In the last couple of months April and May, Almost all business tycoons declared their last quarter financials results. In that period, all investors are hoping for favorable results. That happens but is favorable results also guarantees boom in price of the stock. Uuhhhhh….. may be or may not be. Let me share a personal experience.
Still remember 15th April, 2011. Watching Television while taking supper. I was happy because INFOSYS again perform well. It earned more profit of Rs. 89 Crore for last quarter (Jan – March,2011) in comparison of previous quarter. Company performed well. However, the happiness scattered to ground when on the same day stock price took a U–turn and dip by Rs. 300. I got shocked how it has happened. Why stock reacted adversely? What make stock to go down when financial profits are comparatively good? Both of my brain and heart are in deep thinking. Adverse position of stock create more curiosity to know about reasons. Let us talk about the mentality of common Indian man. A common Indian investor usually judge or choose stock basis of its financial position. But if the stock like Infosys falls after performing financially well than …..... There are other factors other than financial factors, which one has to consider while investing.
Being a student of Chartered Accountancy and having hobby of analysis of stock. I take a dive in sea of knowledge. I have made a research on the stocks. I make an analysis on heavy weight corporate in the particular industry and many other things about the stock market. INFOSYS is nil debt company, one of the favourite stock of the investors.
Now straight forwardly come to the point >>>> “THE SECRET” (Secret of fall in the stock)
THESE ARE -
“These is no correlation between market price of shars and Intrinsic Value (Book Value).”
This will be more clear by an example: - Book Value of Infosys is 426.74 and its current price is 2800(approx).
IT MAKE ANYBODY TO SAY WOWWW…….
But if market prices of shares don’t go with the Intrinsic Value (Book Value) of shares then, what are the factors that determines Tthe market price of shares?
Guess the answer???
And the most common answer is - Demand & Supply.
Yes, it is but this is one of the factors, but as per my understanding only 5 % value of share is determines by demand and supply. Nevertheless, the major factor is that:
INVESTOR’S EXPECTATIONS, AND THE RESULTS OF THE COMPANIES
“Investor’s expectations” includes:
1. Profits earned by the company.
2. Earning Per share of the company.
3. However, the important one is “Growth in the earnings of the company”.
IN SUPPORT OF ABOVE FACTS, THESE ARE THE OBSERVATIONS
Profit earned by the Infosys in last quarter (i.e. Jan-march) of F.Y. 2010-2011 is Rs. 1730 crores, which is Rs. 89 crores more than the previous quarter. Despite of the increase in profits, share price of Infosys fall down by Rs.300 i.e. from Rs. 3200 (approx.) To Rs. 2900 (approx.) in a single day i.e. the 15th April, 2011 when the last quarter’s results of the Infosys announced.
The main reason for fall in stock price is the earning growth rate of the company, which is less than the Investor’s Expectations.
HOPE PICTURE IS START CLEARING IN MIND
That there is no relation between increases in profits of the company and market price of the share of that company.
Rather it’s the correlation between the growth rate of the company and the investor’s expectation.
Growth rate of the earnings of the company and the investor’s expectation are the factors, which determines the market price of the share.
Now let us see how it works i.e. how growth rate defines the market price of the share.
IT’S CAPITALIZATION OF EARNING PER SHARE
[D1 / (ke-g)] (The Gordan Valuation Model)
D1 = D0 x (1 + g)
However market uses EPS1 in place D1.
D0 is current year dividend.
g = b*r (WHERE ‘b’ IS “retention ratio” AND ‘r’ IS “rate of earnings.
Ke It’s the earning rate of the Company.
FOR EXAMPLE :-
EPS = Rs. 100,
Ke = 20%
g = 15%.
Expected price would be 100(1.15) /.20 - .15 which equals to Rs. 2300.
But suppose company actually reported EPS of Rs.114 (i.e. with g = 14%)
So on the same steps the price should have been = Rs.1900.
So, while investing just keep your eye not only on the profits of the company but also on growth rate of earnings of the company.
Thanks and regards
1. This is my first article on the platform of CAclubindia.com. i dedicate it to all my teachers. Because they are there that is why I am writing it.
2. Views and facts expressed in the above article are based on knowledge and understanding. There is no guarantee that the facts and examples are correct and work in practicle life. To err is human. Therefore, if I am wrong please correct me, I will be the happiest person to correct myself.
3. A very special thanks to my dearest friend Navneet Grover for giving my article much better pictures.
4. Source of data :www.moneycontrol.com