Are 'high price' stocks 'expensive'?

Nov 5, 2011

In this issue:
» India's 5 most high-priced stocks are...
» Prevention is better than cure
» Will the BRICs bail out the developed economies?
» Dream plan for Indian pharma industry
» ...and more!
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 Chart of the day
Like most other things in our country, the Indian stock markets, too, abound in myths and false beliefs. Today, we shall try and dispel some of them. Starting with today's chart of the day, you can see the 5 most high-priced stocks in India.

Many a retail investors would shy away from investing in such stocks merely looking at their multi-digit stock quotes. You can often hear investors arguing, "It is way too expensive. I'd rather buy a cheap penny stock. It's easy for a 6 rupee stock to multiply several times. But how far can a 6,000 rupee stock really go! Moreover, I can buy a cheap stock in good quantity which is not possible with the latter."

Data source: Ace Equity

Let us tell you that this is a completely wrong and misguided way of looking at stocks. If you understand the fundamental difference between 'high price stocks' and 'expensive stocks' you would save yourself from big investment mistakes. A 'high price stock' is one that has a high stock price. But please note, it says absolutely nothing about its value or how expensive it is. On the other hand, an 'expensive stock' is one whose market capitalisation (stock price multiplied by number of shares) seems overpriced in terms of its net worth or future earnings prospects. So a penny stock could, indeed, be expensive, while a stock with a high price tag could be a lucrative investment opportunity.

Can you guess which the world's most high-priced stock is? Well, it's none other than legendary investor Warren Buffett's Berkshire Hathaway. Currently quoting around US$ 115,806 (equivalent to Rs 5,674,494), it would require a fortune to buy even a single stock of this conglomerate. What is important to understand here is that the high stock price only makes it difficult for many investors to buy its stock as they would not be able to afford to invest such a big sum. However, whether it is a good value proposition or not one can find only upon systematic analysis of the company's earnings prospects, net worth and compare that with the its market capitalisation.

We'll try and explain this with a hypothetical example. Take two companies- A and B- with identical businesses, management and future growth prospects. While the stock price of company A is Rs 6, the same of company B is Rs 6,000 respectively. How would you find out which one is cheaper? One of the ways is to find the price to earnings multiple (popularly known as the P/E ratio). So you take the latest annual net profit of both the companies, divide it by the number of shares and arrive at the earnings per share (EPS). Say, the EPS of A is Rs 0.5 and that of B is Rs 750. Dividing the stock price by the EPS you get the P/E of both the companies. P/E of A is 12 and that of B is 8. So as per our assumptions, B with a stock price of Rs 6,000 is relatively cheaper than A.

Do you think low price stocks are better than high price stocks? Share your comments with us or post your views on our Facebook page.

A big reason for the current financial crisis is the existence of an unregulated market of super-complicated financial instruments. Which is why when the crisis was triggered in 2008, most governments set about formulating a new, stricter set of rules. But did this really help the businesses in these countries? As per the real estate tycoon, Mr Sam Zell, these regulations only helped worsen the crisis at least in the US. As per him, the new regulations just scared the business community and led to higher disincentives. A direct result of this is the slowdown and the higher unemployment rates. As per him, the US government needs to put a halt on new regulations and let the businesses do their job. At least till unemployment falls to 4.5% levels.

As such we do agree with Mr Zell on the point that regulations can be scary for the businesses which are used to doing things in a certain way. But at the same time it is the absence of these regulations that caused the crisis in the first place. So maybe the US government is not wrong in tightening its controls. But what it needs to do is to also take the business interest into account while formulating these regulations. Otherwise the growing dissent would really not help the government or the companies or the economy.

The global economy is going through one of the worst crisis in history. And naturally all eyes are turned for help towards the only economies that are healthy and growing. We are referring to the BRICs (Brazil, Russia, India and China) here. And by the looks of it they do appear to be eager to help. But a leading daily has raised an important question here. Are the BRICs actually interested in bailing out the entire world from this crisis? And more importantly, are they capable of such a feat?

As per the daily, the BRICs are saddled with their own troubles. Political disputes, the need to outdo each other and a generally difficult environment to do business in, are just some issues that plague each of the BRIC nations. To add to this are worries related to high inflation rates which have burnt a hole in each of their pockets. No denying that some countries like China have offered a helping hand to Greece and even other Euro nations that are reeling under the burden of debt. But this help comes at a price. The price is that the Euro nations have to drop their claims against China's unfair trade policies. As a result, it would not be right to think of the BRICs to be the next dominant power which would rule the world the way the US and Europe did at one point of time. While it is indisputable that the BRICs will grow much faster than their developed peers but they still need to go a long way to become a dominant economic power.

Indian pharma industry has been in the news in recent times. First, it was the National Pharmaceutical Pricing Policy (NPPA) proposing to controversially bring a majority of the market under price control. The last time the NPPA came out with such a policy but which never saw the light of day was in 2006. Now the Department of Pharmaceuticals has recommended a 'dream plan' of Rs 120 bn to the Planning Commission for the 12th Five Year Plan to support education and research and development in the pharmaceutical sector.

The idea is to get Indian pharma companies to take more risks and forge more mature alliances as opposed to routine partnerships. It has also called for a greater involvement of these companies with Government institutions. But the efforts have to be from both sides and not just from the pharma sector. The Government will have to be more proactive in terms of identifying opportunities in the healthcare space which will result in successful tie-ups between the government and private sector. Ideally, both should work out a way of making medicines accessible to a larger section of the population. Although the Government contends that price control will do the trick, India despite having the lowest cost drugs in the world, has still not been able to make drugs accessible to all.

It was a tumultuous week for the world stock markets. Except for China the entire global pack closed the week in red. US stock markets were down 2.0% during the week as uncertainty surrounding the confidence vote in Greek parliament worried investors. However, encouraging domestic jobs data gave investors a reason to cheer. Further, with the Greek Prime Minister winning the crucial confidence vote once can expect some kind of relief rally in the next week.

Indian stock markets were down during the week, with the BSE-Sensex trading lower by 1.4% over the previous week. Increased risk aversion due to political uncertainties in the West continued to overweigh markets. Markets are keenly eyeing corporate earnings and crucial developments in the West. These cues would determine the course of action in next week's trade. Amongst the other world markets, France was down by 6.7% while Germany was down by 6.0% during the week. Even UK and Japan lost gains recorded in the earlier week and were down by 3.1% and 2.8% respectively.

Data source: Yahoo Finance, kitco

 Weekend investing mantra
"If past history was all there was to the game, the richest people would be librarians." - Warren Buffett

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1 Responses to "Are 'high price' stocks 'expensive'?"

dr.m.narayana. bhat

Nov 5, 2011

i wish that life is so simple.
please clarify, whether you are talking of historical p/e
or prospective p/e

Like (2)
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