Benchmarks for Equity Investments
Equity investment is the best investment option that provides better long term returns for those who are ready to accept the higher risk associated with equity investment. There are certain benchmarks that convey whether the equity of a company is good for investments. These benchmarks aid screening of equities. They are easily available and even can be computed from the balance sheet of the companies. Benchmarks often vary from industry to industry. Hence, benchmark of a company shall be compared with that of another company in same industry to have meaningful comparison.
Revenues/Sales growth.
Revenues are the amount realized by the company from its activity over a given period. Sales are often direct performance indicators for companies. Growth of sales over the previous year is an indication of future trend and higher rate of growth often leads to better stock valuation.
Bottom line growth
Bottom-line means the net profit of a company. The growth in net profit indicates the ability of the company to improve profit and hence indicates the attractiveness of the stock. The growth rate of profit varies from industry to industry. For instance, growth in bottom-line of IT sector can be as high as 65-70% whereas that for manufacturing sector can be in the range of 10- 15%.
ROI – Return on Investment
ROI means the return on capital invested in business i.e. if a company invests Rs 2 crore in men, machines, land and material and generates Rs. 50 lakhs of net profit , then the ROI is 25%. The ROI of software industry can be as high as 40% whereas maximum ROI for a manufacturing industry can be just 15%. Thus ROI too varies from industry to industry.
Volume of shares traded
Volume of shares traded in a day shows the activeness of the share of the company. When the expectation of market on a company increases, that leads to higher volume of trading. Similarly, major announcements also lead to more volume. Volume is also an indicator of the liquidity in a stock. An up movement in price along with better volume indicates that big institutional investors are accumulating the stock. Decline in price of a stock happens when there is heavy volume of shares for selling.
Return on Equity
Return on Equity measures how much your investment is actually earning. Net profit divided by investment in percent gives the figure. Around 20% is considered good.
Debt-to-Equity Ratio
The debt-to-equity ratio is arrived by dividing the total debt of the company by the equity capital. Debt equity ratio can be up to 4, but lower number indicates that the company has less debt and hence stronger. When debt is high, in an increasing interest rate scenario, the company will have cough up more for interest servicing with impact on bottom line. But a high debt equity ratio is acceptable in the case of capital intensive industries.
Beta
The Beta factor measures the volatility of a stock compared with an index. The higher the beta, the more volatile the stock is. When the beta is more than 1, share value increases more than 1% with every 1% increase in the index. (A negative beta means that the stock moves inversely to the market so when the index rises the stock goes down and vice versa).
Earnings Per Share (EPS)
Earnings Per Share (EPS) indicates the amount of earning per share. EPS is one of the important benchmarks for equity investment. EPS is calculated by dividing the earnings (net profit) by the total number of equity shares. A company with 2 crore shares earning Rs. 4 Cr in profit means an EPS of Rs. 2
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Price / Earnings Ratio (P/E).
Earnings per share alone do not indicate whether the share of a company is overvalued or undervalued. In order to get a sense of how expensive or cheap a stock is, investor has to look at earnings relative to the stock price and hence employ the P/E ratio. The P/E ratio takes the stock price and divides it by the last four quarters' worth of earnings.
Suppose a company is trading at Rs. 10 and has an EPS of Rs. 2. It means a P/E of 5. When a stock's P-E ratio is high, the majority of investors consider it as overvalued. Stocks with low P-E's are typically considered a good value stock. However, studies done and past market experience have proved that the higher the P/E, the better the stock. The higher P/E in such cases is on account of premium valuation, investors allow for well-run companies.
Price to book ratio or P/B ratio.
Price to book ratio is derived by dividing the current closing price of a share by the book value of a share. A stock is undervalued if it has a lower P/B ratio. Alternately, a low P/B ratio may also indicate that the company has some problems with its fundamentals.
Market Capitalization
Market capitalization indicates the current market value of the shares of the company. Market value is the total number of shares multiplied by the current price of the share.
Company management
A company that adheres to corporate governance principles attract premium valuation. The quality of the top management is one of the most influential factors of share value of a company. An investor must always assess the quality of directors in the Board of the company and also the capabilities of the executives of the company before making any investment decision. The expertise, vision and completeness of company management can elicit premium valuation in market.
PSR (Price-to-Sales Ratio)
PSR (Price-to-Sales Ratio) measures a company's stock price against the sales per share. Lower the number, the better. It should be much below 3, ideally below 1. Studies have shown that a PSR above 3 almost means a loss while that below 1 gives a better chance for profit.
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