividends and ploughback.
Dividend is that portion of a company's profits which is distributed to its shareholders, whereas ploughback is the portion that the company retains and gets added to its reserves.
The figures for ploughback and reserves of any company can be obtained by a cursory glance at its balance sheet and profit and loss account.
Ploughback is important because it not only increases the reserves of a company but also provides the company with funds required for its growth and expansion. All growth companies maintain a high level of ploughback. So if you are looking for a growth company to invest in, you should examine its ploughback figures.
Companies that have no intention of expanding are unlikely to plough back a large portion of their profits.
Reserves constitute the accumulated retained profits of a company. It is important to compare the size of a company's reserves with the size of its equity capital. This will indicate whether the company is in a position to issue bonus shares.
As a rule-of-thumb, a company whose reserves are double that of its equity capital should be in a position to make a liberal bonus issue.
Retained profits also belong to the shareholders. This is why reserves are often referred to as shareholders' funds. Therefore, any addition to the reserves of a company will normally lead to a corresponding an increase in the price of your shares.
The higher the reserves, the greater will be the value of your shareholding. Retained profits (ploughback) may not come to you in the form of cash, but they benefit you by pushing up the price of your shares.
2. Book Value per Share
You will come across this term very often in investment discussions. Book value per share indicates what each share of a company is worth according to the company's books of accounts.
The company's books of account maintain a record of what the company owns (assets), and what it owes to its creditors (liabilities). If you subtract the total liabilities of a company from its total assets, then what is left belongs to the shareholders, called the shareholders' funds.
If you divide shareholders' funds by the total number of equity shares issued by the company, the figure that you get will be the book value per share.
Book Value per share = Shareholders' funds / Total number of equity shares issued
The figure for shareholders' funds can also be obtained by adding the equity capital and reserves of the company.
Book value is a historical record based on the original prices at which assets of the company were originally purchased. It doesn't reflect the current market value of the company's assets.
Therefore, book value per share has limited usage as a tool for evaluating the market value or price of a company's shares. It can, at best, give you a rough idea of what a company's shares should at least be worth.
The market prices of shares are generally much higher than what their book values indicate. Therefore, if you come across a share whose market price is around its book value, the chances are that it is under-priced. This is one way in which the book value per share ratio can prove useful to you while assessing whether a particular share is over- or under-priced.
3. Earnings per share (EPS)
EPS is a well-known and widely used investment ratio. It is calculated as:
Earnings Per Share (EPS) = Profit After Tax / Total number of equity shares issued
This ratio gives the earnings of a company on a per share basis. In order to get a clear idea of what this ratio signifies, let us assume that you possess 100 shares with a face value of Rs 10 each in XYZ Ltd. Suppose the earnings per share of XYZ Ltd. is Rs 6 per share and the dividend declared by it is 20 per cent, or Rs 2 per share. This means that each share of XYZ Ltd. earns Rs 6 every year, even though you receive only Rs 2 out of it as dividend.
The remaining amount, Rs 4 per share, constitutes the ploughback or retained earnings. If you had bought these shares at par, it would mean a 60 per cent return on your investment, out of which you would receive 20 per cent as dividend and 40 per cent would be the ploughback. This ploughback of 40 per cent would benefit you by pushing up the market price of your shares. Ideally speaking, your shares should appreciate by 40 per cent from Rs 10 to Rs 14 per share.
This illustration serves to drive home a basic investment lesson. You should evaluate your investment returns not on the basis of the dividend you receive, but on the basis of the earnings per share. Earnings per share is the true indicator of the returns on your share investments.
Suppose you had bought shares in XYZ Ltd at double their face value, i.e. at Rs 20 per share. Then an EPS of Rs 6 per share would mean a 30 per cent return on your investment, of which 10 per cent (Rs 2 per share) is dividend, and 20 per cent (Rs 4 per share) the ploughback.
Under ideal conditions, ploughback should push up the price of your shares by 20 per cent, i.e. from Rs 20 to 24 per share. Therefore, irrespective of what price you buy a particular company's shares at its EPS will provide you with an invaluable tool for calculating the returns on your investment.
4. Price earnings ratio (P/E)
The price earnings ratio (P/E) expresses the relationship between the market price of a company's share and its earnings per share:
Price/Earnings Ratio (P/E) = Price of the share / Earnings per share
This ratio indicates the extent to which earnings of a share are covered by its price. If P/E is 5, it means that the price of a share is 5 times its earnings. In other words, the company's EPS remaining constant, it will take you approximately five years through dividends plus capital appreciation to recover the cost of buying the share. The lower the P/E, lesser the time it will take for you to recover your investment.
