Sep 13, 2005|
Stockmarkets: Investing on 'margin'!
As the Indian stock markets continue their move uphill will much vigour and gust that would even embarrass Roger Federer (the US Open champion), the fact that investors need to extend their investment horizon beyond 2-3 years to garner adequate return has come to the fore. While this does not mean that investors need to benchmark any index for making their investment decision, it is always important to look at the mood of the broader market along with researching a stock before committing money.
At the current levels, the NSE-Nifty is trading at a P/E of 15.3 times trailing 12-month earnings. This has led to views abound that these are pretty comfortable levels and that Indian markets are not overvalued in any sense of the word. While we do believe that the Indian growth story is here to stay and that investors in the same will reap decent rewards, the fact that fresh investment at the current levels need to be undertaken with utmost care and caution, needs to be understood.
We have conducted a small exercise with respect to the Nifty P/E and have arrived at the conclusion why the investment horizon needs to be long. We have used Benjamin Graham's 'margin of safety' principle to arrive at this judgement.
'Margin of Safety,' is among the concepts that are at the core of stock market investing. For stocks, the margin of safety lies in an expected 'earning power' considerably above the interest rates on debt instruments. Simply calculated, earning power is equal to the reciprocal of P/E ratio, i.e., E/P. For example, a stock with a P/E ratio of 15 has an earning power of 1/15, or around 6.7%. In common parlance, this is often known as the 'earnings yield.' This acts as a protection to investors in the form of a buffer (extra gain over interest rate on a benchmark debt instrument) that they want for the risk they are ready to take by investing in stocks.
Here is a table depicting the margin of safety for investors in the broader Nifty. In the table, 'current' indicates the Nifty P/E of today and the next two rows indicate what the P/E might be 1 and 2 years hence respectively. For arriving at the P/E for the next 1 and 2 years, we have discounted the current P/E by the expected average earning growth of Nifty stocks, i.e., 15% per annum. We then derive the 'earning power' (as explained above) by calculating the reciprocal of the Nifty P/E for each period. And finally, considering the risk free rate of 7% (the current yield on a 10-year G-Sec paper), we arrive at the margin of safety.
What's the margin of safety?
|| (A). Nifty
| (B). Earnings
| (C). Risk-free
rate (10-year G-Sec)
| (D). Margin of
| Current+1 year
| Current+2 years
The table indicates that as you hold your investment (Nifty, in this case) for a longer duration, your margin of safety will increase. However, readers need to consider that this table is made on the basis of two key assumptions:
Earnings of Nifty stocks will grow at a rate of 15% per annum (If earnings grow faster/slower than what is assumed and other things remain constant, margin of safety will be higher/lower than what is indicated in the table).
10-year G-Sec interest rate will be 7% in all the three periods (If this rate were to rise/fall while other things remain constant, margin of safety will decrease/increase).
Investors can use this principle of margin of safety for the stocks that they intend to buy of for those that they already hold and want to check if it is the time to sell. However, other parameters like earning growth potential, management vision and overall growth of the industry also need consideration before making investment decision, the key is to understand the investment properly before committing money.
More Views on News
Jun 10, 2017
Forty Indian investing gurus, as worthy of imitation as the legendary Peter Lynch, can help you get rich in the stock market.
Aug 21, 2017
Most Indians who cannot find jobs, look at becoming self-employed.
Aug 21, 2017
PersonalFN explains the chief factor pushing gold prices up of late.
Aug 21, 2017
One of the hallmarks of successful investing is to look out for companies that have a unique and enduring moat.
Aug 19, 2017
Ever heard of Lindy Effect? Find out how you can use it to pick timeless stocks.
More Views on News
Aug 10, 2017
Don't miss these proxy bets on growing companies or in a few years you will be looking back with regret.
Aug 10, 2017
Bill connects the dots...between money and growth, real money and real resources, gold and cryptocurrencies...and between gold, cryptocurrencies, and time.
Aug 12, 2017
The India VIX is up 36% in the last week. Fear has gone up but is still low by historical standards.
Aug 10, 2017
Bitcoin hits an all-time high, is there more upside left?
Aug 16, 2017
Ensure your financial Independence, and pledge to start the journey towards financial freedom today!
Copyright © Equitymaster Agora Research Private Limited. All rights reserved.
Any act of copying, reproducing or distributing this newsletter whether wholly or in part, for any purpose without the permission of Equitymaster is strictly prohibited and shall be deemed to be copyright infringement. LEGAL DISCLAIMER:
Equitymaster Agora Research Private Limited (hereinafter referred as 'Equitymaster') is an independent equity research Company. Equitymaster is not an Investment Adviser. Information herein should be regarded as a resource only and should be used at one's own risk. This is not an offer to sell or solicitation to buy any securities and Equitymaster will not be liable for any losses incurred or investment(s) made or decisions taken/or not taken based on the information provided herein. Information contained herein does not constitute investment advice or a personal recommendation or take into account the particular investment objectives, financial situations, or needs of individual subscribers. Before acting on any recommendation, subscribers should consider whether it is suitable for their particular circumstances and, if necessary, seek an independent professional advice. This is not directed for access or use by anyone in a country, especially, USA or Canada, where such use or access is unlawful or which may subject Equitymaster or its affiliates to any registration or licensing requirement. All content and information is provided on an 'As Is' basis by Equitymaster. Information herein is believed to be reliable but Equitymaster does not warrant its completeness or accuracy and expressly disclaims all warranties and conditions of any kind, whether express or implied. Equitymaster may hold shares in the company/ies discussed herein. As a condition to accessing Equitymaster content and website, you agree to our Terms and Conditions of Use, available here
. The performance data quoted represents past performance and does not guarantee future results.SEBI (Research Analysts) Regulations 2014, Registration No. INH000000537.
Equitymaster Agora Research Private Limited. 103, Regent Chambers, