Is there any
way to value a share of a company?
Unlike the par value (which is really just a “convenient fixed number”),
the price that could be asked for a share of a company can be very different
and flexible. This is so because, the market value (meaning price) of a stock
is the price that willing purchasers will pay for it, based on their assessment
of the future prospect of the company! It’s somewhat like buying a house;
the owner can ask any price, but it is the purchaser who decides how much he/she
will pay, based on the criteria which that buyer considers to be important.
The following table shows the par value and the price the market was paying for
some stocks on Sept 06, 2004 on the JSE
Table #2
Com.
RBTT Holdings
JMMB
GKCo
BNS
Guardian Holdings
Par Value (JA$)
J$0.25
J$1.00
J$1.00
Market Value @ Sept 06, 2004
441.50
18.55
98.50
47.10
360.00
Many people are of the view that
a par value is really of no value
(no pun intended) and should be dispensed
with. In this vein, the new Jamaican
Companies Act 2004 does not recognize
a par value. One of the most widely
used methods of valueing the share
of companies is what the trade calls
the price /earnings ratio. This ratio
is computed by dividing the current
price of a stock by it’s earnings.
For example on Dec 31, 2004, a Pan
Jamaican share was selling for J$53.00.
At the same time, the analysts were
predicting that the company would generate
earnings per share (EPS) of 528 cents
by it’s year end. Accordingly,
the P/E for this stock was approx
10. One interesting observation is
that
markets tend to have an accepted
P/E value in a usually narrow range
and
most investors in that market accept
it as the metric by which the shares
of companies in that market are valued.
To illustrate, if that P/E was 10,
most investors would accept a stock
as being reasonably valued if its
P/E ratio was in the vicinity of
10! All
things being equal, a stock with
a P/E of say 15, would either be
considered
as being over priced or, as being
a growth stock which merits a higher
valuation. On the other hand, again
all other things being equal, a stock
with a P/E of say 5 would be considered
a value stock to be grabbed up before
other investors do so
Table #3
Com.
RBTT Holdings
JMMB
GKCo
BNS
Guardian Holdings
Par Value (JA$)
J$0.25
J$1.00
J$1.00
Market Value @ 09-06-04
441.50
16.50
98.50
47.10
360.00
Projected earnings per share
(J cents)
2,993 cents J
142 cents J
813 cents J
507 cent J
10,263 cent J
P/E Ratio @ 9/6/04
14.8 T
11.6 T
12.1 T
9.3 T
3.6 T
What about
valuing an entire company; are there
any way to do this?
Yes there are! Over time, the investing community has developed a range of formulae
which are used for valuing entire companies. Some of these are:
a) Market price /share,
b) Market capitalization,
c) ROE i.e. return on invested equity,
d) ROA i.e. return on asset employed
e) Free cash flow
f) Productivity ratio in financial institutions (amount of income from each
dollar of revenue)
g) Annual % rate of growth of earnings
h) Annual % rate of growth of dividends
Each of these metrics have their particular value. Each speaks to a different
sector of a company’s operation such that, taken together, they give a
reasonably comprehensive perspective on a company and its management
Is there
a difference between the price and
value of a stock?
Most investors believe that there is, and the P/E ratio is used as one of the
main determinants. Many persons who buy stocks, especially new entrants to the
field, tend to buy stocks on the basis of price – “the lower the
better”. Instead of using only its current price as a guide for purchase,
seasoned investors integrate the impact of the issues raised at Q’s #64 & #65
combined with the P/E ratio, to arrive at a buying decision. These investors
buy stocks either on the basis of their estimate of a company’s ability
to generate profit and dividend payment in the near or mid term future or, to
grow the price of each share. Many times, the price of a stock bears little or
no relationship to its potential to generate this profit and dividend. A classic
example is NCB in its pre and post Michael Lee Chin phases. On March 2, 1999
the shares sold at 80¢ because owners of these shares at that time saw no
future profitability in the bank. They literally gave away these shares at below ‘bargain’ basement
price …called a value stock at that price level. See at Ques #.56. On the
other hand, the purchasers saw medium to long-term value. Events have proven
them very correct. Each stock bought then is now five (5) because of a 1 for
4 bonus distribution shortly after Lee Chin bought the Bank. At the high point
since then, the price went to J$31.70 (April 27, 2004) At September 6, 2004 NCB
traded at $24.6 at a P/E ratio of 13.6.
