Terminology in equity Markets

 Terminology in equity Markets

Index

1. Face Value (FV)

2. Book Value 

3. Market Value

4. Replacement Value

5. Intrinsic Value

6. Market Capitalization (Market Cap)

7. Enterprise Value

8. Earnings- Historical, Trailing & Forward

9. Earning Per Share (EPS)

10. Dividend Per Share (DPS)

11. Price to Earning Ratio (PE ratio)

12. Price to Sales Ratio (P/S)

13. Price to Book Value Ratio (P/BV)

14. Differential Voting Rights (DVR)

Face Value (FV)

• The nominal price of a share is known as its face value. 

• Equity capital = No’s of Share X FV

For eg- In case a company has issued 1 lakh share with FV of Rs 10, then the equity capital of the company would be 10 lakh ( 100,000 X 10)

• The FV of a company’s share does not usually changes unless the company decides to split or consolidate it’s shares.

• In such case, the FV of company share would reduce - in case of split, or increase- in case of consolidation.

• FV is important for calculating the dividend payable on share.

When dividends are mentioned as a percentage, that percentage is reckoned with regard to the face value. For example, if a company with FV of Rs 10 declares 30% dividend, it means dividend of Rs 3 per share. 

Book Value

• It is the net-worth of the company.

• Net worth of company / Number of outstanding shares = Book Value

• In simple terms, book value per share means the theoretical amount of money each share would get in case the company was to wind up.

Market Value

• This is the market price of a share.

• The market value of the entire equity of a company is termed as market Capitalization.

• Market capitalization =  Market price per share X total number of outstanding shares.

• It depends upon the expected performance of company, market sentiments & Liquidity etc.

Replacement Value

• This refers to the market value of all the assets of a company at any point of time.

• If a new company were to set up with all the infrastructure/plants, which an already existing company has, then the cost which it would have to bear today is known as the “ Replacement Value” of the existing firm.

Intrinsic Value

• Intrinsic value of an assets is the present value of expected free cash flows from the assets.

• Warren Buffett defines the intrinsic value as “It is the discounted value of the cash that can be taken out of a business during it’s remaining life.”

• It is basically the discounted value of its future benefits to the investors.

• Investing in equity is about estimating this intrinsic value and paying a price today to earn the future value.

• If the Intrinsic value is perceived to be more than Market Value = Undervalued Script

• If the Intrinsic value is perceived to be less than Market Value = Overvalued Script.

Market Capitalisation

• Market Capitalization (Market Cap), is the amount of money required to by out the entire company at its current market price. 

• Formula : Market Cap = Market Price per share X No. of Outstanding shares.

• Categorisation of shares depends on Market Cap.

1. Blue chip- Companies with larges market Cap.

2. Mid Cap- Those companies which enjoy a good level of liquidity but are medium in terms of market cap size.

3. Small Cap- Those stocks that are smaller in size & do not enjoy much liquidity.

Enterprise Value

• Enterprise Value or we can say EV is the theoretical takeover price of a firm.

• Enterprise Value= Market Value of Equity (Market Cap) + Market Value of debt - Cash & Cash equivalents

Market Value of debt= It is generally taken as outstanding debt on the balance sheet of the company

Earning - Historical, Trailing & Forward

• Earning are profit in business.

• It can be define at various level like Net profits are the profits available to the equity owners. EBIT are available to serve both equity & debt holders. EBITDA is earning available to a business to replace its assets over a period of time & to serve both equity & debt holders. 

• Earnings of previous year’s are called Historical earnings

• Trailing- refers to the earnings of the latest four quarters, calculated on a rolling basis.

• Earning computed based on future projections are called forward earnings.

Earning Per Share (EPS)

• Net profit of the company belongs to shareholders.

• Formula- 

Earning Per Share= Net Profit / Number of share outstanding.

•  It means the amount of profit company has earned, for every share it has issued. 

• Higher EPS shows higher profitability and better earnings for the shareholders and will be preferred over shares of companies with lower EPS. 

• It is a significant variable in determining a share’s price.

Dividend Per Share (DPS)

• Dividend is generally declared as a percentage of the Face Value of Share.

