Mr Kamkazi and different kind of PE

Mr Kamkazi have tried explaining about Valuation methods to his students.

PE Multiple

Price-earnings or PE is the most commonly used multiple. But it may have several variants- current PE, trailing PE and so on.

The ‘plain vanilla' PE is computed by dividing the share price of the firm by its earnings per share. PE multiples usually take into account the current market prices of a company.

When it comes to the denominator - the per share earnings, one can use the company's earnings for the past twelve months (known as trailing EPS), estimated earnings for the next 12 months EPS (forward EPS) or the earnings for a future year (future EPS).

A higher PE ratio indicates that the market perceives the company's growth rate to be higher or its risks to be lower and its payout ratio too could be higher (alternatively the company's reinvestment needs are lower).

PEG ratio

The “Price Earnings Growth ratio” compares a company's PE multiple with its expected growth rate in profits.

It is computed by dividing the PE multiple of the company by its expected growth rate in EPS. Note that the number used for EPS should be the same in the calculation of both “PE multiple” and “G”. For instance, if Company A expects a 10 per cent growth in its EPS this year and its current PE is 18.15, then its PEG would be 18.15/10 = 1.815 times. A PEG multiple of 1 is considered a rule-of-thumb measure of ‘fair value'.

PEGY Multiple

It is another variant of PE multiple. It is calculated by dividing the PE ratio of a company by the sum of its growth rate and dividend yield, the idea being that dividends also add to an investor's total return.

Here, dividend yield is computed by dividing the expected dividend payout of the company by the market price of the stock. PEGY is relatively better than PEG as it considers the differences between companies in growth rate in EPS as well as expected dividend yield.

For example, if TVS motor's growth rate is 8 per cent and its expected dividend yield is 7 per cent, if the stock's PE is 18.65, then the PEGY for TVS Motors is 18.65 / (8+7) = 1.24 times while its PEG is 18.65/8 = 2.33 times. If a company's PE multiple is lower than the sum of its growth rate in EPS and expected dividend yield, then the company is undervalued.

Relative PE

The PE ratio or PEG may help you evaluate if a stock appears expensive or cheap relative to its profits or growth rates, but how do you decide which stock within the market or a sector is a good buy?

One relative valuation measure is to divide a company's PE multiple by the PE ratio of the market.

For example, the PE ratio for Nifty (this is available from the website www.nse-india.com) as on 24-12-2010 was around 24.

The relative PE for company B was 17.80/24 = 0.74 times. We can state that B is undervalued compared to the Nifty or the market. While using relative valuations here, it is also necessary to take into account the company's historic premium or discount to the markets. For example, if B has historically traded at 90 per cent of the market PE, it is now undervalued.

The above variants of PE ratio measure the market value of a company's shares by comparing it to its earnings. But these multiples do not value the entire firm. This drawback is addressed by the following measures.

Value to Earnings Multiple

It is arrived at by dividing the value of the entire firm by either its pre-tax profits (earnings before interest and taxes or EBIT) or its post-tax profits from operations, operating earnings.

What is the value of the firm here? It is the “Enterprise Value”, calculated as (Market value of Equity +Market Value of Debt – Cash). Higher the number, higher is the valuation the market is assigning to the company.

Value to EBITDA multiple

A small variation of the above, this measure uses EBITDA (Earnings before interest, tax, depreciation and amortization); this is especially applicable to loss-making companies. Some investors may want to value a company before considering the impact of financial leverage and depreciation on its earnings.

It is also possible that some companies may operate in industries with a longer gestation period. In all these situations, one can not arrive at the appropriate value for a company by employing the value to earnings multiple.

Investors able to estimate the future cash flows of a firm also employ a measure called value-to-free cash flow, which examines cash flows to a firm instead of its book profits.

So what is the ideal measure of value? Maybe a combination of the above. Apart from ascertaining the value of a firm using earnings multiples, one should also measure using traditional methods such as discounted cash flow to arrive at the correct value of business.

Each of the above multiples is suitable for a particular situation and no two multiples act as substitutes. After all, the valuation lies in the minds of the valuer.

