WEALTH CREATION : UNDERSTANDING THE MARKET

-Dr Sourojit Gupta

Terminologies

 Market Cap: Price of 1 share x Number of shares = Size of company

 Market Cap: Cash + Debt
 P/E: Price to earning ratio
 EPS: Earning per Share
 EV: Enterprising value
o Eg: If a shop value is Rs 100, Cash in bank Rs 20/- , Debt 10/-
So , EV= 100-20+10=90/-
 Book Value : Amount available against each share
 P/B= Price:Book [Price of 1 share / Book Value]
o If shop is for Rs 100 & has 2 share holders 50:50 so each person has Rs 50/-
 Book value is useful in hard asset companies eg: cement, Power, steel so they have works
like buying a land , building a plant etc.
So, Infoedge which is an IT company and has soft asset BOOK VALUE cant give the right
overview. BUT BANKS can be judged by book value because they have financial assets (Take
cash/give loans)
 Dividend yields: The amount given to the share holders by the company from the amount
earned by the company in 1year.
o Companies which don’t have to spend much in future years will give ahigh Dividend
yield
o At panic time when the market is down then rely on the government companies
who give a high dividend yield
 Face value: Total amount of shares in Rupees/ Number of shares
o Eg. Company has Rs 100000/- in shares & Number of shares are 10000 so Face Value
= Rs 10/-
 Promoter Value: Percentage of shares owned by the owners
o High PV= Good Company
o EXCEPT BANKS
o Also see the Pledge which shows the debts of the promoters
 Also must see if the promoters are decreasing their their shares or
increasing their pledge
 Professionally managed banks have promoter value Zero
 NET/PAT Margin(Profit After Tax)= Selling Price – Cost Price
 Mark Up Percentage = Percentage of increase in price of a product from the cost price
 Eg: SP= 15/-; CP = 10/- ; Mark up % = 50% {Mark up % = SP-CP/CP x
100}
 Profit Margin : SP-CP/SP * 100{ 15-10/15*100=33%}
 ROE(Return on Equity)
o Eg.: if total invested Rs 100/- for 10 pens so CP of 1 pen is Rs10/- . Now if you sell
each pen for Rs20/- So, total selling price =Rs200/-
o Thus, ROE= SP-CP/CP * 100 = 200-100/100* 100
o Profit margin = 200-100/200*100= 50%
o Eg 2: Mr Ram & Mr Shyam: CP of each pen @Rs 10/- so total invested Rs 100 for 10
pens .
Now, SP of Mr Ram of each pen is Rs20/- so total SP is Rs200/- ROE=200-
100/100*100= 100%.
Mr Shyam sold each pen for Rs15/- so got a total of Rs150/- but invested it again to
buy 15pens @Rs10/- each and again sold them @Rs15/- each to get a total of
Rs225/-. Thus, ROE = 225-100/100*100= 125%

So, margins are important and is supposed to be compared with ROE due to the roll
over of product(Eg Reliance fresh : margin is low but roll over is high so, ROE is High)
Compare Eicher Motors & Page industries “PLAY IN QUANTITY”

 DEBT:
o Eg.

CASE 1 CASE 2
Equity capital 100/- 50/-
Debt 0/- 20/-(@12%)
Net Profit 20/- 14/-(20-6 of debt)
ROE 20% 28%(NP/Eq. Cap *100)
100% Equity 0 Debt 50% Equity 50%Debt
o Ideal Debt:Equity = 0
o ***NA in Banks (Debt:Equity=>20%)
 Asset Turnover: Amount earned through initial investment
 Cash cycle : no of days required to convert to cash. Eg. HUL has negative cash cycle
because the cash is paid to the company later. ** Negative cash cycle shows the
reputation of the company
  Split: splitting the shares Face Value into the desired parts thus, ownership
decreases to increase the flexibility
 Bonus: reverse of split but face value is the same

Company A Company B
Face value 10 10
No. Of Shares 100 200
Share Capital 1000 2000
Total Reserve 2000 1000
Total share holding fund 3000 3000

 Cash flow: see operating cash flow of 5 years which shows amount received in last 5
years
o Compare cash flow and Net profit in Profit & Loss figures
o If these two are almost the same then trust the company
 Rights Issue : Rights given by a company to a share holder to buy more shares at a
discounted rate . it decreases the value of EPS

RATIOS

 EPS: How much the company has earned per share

How much profitable is the share
It has to be a steady growth and has to be compared to its PEERS
EPS is to be compared to P/E
EPS= Net income / no of company’s shares

 P/E: Price to earning ratio ; it tells weather the company’s share is expensive or cheap
P/E: SHARE PRICE/EPS
If P/E is high means that due to the company’s reputation price has gone up. So, even if
the price is high, people buy
It speaks about the company’s trust
Compare it to the peers
 Debt:Equity tells us how much amount the outsiders have invested in the company
Interest is always paid on DEBT and Dividend is paid on Equity
Ideal D:E=1
If D/E is high means loan is high
Rising D/E is bad
Low D/E is good
Around 1-1.7 is fair

