The main factor which decides the price is the P/E ratio (price to earnings ratio). This means the amount you want to pay to get Re 1 in return. For example, if the P/E ratio of a company is 15, it means one must invest Rs 15 to get a return of Re 1. Because earning has direct relation with the company’s performance, many value investors take into account this ratio while taking an investment decision
Many people, especially the new investors, often ask when to enter the stock market. Though it looks like an easy question, the answer is not that easy. Because even the share pundits who made billions from the stock market can’t exactly predict the top and bottom level of the market.
There are many factors that determine the stock price. There is the company’s background, demand and supply, media, social network, opinions of expert investors, political and social unrest and lack of other suitable alternatives of investment. Relevant information of these factors creates a certain type of sentiment that reflects on the market, which creates a bullish or bearish trend.
The main factor which decides the price is the P/E ratio (price to earnings ratio). This means the amount you want to pay to get Re 1 in return.
For example, if the P/E ratio of a company is 15, it means one must invest Rs 15 to get a return of Re 1. Because earning has direct relation with the company’s performance, many value investors take into account this ratio while taking an investment decision.
Another factor that a value investor considers is the P/BV ratio (price to book value ratio.) Book value is the total assets minus total liabilities. This is the amount the shareholders get proportionately when a company dissolves.
If we divide this figure by the total outstanding shares, we will get the book value per share. The market price of the stock divided by the book value per share is the P/BV ratio.
The P/BV ratio compares a company’s market share price with its book value.
Traditionally, any value under 1 is considered a good P/BV, which, however, is rarely possible, for value investors, indicating a potentially undervalued stock. However, they may often consider stocks with a P/B value under 3 as their benchmark.
Shares are rarely available on discounted price. But sometimes, the factors discussed above increase the negative sentiment of the investor, which creates a negative impact on the demand side. And this results in price fall.
But all the above factors never exist for ever. With time, these factors have no or little effect on the stock market, and the price starts to graduate slowly.
So, the value investor analyses the prevailing factors, to see whether they will go for a long time or not, and, if they see a favourable improvement in those factors in the coming days, then they will invest on the shares at discounted price.
Another alarming finding in this regard is: The market always swings between low average P/E and high P/E of the market.
In Nepal, the NEPSE does not calculate the average P/E of the market. So we do not have that information.
But in India, the stock exchange calculates the average P/E of the market. And it is said that the Indian Stock market has never gone below the average of 10/11 P/E. And also it has never gone beyond the average P/E of 28/29.
Even when knowing this real factor, investors are reluctant to buy stocks if the average market P/E is around 10, 11 or 12.
Because those times are always in a panic or bearish situation, and the investor sentiment has largely been determined by the fear factor (emotion).
In the same way, when the market reaches around the average P/E of 24, 25 or 26, the investor should exit from the market and sell the stock.
But instead, the investor will try to buy more and more to make easy money driven by the greed factor (emotion).
Now let us try to analyse the history of the NEPSE index. When the NEPSE was at its lowest point,
the transaction amount was about Rs. 2 crore and the number of transactions was 856 (low participation).
But when the NEPSE was at its highest point of 1881, the same figure was Rs 227 crore and 10,793 respectively (high participation).
The above information clearly shows the investors’ sentiment.
The time when the index was at its lowest level, the general investors were reluctant to invest despite the low P/E and P/BV ratio. Conversely, when the index was at its all time high, investors went out to buy.
The above data have been calculated as per the data available from the NEPSE website and respective Bank’s Annual Report and second quarterly report. When the index was 1112 on February 14, 2019, the average P/E was 12.27 and P/BV was 1.78. Today’s market indicators are more or less the same when the market was at its lowest level, that is, an index of 292.
One who invested at the time around June 15, 2011 will never have to panic from the market downfall. That is because he had invested the money when almost every stock was below its fair value.
Based on these historical data, one would do best in a market where everyone acted foolishly, as advised by Warren Buffett, by investing for the long term, showing the power to be brave when others are afraid.
Bhattarai is a retired under secretary, Ministry of Finance
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