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Which is attractive: Rs 10 or Rs 50? - Views on News from Equitymaster
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  • Apr 1, 2005

    Which is attractive: Rs 10 or Rs 50?

    There are some myths at the retail investors end when it comes to investing in stock markets. In a series of articles aimed at addressing these issues, we will focus on what is important when it comes to selecting a stock i.e. the stock 'price' or the stock 'value'?

  • Read our first article: Does Sensex trace GDP growth?

    It is a common perception among retail investors, based on various feedbacks that we receive from our subscribers and visitors on our website, that a company's share is supposedly 'cheaper' when it is trading at Rs 10 as against Rs 50 i.e. after it appreciates. The interest level for low price stocks seem to be disproportionately higher these days because of two reasons. One, the stock market has been going up and secondly, prices have run up significantly in the last two years, thus the craze for small and mid-caps. The major attraction when it comes to mid-caps among retail investors, besides the upside, is that one could buy a lot more shares for the same outlay.

    We take a practical example and bring forward what is important. Here we compare, Tata Motors and Ashok Leyland. Remember, we are not recommending any stocks by this comparison.

    What is 'cheap'?
    FY04 Tata Motors Ashok Leyland
    Current price (Rs) 414 21
    Face value (Rs) 10.0 1.0
    Price to earnings (times)* 12.8 10.9
    Price to book value (times)** 4.1 2.5
    Key ratios
    EBDITA margin 13.5% 12.6%
    Net profit margin 5.6% 5.3%
    Return on net worth 24.2% 20.9%
    *Based on trailing twelve months earnings. **FY04

    As a retail investor, it is possible that with a sum of Rs 1,000, one can buy 47 shares of Ashok Leyland whereas for a similar outlay, investors can get hold of only 2 shares of Tata Motors. But does that mean Ashok Leyland is 'more attractive' than Tata Motors? The answer is a clearer no! Though one may be buying fewer shares of Tata Motors, this should not be the governing factor for investing. What matters is 'at a price', what is the underlying 'value' that the investor is getting. The stock may be trading at a higher valuation also because the fundamentals are stronger.

    Some caveats:

    1. Price is governed by value: The stock price (governed by value) is supposed to indicate the long-term earnings growth potential of the company. What is history is already into the stock price because everyone knows it! This long-term growth potential has to be 'valued', taking into account the industry dynamics, the past track record of the management and what the future looks like. It is for this reason that high-growth sectors (software and pharma, for instance) generally tend to command higher valuation as compared to a textile stock.

    2. FIIs do not care about pennies: If you think the penny stocks will go up because Foreign Institutional Investors (FIIs) are going to buy into these, then we must point out that you are most likely to be wrong and are being misled if you are being told that this is true. Serious FIIs and domestic mutual funds have stringent criterias like floating stock (% of shares not owned by promoters and is liquid), minimum level of market capitalisation and sales turnover and so on. If any broker is suggesting buying into a penny stock because growth prospects are good and FIIs 'would' buy, then it is time to exercise caution.

    3. Face value: Investors have also got to keep in mind as to the face value of the share they are buying. Like in the case above, Ashok Leyland may be trading at Rs 21. But its face value is Re 1 (if we equate it, the buying price is actually Rs 210). Some companies change their face value to increase liquidity in the stock market with a good intention.

    4. Same is the case with Mutual Funds: Just because the NAV (net asset value) of a mutual fund scheme is below par or at par (i.e. less than or equal to Rs 10), it does not become attractive.

    To conclude, focus on the 'value' and not on the 'price'. So, what is attractive? Rs 10 or Rs 50!



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