Why should i write blog?

Great! I guess blogging came about when folks (including me) moved away from their 'Dear Diary' moments onto the web. I wish Anne Frank (Acknowledged for the quality of her writing, her diary has become one of the world's most widely read books, and has been the basis for several plays and films) had lived to see this day.

With some amount of surprise, I read somewhere that if you own a blog, it better be something special. I have also read that, if one is not putting up something useful or interesting, they are not blogging, they are 'blagging'. Honestly speaking, I am happy doing blagging (though that's a criminal misuse of sacred space) for next few years before I think of professional writing. 

Here, this being my blog post, I will write about things or events or situations especially Economics and Finance that affected me.

And I promise to myself i ll never write more than 0.5% of what I read, so i have to read more and more to improve my level of understanding and quality of writing.

Mr Kamkazi and Trade Deficit

FEW Questions to Mr Kamkazi

Question from student 1

How would lower trade deficit strengthen rupee and its effect on economy??what is trade deficit?

 

Answer from Mr Kamkazi

in simple terms

Trade deficit

=imports minus exports

 

suppose 2009: India exported 10 billion$ worth stuff, and imported 50 billion$ worth stuff.

So trade deficit (2009)=50-10=40 billion$.

 

in 2010, the case improves, our import remains same, but we export 20 billion$ worth stuff. So,

trade deficit (2009) = 50-20=30 billion$

 

As you see, our trade deficit has lowered from 40 to 30.

Question from student 2

How would lower trade deficit in above example, strengthens rupee?

 

Answer from Mr Kamkazi

Forex market is a place where people buy and sell currency, based on supply and demand.

When you've to import from USA to India, you goto forex market, get your rupees converted into dollar$ to pay the bill and import it.

 

When an American, is importing mangoes from India, he pays the Indian seller in dollar$, and that Indian guy, goes to forex market and gets those dollar$ converted into Rupees, so that he can do his son's wedding, payback the home-loan etc. for which he needs Indian currency (Rs.)

 

So like that, there is a supply-demand of currencies in the Forex Market.

Question from student 3

How a currency strengthens when its in more demand in forex market?

 

Answer from Mr Kamkazi

When trade deficit is lower,

means we are exporting more.

Means we are receiving more dollars than earlier.

Means people are demanding more rupees than earlier @ Forex Market.

So Rupee is in higher demand @ Forex market, hence Rupee is strengthened.

 

Question from student 4

How does it effect on economy?

Answer from Mr Kamkazi

When Rupee strengthens, i.e.

(2009) 1$=60 Rs.

(2010) 1$=40 Rs.

 

In above case, Rupee is strengthened. So, when you're importing, you've to pay less Rupees.

But when you're exporting, you also get less Rupees money as payment.

 

So Rupee's strengthening or appreciation, is good for importers but bad for exporters.

Hence lower trade deficit, in long term is good for importers but bad for exporters.

 

In such a scenario, If a country has export oriented economy (like China or Taiwan) it'll move towards recession.

Majority of people make living by working in some export oriented mobile-phone, stuffed toys factory. when they receive less money for export = job loss etc bad things.

 

 

 

Mr Kamkazi and Bond

"So boys today we are going to discuss basics about bonds" Mr Kamkazi started his class, 'There are certain things you must understand about bonds before you start reading about them. Not understanding these things may cause you to purchase the wrong bonds, at the wrong maturity date. The three most important things that must be considered when purchasing a bond include the par value, the maturity date, and the coupon rate".

'The par value of a bond refers to the amount of money you will receive when the bond reaches its maturity date. In other words, you will receive your initial investment back when the bond reaches maturity. The maturity date is of course the date that the bond will reach its full value. On this date, you will receive your initial investment, plus the interest that your money has earned. The coupon rate is the interest that you will receive when the bond reaches maturity. This number is written as a percentage, and you must use other information to find out what the interest will be. A bond that has a par value of Rs1000, with a coupon rate of 10% would earn Rs100 per year until it reaches maturity. Because bonds are not issued by banks, many people don’t understand how to go about buying one. There are two ways this can be done. You can use a broker or brokerage firm to make the purchase for you or you can go directly to the government. If you use a brokerage, you will more than likely be charged a commission fee".

