• Australian (ASX) Stock Market Forum

Hello and welcome to Aussie Stock Forums!

To gain full access you must register. Registration is free and takes only a few seconds to complete.

Already a member? Log in here.

Applying some Maths to stocks

Discussion in 'Stock Market Nuts and Bolts' started by OFS, Jan 20, 2014.

  1. OFS

    OFS

    Posts:
    3
    Likes Received:
    0
    Joined:
    Jan 20, 2014
    Hi all,

    This is my first post after some time spent reading this great forum.

    I've decided to register and make some questions to people more expert than me on financial matters.
    I would like to play Maths with stocks, but not in terms of Moving Averages et simila, but working on fundamentals, instead.


    First question is related to the Price-to-Earnings ratio, P/E. It can be calculated on past performance or future expectations.

    P/E = Price / Earnings per share

    Price = $540.67
    EPS = $39.75

    P/E = 540.67 / 39.75 = 13.6

    A P/E of 13.6 seems a bargain for a big company like Apple.
    Question 1: Would you agree on the above statement?
    Question 2: How you pick stocks based on P/E ratios?






    The P/E/G ratio is similar but takes into account the growth rate estimated for the next 5 years.
    P/E/G = Price to earnings ratio / growth rate next 5 years

    P/E = 13.60
    Growth rate for EPS in next 5 years = +12.10%

    P/E/G = 13.60 / 12.10 = 1.12

    When referring to EPS in next 5 years, it seems that Apple isn't a good buy. P/E is bigger than growth, meaning it is overvalued.
    Question 3: would you agree with the above statement?





    If the above outcome seems unfair for Apple, let's what happens if we refer to the past performance (+41.52%):

    13.60 / 41.52 = 0.33

    In this case, if we refer to past performances of growth rate, the actual P/E seems to be a great bargain.
    Question 4: would you agree with the above statement?



    Next analysis is related to regarding the stock price as the discounted value of expected future dividends, that is:

    P = D / K

    Where:
    P = Current stock price;
    D = Current dividend rate;
    K = Required rate of return.

    We get:

    D = $3.05 (declared on 28th of October 2013)
    K = 10%

    P = 3.05 / 0.10 = $30.50

    Now, to get a decent return based on future dividends, the fair price for Apple should be $30.50. In terms of dividends, Apple is 17.7 times overvalued.
    Question 5: would you agree with the above statement?

    The return rate I get from Apple in terms of dividends is:
    K = 3.05 / 540.67 = 0.6%
    The return I get from dividends investing in Apple is an absolute "stay away".
    Question 6: would you agree with the above statement?





    The last analysis is fair for a no-growth company that gives satisfactions to its shareholders through dividends, but Apple is a growth-company, even a fast-growing one if we refer to past performance. Something different should be used, in this case:
    P = D / (K - g)

    Where:
    P = Current stock price;
    D = Current dividend rate;
    K = Required rate of return;
    g = growth rate in earning per share = 9.50% (estimates for next year)

    We get:
    P = 3.05 / (0.10 - 0.0.95) = $610.00

    If we take into account the growth rate in earning per share, a fair price for Apple would be $610.0 versus the actual $540.67. In these terms, the actual stock price is slightly underestimated.
    Question 7: would you agree with the above statement?



    Let's stop here to avoid to make it too long.
    You can decide to answer also to just some of the above 7 questions.


    Best regards,
    OFS
     
  2. Value Collector

    Value Collector Have courage, and be kind.

    Posts:
    6,911
    Likes Received:
    1,423
    Joined:
    Jan 13, 2014
    Hi,

    One thing I would like to point out is that mathematics only get you so far. When it comes to investing you have to be able to assess the Quality of the business also, you may sometimes hear people discuss the two areas as being quality and quantity.

    the reason it is important to be able to judge quality is that some companies may only be worth PE10, where others may be worth PE25, It's its not as simple as just looking at the previous growth in earnings, You have to be able to put your business man hat on and value businesses from the ground up, only after you have a understanding of the businesses quality can you judge what the correct PE ratio should be and whether it is under or over valued.
     
  3. OFS

    OFS

    Posts:
    3
    Likes Received:
    0
    Joined:
    Jan 20, 2014

    Hi Value Collector,

    Thank you for your reply.
    I totally agree with your post and I share your same vision: a stock trader should be a good businessman first and then he should know some numbers basics.
    There are two different fields, as you point out: quality and quantity.

    Let's say this thread is fully focused on quantity, well knowing that it is just one part of the whole picture.