P/E ratio is a reflection of the market's opinion of the earnings capacity and future business prospects of a company. Companies which enjoy the confidence of investors and have a higher market standing usually command high P/E ratios.
For example, blue chip companies often have P/E ratios that are as high as 20 to 60. However, most other companies in India [ Images ] have P/E ratios ranging between 5 and 20.
On the face of it, it would seem that companies with low P/E ratios would offer the most attractive investment opportunities. This is not always true. Companies with high current earnings but dim future prospects often have low P/E ratios.
Obviously such companies are not good investments, notwithstanding their P/E ratios. As an investor your primary concern is with the future prospects of a company and not so much with its present performance. This is the main reason why companies with low current earnings but bright future prospects usually command high P/E ratios.
To a great extent, the present price of a share, discounts, i.e. anticipates, its future earnings.
All this may seem very perplexing to you because it leaves the basic question unanswered: How does one use the P/E ratio for making sound investment decisions?
The answer lies in utilising the P/E ratio in conjunction with your assessment of the future earnings and growth prospects of a company. You have to judge the extent to which its P/E ratio reflects the company's future prospects.
If it is low compared to the future prospects of a company, then the company's shares are good for investment. Therefore, even if you come across a company with a high P/E ratio of 25 or 30 don't summarily reject it because even this level of P/E ratio may actually be low if the company is poised for meteoric future growth. On the other hand, a low P/E ratio of 4 or 5 may actually be high if your assessment of the company's future indicates sharply declining sales and large losses.
5. Dividend and yield
There are many investors who buy shares with the objective of earning a regular income from their investment. Their primary concern is with the amount that a company gives as dividends -- capital appreciation being only a secondary consideration. For such investors, dividends obviously play a crucial role in their investment calculations.
It is illogical to draw a distinction between capital appreciation and dividends. Money is money -- it doesn't really matter whether it comes from capital appreciation or from dividends.
A wise investor is primarily concerned with the total returns on his investment -- he doesn't really care whether these returns come from capital appreciation or dividends, or through varying combinations of both. In fact, investors in high tax brackets prefer to get most of their returns through long-term capital appreciation because of tax considerations.
Companies that give high dividends not only have a poor growth record but often also poor future growth prospects. If a company distributes the bulk of its earnings in the form of dividends, there will not be enough ploughback for financing future growth.
On the other hand, high growth companies generally have a poor dividend record. This is because such companies use only a relatively small proportion of their earnings to pay dividends. In the long run, however, high growth companies not only offer steep capital appreciation but also end up paying higher dividends.
On the whole, therefore, you are likely to get much higher total returns on your investment if you invest for capital appreciation rather than for dividends. In short, it all boils down to whether you are prepared to sacrifice a part of your immediate dividend income in the expectation of greater capital appreciation and higher dividends in the years to come and the whole issue is basically a trade-off between capital appreciation and income.
Investors are not really interested in dividends but in the relationship that dividends bear to the market price of the company's shares. This relationship is best expressed by the ratio called yield or dividend yield:
Yield = (Dividend per share / market price per share) x 100
Yield indicates the percentage of return that you can expect by way of dividends on your investment made at the prevailing market price. The concept of yield is best clarified by the following illustration.
Let us suppose you have invested Rs 2,000 in buying 100 shares of XYZ Ltd at Rs 20 per share with a face value of Rs 10 each.
If XYZ announces a dividend of 20 per cent (Rs 2 per share), then you stand to get a total dividend of Rs 200. Since you bought these shares at Rs 20 per share, the yield on your investment is 10 per cent (Yield = 2/20 x 100). Thus, while the dividend was 20 per cent; but your yield is actually 10 per cent.
The concept of yield is of far greater practical utility than dividends. It gives you an idea of what you are earning through dividends on the current market price of your shares.
Average yield figures in India usually vary around 2 per cent of the market value of the shares. If you have a share portfolio consisting of shares belonging to a large number of both high-growth and high-dividend companies, then on an average your dividend in-come is likely to be around 2 per cent of the total market value of your portfolio.
6. Return on Capital Employed (ROCE) and
7. Return on Net Worth (RONW)
While analysing a company, the most important thing you would like to know is whether the company is efficiently using the capital (shareholders' funds plus borrowed funds) entrusted to it.
While valuing the efficiency and worth of companies, we need to know the return that a company is able to earn on its capital, namely its equity plus debt. A company that earns a higher return on the capital it employs is more valuable than one which earns a lower return on its capital. The tools for measuring these returns are:
1. Return on Capital Employed (ROCE), and
2. Return on Net Worth (RONW).
Return on Capital Employed and Return on Net Worth (shareholders funds) are valuable financial ratios for evaluating a company's efficiency and the quality of its management. The figures for these ratios are commonly available in business magazines, annual reports and economic newspapers and financial Web sites.
Return on capital employed
Return on capital employed (ROCE) is best defined as operating profit divided by capital employed (net worth plus debt).
The figure for operating profit is arrived at after adding back taxes paid, depreciation, extraordinary one-time expenses, and deducting extraordinary one-time income and other income (income not earned through mainline operations), to the net profit figure.
The operating profit of a company is a better indicator of the profits earned by it than is the net profit.
ROCE thus reflects the overall earnings performance and operational efficiency of a company's business. It is an important basic ratio that permits an investor to make inter-company comparisons.
Return on net worth
Return on net worth (RONW) is defined as net profit divided by net worth. It is a basic ratio that tells a shareholder what he is getting out of his investment in the company.
ROCE is a better measure to get an idea of the overall profitability of the company's operations, while RONW is a better measure for judging the returns that a shareholder gets on his investment.
The use of both these ratios will give you a broad picture of a company's efficiency, financial viability and its ability to earn returns on shareholders' funds and capital employed.
8. PEG ratio
PEG is an important and widely used ratio for forming an estimate of the intrinsic value of a share. It tells you whether the share that you are interested in buying or selling is under-priced, fully priced or over-priced.
For this you need to link the P/E ratio discussed earlier to the future growth rate of the company. This is based on the assumption that the higher the expected growth rate of the company, the higher will be the P/E ratio that the company's share commands in the market.
The reverse is equally true. The P/E ratio cannot be viewed in isolation. It has to be viewed in the context of the company's future growth rate. The PEG is calculated by dividing the P/E by the forecasted growth rate in the EPS (earnings per share) of the company.
As a broad rule of the thumb, a PEG value below 0.5 indicates a very attractive buying opportunity, whereas a selling opportunity emerges when the PEG crosses 1.5, or even 2 for that matter.
The catch here is to accurately calculate the future growth rate of earnings (EPS) of the company. Wide and intensive reading of investment and business news and analysis, combined with experience will certainly help you to make more accurate forecasts of company earnings.
1. Ploughback and Reserves
After deduction of all expenses, including taxes, the net profits of a company are split into two parts -- dividends and ploughback.
Dividend is that portion of a company's profits which is distributed to its shareholders, whereas ploughback is the portion that the company retains and gets added to its reserves.
The figures for ploughback and reserves of any company can be obtained by a cursory glance at its balance sheet and profit and loss account.
Ploughback is important because it not only increases the reserves of a company but also provides the company with funds required for its growth and expansion. All growth companies maintain a high level of ploughback. So if you are looking for a growth company to invest in, you should examine its ploughback figures.
Companies that have no intention of expanding are unlikely to plough back a large portion of their profits.
Reserves constitute the accumulated retained profits of a company. It is important to compare the size of a company's reserves with the size of its equity capital. This will indicate whether the company is in a position to issue bonus shares.
As a rule-of-thumb, a company whose reserves are double that of its equity capital should be in a position to make a liberal bonus issue.
Retained profits also belong to the shareholders. This is why reserves are often referred to as shareholders' funds. Therefore, any addition to the reserves of a company will normally lead to a corresponding an increase in the price of your shares.
The higher the reserves, the greater will be the value of your shareholding. Retained profits (ploughback) may not come to you in the form of cash, but they benefit you by pushing up the price of your shares.
2. Book Value per Share
You will come across this term very often in investment discussions. Book value per share indicates what each share of a company is worth according to the company's books of accounts.
The company's books of account maintain a record of what the company owns (assets), and what it owes to its creditors (liabilities). If you subtract the total liabilities of a company from its total assets, then what is left belongs to the shareholders, called the shareholders' funds.
If you divide shareholders' funds by the total number of equity shares issued by the company, the figure that you get will be the book value per share.
Book Value per share = Shareholders' funds / Total number of equity shares issued
The figure for shareholders' funds can also be obtained by adding the equity capital and reserves of the company.
Book value is a historical record based on the original prices at which assets of the company were originally purchased. It doesn't reflect the current market value of the company's assets.
Therefore, book value per share has limited usage as a tool for evaluating the market value or price of a company's shares. It can, at best, give you a rough idea of what a company's shares should at least be worth.
The market prices of shares are generally much higher than what their book values indicate. Therefore, if you come across a share whose market price is around its book value, the chances are that it is under-priced. This is one way in which the book value per share ratio can prove useful to you while assessing whether a particular share is over- or under-priced.