 ROE: Return on Equity

How much profit company is giving to the share holders
Total profit/Total Equity
 Price to Book value: Tells us if the share value is overvalued or undervalued
 Price of per share in market/ book value per share
 Compare to PEERS
 Read P/B with ROE
  If P/B & ROE is rising then its good but is a red flag if one is rising
and other is falling
 Tells the valuation of a company
 Current Ratio: Does the company has enough liquidity to settle
Current assets/Current liablities
CR=1.5-2 is fair
Deals in short term liablities

HOW TO ANALYSE BANKS

 CASA RATIO: Current Account + Saving Account in a bank
o Because banks have very less interest in Saving accounts
o New banks give high interests
o Shows how much money does a bank have in which it doesn’t have to give much
interest
o High CASA means banks have good amount of money
o Compare HDFC/AXIS/SBI/ICICI/KOTAK
o If CASA is less means bank has less SA & CA so in order to open more accounts are giving
high interests which usually the newer banks do

 Net NPA(Non Performing Assets

o High NPA means less amount of money has come back to the bank from the money that
it had lend (Usually increases when there is a fraud)
o It also tells the reputation of the bank as to which bank will be able to get the money
back
o Compare HDFC/Central bank/PNB/YES BANK/ICICI/Kotak
o Must be <1

 Cost of funds or cost of liablities

o CA+SA+FD: average how much interest bank has to give over all
o HDFC 4.88
o Less the better
 Advances growth or Loan Growth
o How much loan bank has given per year

Two things :
 LOW NPA
 HIGH CAPITAL(Capital adequate ratio- CAR%)
 Net Interest Margin(NIM)
 Total interest given by bank – total interest received
 Should be >4
 ROA(Return of asset):
o Assets for banks = loans
o Deposits(CA+SA+FD) – liablities
o Should be >1
o Check the documents for liablities
  ROCE(Return on Capital employed)
o Capital is a money that is put in a business
o To get money:
 Against giving shares(EQUITY)
 Loan(not giving shares but giving interest): DEBT
 Eg: self :100/- & Loan 100/- so, Capital employed= 200/- if return received =
100/- so actual return is 50/- thus, retorn received or earned on the Capital
employed (CE)
 Thus its important to see ROCE as a whole as it shows how much money the
company will give you from the total money invested
 ROE : Return on Equity
o Here “E” is from whereever the money has come is considered
o How much money the company makes from your money
o Here DEBT is not counted

Where ever there is “0” debt see ROE & for debt companies see ROCE
So, Net profit / (Share capital + total reserves) * 100= ROE
ROCE= Operating profit/ (Share capital + total reserves+ Borrowings) * 100

How to read annual reports

1. Go to Documents
2. Go to contents
3. See the following:
 Promoter share holding
 Chairman’s review
 Product basket
 Reasons for acquisition
 New products
 Market share
 Weather dominating
 Details of brands
 Management decision & analysis
 Risk identification
 Share holding pattern
 Contingent liablities

VALUATION METHODS
 P/E: (Price of share/ EPS) eg.: 70 so, you earn this share at 72 times its value
 PEG (Profit earning/ growth)
o PE shouldnot be greater than profit growth
o Should be around 1
o Use this in FMCG / Pharma /IT
o So if its > 2 then its expensive PE/Profit growth
 Price to cash flow
o Price of share / profit growth
 o To buy 1 share the number of times of money required
 Share holding pattern : (>40%) or increasing is a good indication
 Interest coverage ratio : amount of profit earned against the loan ( MORE
THE BETTER)
 Quick ratio (>1) to give the kliablities

FINAL CHECKS
 Profitable or not
 CFO/PAT (>1)
 Interest ratio
 Quick ratio(>1)
 Debt or not
 Good ROE & ROCE (>15)
 Enterprise value
 P/E
 Price to cash flow
 PEG

READING THE P&L statement

 See for consolidated statement
 Remember P&L shows this year picture & balance sheet shows overall
picture

1. Net sales : Amount of goods sold

2. Other income(Rent+Interest rates)
3. Total expenses : to increase the sales + salaries
4. Operating profit : Profit earned from sales and bills(core business
5. Interest : Amount of interest to be paid against the loans
6. Depriciations: Expenditures of goods to be used over a span of
years
7. Exceptional items: unpreceded loss/profit
8. Profit before tax
9. Tax
10. Net profit *** Including everything
11. Adjusted EPS

Quaterly reports : TELLS US WHICH QUARTER HAS DONE HOW

Months quarterly sales helps to understands mechanism of the business

CASH FLOW STATEMENT

ACTUAL CASH GENERATED EXCLUDING CREDITS

OPERATING INVESTING FINANCING

Income generated Fixed assets Tells about capital

Negative: may be strength
 bought something I. Dividends
Positive: maybe sold II. Loan repay
something III. Share issue
Huge positive: RED IV. Bond issue
FLAG V. New loan

** Negative means of
repaymentof loans or
buyback shares

Sales increased , profit

increased but cash
decreased so RED FLAG

CFO/PAT : >1 is Good <1 negative or RED FLAG