• It is the portion of profit which company distribute it to the shareholder.

Price to Earning Ratio (PE Ratio)

• PE Ratio measures the price that the market is willing to pay for the earnings of a company. 

• Formula=  Market price per share / Earning per share

• PE is referred as a multiple of per rupee of earnings. When one refers to a stock trading at PE multiple of 12x, it means the stock is trading at twelve times its earnings.

• PE is based on historical earnings is of limited value. The prices changes dynamically while the reported earning is updated every quarter. Therefore prices tend to move even after the historical earning per share is known. In anticipation of the future earnings.

• If it is expected that earnings of a firm will grow, then the market will be willing to pay a higher multiple per rupee of earning. The focus is therefore on prospective PE or how much the current price is discounting the future earnings. 

• For eg.  when analyst say that shares of XYZ company is trading at 20 times its 2014 earnings, but is still about 15 times the 2015 earnings, given the state of its order book. What the are saying is that the growth in EPS is likely to be high, and therefore the current high PE based on historical numbers may not be the right one to look at.

• It is common to look at the PE multiple of the index to guage if the market is overvalued or undervalued. The PE multiple moves high when prices run ahead of the earnings numbers and the market is willing to pay more and more per rupee of earning. 

• When market correct and uncertainty about future earnings increase the PE multiple also drops. A value investor, who would like to pick up stocks when they are cheap, may be interested to purchase when PE is low.

• The analysts also compare the PE of one company with another, to check the relative value. The PE multiple of a stable, Large & well known company is likely to be higher than the PE multiple the market is willing to pay for another smaller, less known, and risky company in the same sector.

Price to Sales Ratio (P / S)

• Price to sales ratio is a valuation ratio that measures the price investors are willing to pay for each rupee of sales. 

• Formula

P/S = Current Market Price (CMP) / Annual Net Sales per Share

Or

P/S = Market Capitalization / Annual Net Sales

For eg. a company with annual net sales of 1 crore, outstanding shares of 10 lakh and CMP of Rs 40, P/S Ratio would be

Annual Net Sales per Share = 1 Crore / 10 Lakhs = 10

P/S Ratio = 40/10 = 4

• A low P/S ratio may indicate an undervalue stock, and if it is paired with a trend of strong gowing sales then it may be an attractive investment proposition,

• While high P/S ratio indicates a highly priced stock, it may also indicate and expectation of high future growth rate in sales and therefore the market willingness to pay a high price for it.

• A drop in the revenue growth rate will be a high risk for these stocks.

• Like all multiples, the P/S ratio should be used along with other data and compared with similar companies in the industry before making an investment decision.

Price to Book Value Ratio (P/ BV)

• It is one of the most widely used ratio to find price relative to the value. It measures a company’s current market price (CMP) vis-a-vis its book.

• It is calculated by dividing net-worth by the number of outstanding shares.

• The book value is the accounting value per share, in the books of the company. It represents the net-worth (Capital plus reserve) per share.

• An important limitation of this number is that most assets on the books of the company are shown at their historical cost less depreciation and not their realizable/ liquidation value.

• For eg. let us compare P / BV of a company with following information

Equity Capital = 10 Lakhs

Reserve & Surplus = 50 lakhs

No of o/s share = 6 lakhs

CMP = 20

Then BV would be:

Net worth / No. of share O/s = (10 lacs + 50 lacs) / 6 lacs= Rs 10

And P / BV would be

P / BV = CMP / BV = 20/10 = 2x

Hence P/BV ratio of this company would be 2 times.

• P /BV less than 1 indicates the company is trading below its book value, and hence the stock is deemed to be undervalued.

• Please note there are various factors which affects Book value, hence all the companies with P/BV less than 1 may not be value to buy.

Differential Voting Rights (DVR)

• A DVR is just like a normal share of a company, except that it carries less than 1 voting right per share unlike a common share.

• Such an instrument is useful for the issuer who wish to raise capital without diluting voting rights.

• Investors who wish to invest only  for dividends and capital appreciation and are not really bothered about the voting rights find these share attractive.