    I have some stocks on my watchlist that I would like to discuss in a separate thread, but for the moment I want just to be sure that I have the correct knowledge of the basic ratios.


    Best regards,
    OFS
     
  4. pixel

    pixel DIY Trader

    Posts:
    5,359
    Likes Received:
    322
    Joined:
    Feb 3, 2010
    Yes, "what he (Value Collector) said."

    Plus, Sentiment Rules. OK. You can do all the Math and Fundamentals you like: It's the market perception that defines the value. Be prepared to accept that it may differ widely from your estimate.
    For example: Where do you get the next 5 years' earnings estimates? Do you accept brokers/ analysts' fore casts? If so: Which ones?

    I would suggest you obtain some past data and forecasts of a significant number of stocks (use some that you wish to trade) and apply your Maths retrospectively to those data. That way, you can answer Dr. Phil's stock question and work out "How's it workin' for ya?"
     
  5. burglar

    burglar

    Posts:
    3,661
    Likes Received:
    2
    Joined:
    Nov 22, 2010

    free download from “Master the Markets”, Tom Williams

    Read more here:
     
  6. pixel

    pixel DIY Trader

    Posts:
    5,359
    Likes Received:
    322
    Joined:
    Feb 3, 2010
  7. burglar

    burglar

    Posts:
    3,661
    Likes Received:
    2
    Joined:
    Nov 22, 2010
    A smallish correction if I may ... market perception defines price.

    Given intangibles and assorted variables, no-one can correctly calculate the value.
     
  8. Zedd

    Zedd

    Posts:
    152
    Likes Received:
    0
    Joined:
    May 8, 2009
    To your actual specific questions:

    P/E gives a quick way of comparing a company to current market/industry valuations/sentiment, rather than a buy signal. I'd be comparing it to competitors - Microsoft, Google, Samsung? If it's significantly different to it's peers then it raises the valuable question of why?

    If you're looking for undervalued companies based purely on an earnings valuation then P/E will flag those for consideration.

    Again, raises questions rather than black/white answers, but from this I'd think it likely that the market believes the company has something else going for it besides it's projected earnings growth.

    It's certainly an interesting POV. Personally never looked at this valuation. As a general rule though past performance is a dangerous place to look for future outcomes.

    All I'd be taking from these valuations is that you've correctly identified that there's no profit to be had at current dividend levels.

    Yes - providing you're RRR is 10% and not 11%, and that you're confident they'll hit the earnings growth projected.

    From reading the news I know Apple has experienced exceptional growth over the last few years due to it's largely unique product line but this market advantage has been worn down so growth is not expected to be as stellar in coming years. It has managed to amass a rather large amount of cash though so there's an expectation that the cash will be used to fuel growth through large R&D or acquisition. There's also been a shareholder movement pushing to have a significant portion of the cash returned to shareholders through a special dividend also.

    All of this is hinted at by your various valuations and that's what I like about the maths aspect of stock picking. In a matter of minutes you've managed to ask a number of valuable questions that point you in the right direction.

    The decision I then have in my mind is after understanding why it's valued where it is what am I willing to speculate on that isn't being allowed for?
     
  9. Value Collector

    Value Collector Have courage, and be kind.

    Posts:
    6,911
    Likes Received:
    1,423
    Joined:
    Jan 13, 2014
    Sentiment is the leading driver of market price, and companies can remain both undervalued and over valued for an extended period of time, which in my opinion makes a value approach less suited to trading. As they say, short term the market is a voting machine, long term its a weighing machine.

    If you want to use the value approach you have to be willing to be am investor rather than a trader, for example when (TGR) Tassal was $1.50. I had it conservatively valued at $2.92, So I loaded up, But it took 2 years to get to $3.25 where it sits now, which more than compensated my waiting time of 2 years, especially with dividends, But a lot of traders don't have the will to stay in like that.
     
  10. OFS

    OFS

    Posts:
    3
    Likes Received:
    0
    Joined:
    Jan 20, 2014

    Hi pixel,

    Thank you for adding your point of view to this thread.
    I agree with you and I'm not confident at all on estimates and analysts' forecasts. I won't forget what I read on Peter Lynch's book: an analyst once published the following statement "given the recent bankruptcy, we are removing the company from our Buy List".

    I'm also aware that past performances are not an indicator of future earnings.

    - - - Updated - - -

    Hi burglar,

    Thank you for this great suggestion. I've downloaded it and it is in my list of books to be read.
     
Loading...

Share This Page