We looked at some of the key parameters for Gitanjali in our last post. We looked at Revenue growth, Net margins growth, Market Cap, Book Value and their comparison. But the question remains for you the investor – At what price one should own Gitanjali Gems.
I mentioned that there were multiple opportunities to own Gitanjali at less than its Book Value (current BV = Rs. 265) in year 2011-12. But now when the stock is trading above BV, how to determine whether to buy a stock, or let it pass. One key parameter is to look at EPS (Earning per Share) and PE (Price/Earning ratio) ratios. These are very common calculations, commonly used and yet commonly ignored concepts of stock price. A stock is nothing but a bond yielding an “X” amount of profit each year, which is similar in nature to the yield of the corresponding bond. i.e. Let’s say a stock is yielding 8% of profit margin each year. If the promoters decide to pay out entire amount as dividend, then you as an investor will receive 8% of yield per year, which is similar to a bond or fixed deposit providing 8% returns in a year.
What about risks of owning stocks, you may ask. A fixed deposit is safe, or as good as safe, provided bank doesn’t fails. Whereas a stock carries multiple risks, such as business failing, promoter ethics issues, misreporting of financials, high debt, losses in a given year or a string of years and so on. Rightly said, therefore comparison of stock and bond becomes much more complicated when you introduce the risk premium. But nevertheless, it’s a useful yardstick to understand stock pricing and value pricing in an overpriced and bullish markets, or underpriced or bearish markets to pick bargains.
Returning back to Gitanjali Gems, the corresponding ratios are EPS for year ending Mar, 11 is Rs. 26.46. For the next year, FY11-12, EPS for three quarters for which the results have been declared is Rs 8.26, Rs 9.88 and Rs. 6.33. So EPS for three quarters is Rs 24.47, goes without saying that EPS is definitely showing uptrend and strength.
To introduce, PE ratio, PE or Price/Earning ratio is a ratio of current market price of the stock divided by its Earnings per share. To calculate for this case, current market price is 374.35 as I am writing this and Earnings for Yr 2010-11 is 26.46 for the whole year. Thus PE ratio is 374.35 divided by 26.46 or about 14.14. This means that you are paying 14 times Gitanjali’s earnings in a year to own the stock. PE in itself is a simplistic measure, but like most simple things, is also very powerful. At 14 PE ratio, owning a stock is a like owning a bond of about (100/14.14) or 7.07% return a year. Not including the risks of given equity, 7% is a moderate to low return in today’s scenario.
At about Rs 250 market price, you were getting this great business at a PE ratio of just about 10, which was a great price to buy in Gitanjali. Did you buy it then? Bear market is a amazing time to own great companies at great prices, and value investors like us look forward to bearish times, when the going gets tough. As the common saying goes, when the going gets tough, the tough gets going. Still the times are bearish and markets are showing daily 1-2% of upswing or downswing. I will try to highlight some great companies that you can buy at current prices in next few posts. Stay tuned and happy investing.