In one of the pieces I wrote recently, I pointed out a few of the important financial ratios that come handy when researching and analyzing stocks to buy. However, there are other “ratios” that help in stock selection; they are called market or price multiples.
What are market or price multiples?
Price multiples are the ratios of a stock’s market price expressed in relation to some measure of value per share of the stock. Price multiples are used for stock selection and valuation because they are based on the notion that one cannot judge whether a stock is overvalued, undervalued or fairly valued if one does not know what a share of the stock in question can buy in terms of assets, earnings or other measures of value.
The good thing about market multiples is that they are easy to use and easy to communicate and understand. In fact, a price or market multiple communicates, with a single number, the valuation relationship between a stock’s price and other familiar quantities like earnings, sales, or book value. Price multiples are calculated by dividing the price of a stock by a measure of value per share.
Price multiples make comparison among different stocks easy and possible. This concept is called “the method of comparable.” The method of comparable entails the use of a price multiple to evaluate whether an asset is relatively fairly valued, relatively overvalued or relatively undervalued when compared to a benchmark value of a multiple.
For example, if you have two stocks, one with a price to sales (P/S) of 1 and another with a price to sales, P/S, of 1.6, if the two stocks are similar in terms of risk, profit margin, and even growth prospect, it becomes easy for the investor to conclude that the stock with a P/S of 1 is undervalued relative to the stock with a P/S of 1.6. The concept of comparable is underscored by the economic principle of one price. This principle denotes that two identical assets should sell for the same price, otherwise, one is over or undervalued relative to the other.
[READ MORE: Financial ratios you need for stock analysis]
Commonly used price multiples
There are and could be a lot of price multiples to choose from, but the most commonly used ones are Price Earnings, (P/E), Price Sales (P/S), Price Book Value (P/BV) and Price to Cashflow ratios.
Price per share is the most popular valuation measure currently in use. To calculate P/E, you will need to know or calculate the Earnings per Share (EPS) of the stock in question. However, armed with the financial statement of the company whose stock you want to value or analyze, you will get the earnings on the income statement portion of the financial statement.
Then, looking at the capital and owners’ equity section of the balance sheet or the financial statement, you will most likely get information on the issued and/or outstanding number of shares. By dividing the net profit by the outstanding shares, you arrive at the EPS. Some financial statements come with the EPS (actual or diluted) already calculated.
In that case, by dividing the current price of the stock by the pre-calculated earnings per share, you get the price earnings ratio. For example, looking at the recently released Q2 financial statement of Cutix Plc, you will discover on page 3 “Results at a Glance” that the number of shares outstanding is 1,761,322 while the profit after tax is N141,282 (all in thousands), by dividing the profit before tax by the number of shares, you get the earnings per share of 8.02 kobo which compares favourably with the EPS number of 8 kobo provided on the financial statement. According to the same page on the financial statement, the price of Cutix Plc as at October 31, 2019, was N1.4, so by dividing that price by the EPS, you get a P/E ratio of 17.
Drawbacks of P/E Ratio
Though price earnings ratio is easy to calculate and use, it loses it economic meaning if the EPS is negative because a company ended the period in the red. Another drawback is that if a company’s management window dresses or distorts the earnings, EPS gets distorted and therefore, the comparability of P/E gets affected or even distorted as well.
Yet another drawback of the P/E ratio is that because it is based on past earnings per share (EPS), it may not be informative about the future and therefore not credible enough for valuation. To cure this particular drawback, analysts have come to use what they call leading P/E ratio rather than the trailing P/E ratio.
The difference between the two is that the trailing P/E ratio is backwards-looking while leading P/E ratio is forward-looking. In calculating leading P/E ratio, the current price of the stock of interest is divided by the expected earnings per share. In most cases, analysts arrive at leading EPS based on forecasted fundamentals of a company.
In the next piece of this article, I will be looking at Price to Book value as a stock valuation statistic.
How to thrive as a small business in today’s era of globalization
Small businesses play a critical role in developing the entire economy of any country, hence the need to activate the interests of potential clients.
The globalization of the world economy is a reality in which companies in all countries have been living for two decades. According to statistics, more than 50% of all innovative developments appear precisely in small businesses, and globalization, in this case, involves the investment in small businesses and their development by larger entrepreneurs and investors.
Small business and globalization
Today, small business development is based on the following factors:
- Availability of a state support program
- Venture investment
- Business incubators
Emphasis is on the formation of substantial assistance and support for the development of small businesses in the first place. At the same time, a significant emphasis is also placed on providing honourable working conditions. In some zones, even very loyal conditions have been created for the normalized work of entrepreneurs since there is a definite need to improve the economic performance of this or that region.
Thus, globalization is the process of implementing a variety of assistance, which is aimed directly at creating standardized conditions for the work of entrepreneurs. Naturally, at the moment, the sphere of activity of small businesses in the field of innovative developments is actively developing. In this case, individual private investors take an active part in globalization, offering various programs for investing money.
Enhancing small business development
Since small business plays a critical role in developing the entire economy of any country, there is a dire need to activate the interests of potential clients. Business development is provoked by the fact that all conditions have been created for it, and large companies are ready to invest their funds in its development.