3. Earnings per share (EPS)
EPS is a well-known and widely used investment ratio. It is calculated as:
Earnings Per Share (EPS) = Profit After Tax / Total number of equity shares issued
This ratio gives the earnings of a company on a per share basis. In order to get a clear idea of what this ratio signifies, let us assume that you possess 100 shares with a face value of Rs 10 each in XYZ Ltd. Suppose the earnings per share of XYZ Ltd. is Rs 6 per share and the dividend declared by it is 20 per cent, or Rs 2 per share. This means that each share of XYZ Ltd. earns Rs 6 every year, even though you receive only Rs 2 out of it as dividend.
The remaining amount, Rs 4 per share, constitutes the ploughback or retained earnings. If you had bought these shares at par, it would mean a 60 per cent return on your investment, out of which you would receive 20 per cent as dividend and 40 per cent would be the ploughback. This ploughback of 40 per cent would benefit you by pushing up the market price of your shares. Ideally speaking, your shares should appreciate by 40 per cent from Rs 10 to Rs 14 per share.
This illustration serves to drive home a basic investment lesson. You should evaluate your investment returns not on the basis of the dividend you receive, but on the basis of the earnings per share. Earnings per share is the true indicator of the returns on your share investments.
Suppose you had bought shares in XYZ Ltd at double their face value, i.e. at Rs 20 per share. Then an EPS of Rs 6 per share would mean a 30 per cent return on your investment, of which 10 per cent (Rs 2 per share) is dividend, and 20 per cent (Rs 4 per share) the ploughback.
Under ideal conditions, ploughback should push up the price of your shares by 20 per cent, i.e. from Rs 20 to 24 per share. Therefore, irrespective of what price you buy a particular company's shares at its EPS will provide you with an invaluable tool for calculating the returns on your investment.
4. Price earnings ratio (P/E)
The price earnings ratio (P/E) expresses the relationship between the market price of a company's share and its earnings per share:
Price/Earnings Ratio (P/E) = Price of the share / Earnings per share
This ratio indicates the extent to which earnings of a share are covered by its price. If P/E is 5, it means that the price of a share is 5 times its earnings. In other words, the company's EPS remaining constant, it will take you approximately five years through dividends plus capital appreciation to recover the cost of buying the share. The lower the P/E, lesser the time it will take for you to recover your investment.
P/E ratio is a reflection of the market's opinion of the earnings capacity and future business prospects of a company. Companies which enjoy the confidence of investors and have a higher market standing usually command high P/E ratios.
For example, blue chip companies often have P/E ratios that are as high as 20 to 60. However, most other companies in India [ Images ] have P/E ratios ranging between 5 and 20.
On the face of it, it would seem that companies with low P/E ratios would offer the most attractive investment opportunities. This is not always true. Companies with high current earnings but dim future prospects often have low P/E ratios.
Obviously such companies are not good investments, notwithstanding their P/E ratios. As an investor your primary concern is with the future prospects of a company and not so much with its present performance. This is the main reason why companies with low current earnings but bright future prospects usually command high P/E ratios.
To a great extent, the present price of a share, discounts, i.e. anticipates, its future earnings.
All this may seem very perplexing to you because it leaves the basic question unanswered: How does one use the P/E ratio for making sound investment decisions?
The answer lies in utilising the P/E ratio in conjunction with your assessment of the future earnings and growth prospects of a company. You have to judge the extent to which its P/E ratio reflects the company's future prospects.
If it is low compared to the future prospects of a company, then the company's shares are good for investment. Therefore, even if you come across a company with a high P/E ratio of 25 or 30 don't summarily reject it because even this level of P/E ratio may actually be low if the company is poised for meteoric future growth. On the other hand, a low P/E ratio of 4 or 5 may actually be high if your assessment of the company's future indicates sharply declining sales and large losses.
5. Dividend and yield
There are many investors who buy shares with the objective of earning a regular income from their investment. Their primary concern is with the amount that a company gives as dividends -- capital appreciation being only a secondary consideration. For such investors, dividends obviously play a crucial role in their investment calculations.
It is illogical to draw a distinction between capital appreciation and dividends. Money is money -- it doesn't really matter whether it comes from capital appreciation or from dividends.
A wise investor is primarily concerned with the total returns on his investment -- he doesn't really care whether these returns come from capital appreciation or dividends, or through varying combinations of both. In fact, investors in high tax brackets prefer to get most of their returns through long-term capital appreciation because of tax considerations.