Mr Kamkazi took a break and again came back to topic, explaining equations about the topic.

Notes of Mr Kamkazi- Few Investment options

Few Investment options available in India

1. Fixed deposit - Money placed with banking institutions for a fixed tenure.

2. Bond fund - An investment fund that invests primarily in bonds or other debt securities.

3. Capital guaranteed product - A product that provides a return while at the same time provide capital guarantee at the end of maturity.

4. Corporate bond - A debt instrument for a loan which is issued by a borrower to an investor who is the buyer of the bond and lender of the money. In return for the money, the issuer agrees to pay regular interest to the bondholder for the term of the loan and the principal sum borrowed upon maturity.

5. Equity fund - An investment fund that invests primarily in shares.

6. Investment linked insurance - A life insurance plan that combines investment and protection. The premiums paid will partly be used to pay for life insurance cover and partly for investment in specific investment funds of the policyholder's choice.

7. Listed large capital stock - Companies whose shares are listed on BSE or NSE with market capitalization of generally above Rs 5000 cr.

8. Listed small capital stock - Companies whose shares are listed on BSE or NSE with market capitalization of generally below Rs 5000 cr

9. Option/warrant - An instrument that gives the holder the right but not the obligation, to subscribe for a particular instrument, e.g. new ordinary shares, at a pre-determined exercise price within a stipulated validity time frame (exercise period). The warrant becomes worthless after the expiry of the exercise period.

10. Separately managed equity portfolio - A portfolio managed by fund manager where investors own the securities individually.

11. Mutual Funds - Pools of money managed by an investment company. They offer investors a variety of choice, depending on the fund and its investment objective.

12. Gold funds- Gold is a liquid form of investment and is usually incorporated in investment portfolios to hedge against other market positions. This is especially true when you have exposures in the currency and stock markets. But if you are planning to invest in gold as a primary investment vehicle, then timing is the key - as they say “Buy Low, Sell High”. But then again, it is not as simple as that. Lows and highs happen every hour – minutes even.

There are many gold investment products to choose from and they are primarily classified as “physical” and “paper” gold investment products. The appropriate gold product to invest in depends on how much you are willing to invest in, and how long you are committed to stay in the market. Deciding on your gold investment plan needs careful study - if not, an expert’s advice. Whichever step you take, starts with knowing the different gold investment products available in the market today.

Mr Kamakazi and CDO

It was usual day for Mr Kamkazi , class was not much interactive, students took no interest in class. But at the end of class one student asked one Question, `sir please explain me CDO and use of it in our banking system”.

Mr Kamkazi knew this is one of the complex topic to explain, it need utmost care to use examples otherwise it may be misunderstood and the most important is to keep check on your emotion towards this particular instrument.

He explained `Few years back banks were operating at the limit of Basel Norms and were eager to tap into the lending business without diluting their equity capital. Part of the reason securitization picked up so rapidly was that it offered a way lender to do just this. The method was simple. Say a bank has 100 crore as the equity capital and is allowed by the Basel Norms to lend up to 1000 crore of home loans. If the NIM on such loan asset is 1%, the bank can lend the Rs 1000 crore and make Rs 10 crore of net income every year. Alternatively, if it securitizes Rs 800 crore out of Rs 1000 crore of loans, and sell them to other investors, this investment tool is called as Collateralized Debt Obligation(CDO). Now bank`s  lending come down to Rs 200 crore. Within the limits of Basel Norms it can again relend Rs 800 crore more”.

`Now you may raise the question ,what is the benefit of it on the other part? And my answer is simple, while securitizing , it makes the fee out of the difference of interest rate paid by the home loan borrowers and that received by CDO investors. In doing so , on the Rs 100 crore of Equity capital, instead of earning Rs 10 crore in the single lending case, it can make Rs 20 crore or more.”

Now Mr Kamkazi take a look over all his students and satisfied.