No voting, no betting what matters in the stock market is only weighing!

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In the short run, the market is a voting machine but in the long run, it is a weighing machine— Benjamin Graham

As far the state elections are concerned, the voting is over, results are out and markets have cheered them already. The scorecards of political parties announce the average public opinion about their ability to run the state affairs efficiently. The process of weighting the performance of elected candidates may continue over the next five years and in the end that matters the most, doesn’t it?

The same principle applies to the stock market. The stock prices, expert opinions, everyday news flow and the inflow of new money decide the market direction in the short run. But in the long run, the performance of companies matters the most.

In that sense, Indian markets still appear to be in the voting phase!

On November 26, 2021, CDSL issued a press-release declaring that it crossed the mark of 5 crore accounts. And guess what, by the end of February 2022 the tally of accounts with CDSL zoomed past 6 crore. The tier-2 and tier-3 cities have been contributing to the total of new accounts. We haven’t even considered the scoreboard of NSDL.

Clearly, markets are gaining popularity in India (ahead of LIC IPO). Had domestic investors not propped up markets, the FPI (Foreign Portfolio Investors) outflows of 1.1 lakh crore in 2022 so far might have pulled the rug out from under the Indian equities.

Now let’s come to the ‘weighting’ part.

Price-to-Earnings (P/E) ratio is one of the most widely used valuation ratios that measures the attractiveness of ‘stock price’ (P) with respect to the company’s ‘Earnings’ (E). Earnings can be trail or forecasted earnings.

At present, the P/E of Nifty 500 is hovering above its long period averages. But does that make all the index constituents unattractive?

We decided to find the answer using a small variation of P/E ratio.

The conventional formula for P/E= Price per share/Earnings Per share

The one we used instead was:  Market capitalization/ (Net profit + Depreciation)

In other words, we considered cash profits to arrive at the valuation multiples of Nifty 500 constituents on trailing twelve month earnings.  Since depreciation is a non-cash item on the profit and loss account of a company it was added back to the net profit. Higher depreciation, at times, can make valuations look stretched.

Not much to our surprise, some large capital intensive businesses having a large base of fixed assets topped the list of companies claiming the highest amount of depreciation. However, a few large IT companies also made it to this list.

Companies witnessing a sharp difference between conventional and adjusted P/E have been from across the sectors and market capitalizations. Capital requirements of their businesses differ too.  Some of them are manufacturing companies while others cater to the services sector.

Many of them may suddenly start looking inexpensive or reasonably valued.

To conclude

Using cash earnings to calculate the earnings multiple may also come handy besides using the conventional P/E ratio. We don’t say this is a full-proof method either.

The common objective of various valuation metrics is to spot companies wherein valuations haven’t run ahead of their earnings potential.

We would like to know what stock selection criteria you follow. Do leave your reply in the comments section. And if you found this variation of P/E helpful, please don’t forget to share it with your friends.

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Disclaimer

The blog is for information purposes only and anything mentioned herein shouldn’t be construed as a fundamental reason to buy/hold/sell any stock. Furthermore, the information provided in the blog and observations made therefrom shouldn’t be treated as the extension of recommendations made on the other properties of Ventura Securities. If you follow any research recommendations made by our fundamental or technical experts, you should also read associated risk factors and disclaimers.

We strongly suggest you to consult your financial advisor before taking any decision pertaining to your finances. Asset allocation becomes extremely relevant.

We, Ventura Securities Ltd, (SEBI Registration Number INH000001634) its Analysts & Associates with regard to blog article hereby solemnly declare & disclose that:

We do not have any financial interest of any nature in the company. We do not individually or collectively hold 1% or more of the securities of the company. We do not have any other material conflict of interest in the company. We do not act as a market maker in securities of the company. We do not have any directorships or other material relationships with the company.

We do not have any personal interests in the securities of the company. We do not have any past significant relationships with the company such as Investment Banking or other advisory assignments or intermediary relationships. We are not responsible for the risk associated with the investment/disinvestment decision made on the basis of this blog article.

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