67.Explain the P/E ratio
Buying a stock i.e. buying a company over any stock exchange is not very different
from buying a piece of land, a house or a business. Before one draws the cheque,
he must satisfy himself that he is paying a reasonable price. One way to gauge
this reasonableness is to get an independent valuation. When buying a stock,
one should also try to get an “independent” valuation. There are
many “formulas” that one can use to get to this “independent” valuation.
Some are:
a) Return on Asset
b) Return on Equity
c) Efficiency Ratio (Banking)
d) Free Cash Flow
e) Price/Earnings Ratio
The formula for the Price/Earnings ratio or multiple is the price of a share
at any time divided by earnings per share (EPS) and multiplied by 100. This measures
the number of times (or multiples) the annual earnings of a stock can be divided
into its price at any given time during the company’s financial year. At
the practical level, and using a full year’s earnings (real or projected)
this number, in effect, tells an investor how many years he will have to wait
to get back his investment from company earnings, all other things remaining
constant. Since the price of a stock will rise and fall based on the perceptions
of purchasers, it means that the P/E ratio will keep changing in line with those
perceptions. This is in stark contrast with the same company’s par value
which usually remains static throughout the existence of such company. Following
are some P/E ratios for the same five stocks as at Q # 64, courtesy of NCB Capital
Markets at September 06, 2004. (T = Times as in multiples)
What is the
significance of the P/E ratio?
As indicated by the T’s (times) one major use of the P/E Ratio is to predict
how long it will take, under present conditions, for a purchaser to get back
the money he spent to buy a stock i.e. get back his investment. A glance at Table
#3 will make this clear. For example, with Guardian Holdings’ expected
earnings per share (EPS) this year of 10,263 cents (J$), and a price of J$360,
the P/E at 3.6 times is saying that, in 3.6 years, a purchaser would get back
his investment (in addition to all dividends paid during that period), used to
buy the share whether he had bought just one or one million shares! By the same
token, it would take the holder of a RBTT share approximately 4.8 years in the
present scheme of things to get back his investments. Remember though, that P/E
ratios are ‘moving indicators’. They are not gospel or cast in stones.
Does it necessarily mean that all stocks with low P/E ratios are good buys? No,
not necessarily so. There are many factors, other than P/E Ratios, which investors
use to gauge what they consider to be good, versus not so good stock values.
Some of these are given at the beginning of this paragraph.
69.What does the term ‘damaged stock’ mean? (NCB prior to Lee Chin)
One of the unique things about investing is that everybody will not necessarily
agree on everything. This is part of the reason why different investors in the
same market get different results. In general, the term ‘damaged stock’ means
a stock whose ‘reputation’ has become impaired for a reason or reasons.
Two Jamaican stocks, in the view of some, come to mind. One is the same NCB prior
to Michael Lee Chin in March 2002. The other is Carreras Ltd. In the case of
the former, it was a victim of the government’s prolonged high interest
rate policy and became the holder of massive bad debt which destroyed its Balance
Sheet. Eventually, it had no money to lend and had to be bailed out to the extent
of J$50.3B by FINSAC, becoming the largest bailout recipient by an exceedingly
wide margin (Source: FINSAC Statement, Financial Gleaner, June 25, 1999) During
this phase, the stock went as low as just J$0.80/share. The reputation of Carreras
as a corporate standard bearer and premium dividend payer might have been damaged
by its dispute with the Jamaican Tax Authorities who say the company is due to
pay them nearly J$6B in back taxes and penalties. The company is ‘begging
to disagree’ but the matter may not be put at rest until it goes to the
Privy Council in London. As in the case of NCB, this stock has lost a lot of
favour and, at end Dec 2004 was selling at a steep discount to its peers (P/E
6.48 vs. 11.29) and the full market as a whole (6.48 vs. 14.81 Again, as in the
case of NCB, those who feel the company will win the case see this as an outstanding
value stock and are loading up on it. As with relationships, in stock market
investing, the ‘beauty’ is in the eye of the beholder!