Companies that give high dividends not only have a poor growth record but often also poor future growth prospects. If a company distributes the bulk of its earnings in the form of dividends, there will not be enough ploughback for financing future growth.
On the other hand, high growth companies generally have a poor dividend record. This is because such companies use only a relatively small proportion of their earnings to pay dividends. In the long run, however, high growth companies not only offer steep capital appreciation but also end up paying higher dividends.
On the whole, therefore, you are likely to get much higher total returns on your investment if you invest for capital appreciation rather than for dividends. In short, it all boils down to whether you are prepared to sacrifice a part of your immediate dividend income in the expectation of greater capital appreciation and higher dividends in the years to come and the whole issue is basically a trade-off between capital appreciation and income.
Investors are not really interested in dividends but in the relationship that dividends bear to the market price of the company's shares. This relationship is best expressed by the ratio called yield or dividend yield:
Yield = (Dividend per share / market price per share) x 100
Yield indicates the percentage of return that you can expect by way of dividends on your investment made at the prevailing market price. The concept of yield is best clarified by the following illustration.
Let us suppose you have invested Rs 2,000 in buying 100 shares of XYZ Ltd at Rs 20 per share with a face value of Rs 10 each.
If XYZ announces a dividend of 20 per cent (Rs 2 per share), then you stand to get a total dividend of Rs 200. Since you bought these shares at Rs 20 per share, the yield on your investment is 10 per cent (Yield = 2/20 x 100). Thus, while the dividend was 20 per cent; but your yield is actually 10 per cent.
The concept of yield is of far greater practical utility than dividends. It gives you an idea of what you are earning through dividends on the current market price of your shares.
Average yield figures in India usually vary around 2 per cent of the market value of the shares. If you have a share portfolio consisting of shares belonging to a large number of both high-growth and high-dividend companies, then on an average your dividend in-come is likely to be around 2 per cent of the total market value of your portfolio.
6. Return on Capital Employed (ROCE) and
7. Return on Net Worth (RONW)
While analysing a company, the most important thing you would like to know is whether the company is efficiently using the capital (shareholders' funds plus borrowed funds) entrusted to it.
While valuing the efficiency and worth of companies, we need to know the return that a company is able to earn on its capital, namely its equity plus debt. A company that earns a higher return on the capital it employs is more valuable than one which earns a lower return on its capital. The tools for measuring these returns are:
1. Return on Capital Employed (ROCE), and
2. Return on Net Worth (RONW).
Return on Capital Employed and Return on Net Worth (shareholders funds) are valuable financial ratios for evaluating a company's efficiency and the quality of its management. The figures for these ratios are commonly available in business magazines, annual reports and economic newspapers and financial Web sites.
Return on capital employed
Return on capital employed (ROCE) is best defined as operating profit divided by capital employed (net worth plus debt).
The figure for operating profit is arrived at after adding back taxes paid, depreciation, extraordinary one-time expenses, and deducting extraordinary one-time income and other income (income not earned through mainline operations), to the net profit figure.
The operating profit of a company is a better indicator of the profits earned by it than is the net profit.
ROCE thus reflects the overall earnings performance and operational efficiency of a company's business. It is an important basic ratio that permits an investor to make inter-company comparisons.
Return on net worth
Return on net worth (RONW) is defined as net profit divided by net worth. It is a basic ratio that tells a shareholder what he is getting out of his investment in the company.
ROCE is a better measure to get an idea of the overall profitability of the company's operations, while RONW is a better measure for judging the returns that a shareholder gets on his investment.
The use of both these ratios will give you a broad picture of a company's efficiency, financial viability and its ability to earn returns on shareholders' funds and capital employed.
8. PEG ratio
PEG is an important and widely used ratio for forming an estimate of the intrinsic value of a share. It tells you whether the share that you are interested in buying or selling is under-priced, fully priced or over-priced.
For this you need to link the P/E ratio discussed earlier to the future growth rate of the company. This is based on the assumption that the higher the expected growth rate of the company, the higher will be the P/E ratio that the company's share commands in the market.
The reverse is equally true. The P/E ratio cannot be viewed in isolation. It has to be viewed in the context of the company's future growth rate. The PEG is calculated by dividing the P/E by the forecasted growth rate in the EPS (earnings per share) of the company.
As a broad rule of the thumb, a PEG value below 0.5 indicates a very attractive buying opportunity, whereas a selling opportunity emerges when the PEG crosses 1.5, or even 2 for that matter.
The catch here is to accurately calculate the future growth rate of earnings (EPS) of the company. Wide and intensive reading of investment and business news and analysis, combined with experience will certainly help you to make more accurate forecasts of company earnings.
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