In recent years, there has been an intensification of interest in developing small businesses all over the world. It is becoming clear that this business can bring the state to a new level in the global economy. It is in small businesses that many exciting and truly original ideas are born. But, due to lack of funding, such ideas have no prospects for active development. For this reason, in Europe and America, this business is at the peak of development, and it receives assistance not only from the state but also from private investors and large entrepreneurs.
How to help your businesses thrive?
It is a question that only successful entrepreneurs have. An entrepreneur cannot be successful without the desire to constantly develop his business, conquer new business heights and achieve new goals. A company cannot go on a knurled one. Sooner or later, such a business will be at the bottom. Technologies change, competitors change, customers change with their needs, and if your business stands still, it will not meet new requirements. Therefore, it is imperative to grow and develop a business constantly:
- Expand the range of products and services;
- Improve the quality of goods and services and raise the price, as well as take customers away from competitors;
- Attract new customers with marketing and advertising. Use translation equipment in your business to attract clients from all over the world. For example, simultaneous translation equipment will allow you to overcome the language barrier.
- Expand your business – open new points of sale and branches;
- Expand the market through related activities;
- Sell Better – Train Your Sellers;
- Combine different methods;
Risk management system
Even the smallest business depends on changes in the global economy. No doubt, this does not mean that every entrepreneur has to watch Bloomberg all day and become an expert in different fields to predict which direction oil prices will go. There are specially trained people for this. You have to go about your business. To do this, you need to have a well-structured risk management system that will allow you to effectively monitor all types of risks, including global ones.
Remember that the modern economy is just as global as small business needs. Suppose an entrepreneur wants his goods to sell equally well in New York and Milan. In that case, he will strive to enter the Italian market, and, therefore, he will carefully study those peculiarities of doing business inherent in Italy.
In the modern world, the presence of a risk management system is not just a tool for preventing the dangers and threats of a particular enterprise in a specific country. It is a mechanism for promoting a company to its own country and the markets of other countries.
Simultaneously, it is obvious that to enter the markets of other countries, which means that the organization becomes a player in the global economy, the management system as a whole and the risk management system must change depending on the situation and show flexibility and adaptability. Only if these conditions are met can we say that your company is ready to enter the global market and will be able to withstand the impact of the worldwide economy.
Rachel Eleza, Growth Marketing Director at UpSuite and a part-time writer.
How to curb Ponzi schemes in Nigeria – TGIC Founder
The economic situation and the high incidence of these fraudulent schemes show an urgent need for financial education.
The activities of Ponzi schemes operators have been on the increase in Nigeria, especially since the COVID-19 pandemic hit the nation. Several young people have fallen victim to these scams.
To curb this menace, commercial banks and other financial institutions have been tasked to support investment clubs. Tomie Balogun, Founder, The Green Investment Club (TGIC) is one of the investment experts who has called for more support to curb Ponzi schemes in the country.
She disclosed this at TGIC’s event tagged “The money movements of the young Nigerian of today.” According to her, the economic fallout from events such as the global market crash, economic recession and COVID-19 pandemic has pushed young Nigerians into the Ponzi camp.
She said, “The economic situation and the high incidence of these fraudulent schemes show an urgent need for financial education. TGIC is working to bridge the financial literacy gap among young people in Nigeria through its products and services. The club, from 35 members at its inception to over 1,700 members in three years, is targeting 10,000 members over the next five years.
“Our five-year vision is to help at least 10,000 people acquire financial education and provide them with investment advisory services. We expect this to increase savings deposits at financial institutions. The deposits will be mobilized to invest in small businesses in the economy. When these companies are supported, they will provide jobs for more people and reduce unemployment figures by at least 20%.”
She disclosed that the club found direct investment opportunities in the capital market, agribusiness, consumer lending, logistics, FinTech and real estate development sectors in Nigeria, United Kingdom and the United States.
Oladunni Olawuyi, Chief Operating Officer, Apel Asset Limited explained that investment platforms need the support of financial institutions to boost investment education.
She said, “The investment clubs help to clean up the economy of Ponzi schemes, promote financial education and diversification of investments in different economies.”
Unify exchange rate to cut production cost
Balogun tasked the Federal Government to unify the country’s exchange rate to reduce production costs. To her, multiple exchange rates lead to arbitrary fees, production costs, and higher prices for goods and services.
“The government should help SMEs and the manufacturing sector to increase their production in order to boost gross domestic product. The COVID-19 pandemic, despite the challenges, came with many investment opportunities for savvy investors,” she added.
Nairametrics | Company Earnings
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- Okomu Oil proposes dividend worth N6.7 billion for shareholders.
- Ardova Plc confirms appointment of Oladeinde Nelson-Cole as secretary.
- Cadbury Nigeria Plc set to hold 56th Annual General Meeting (AGM) on June 16.
- FCMB Group Plc appoints Muibat Ijaiya as Director.
- Afromedia Plc reports a loss after tax of N27.3 million in Q1 2021.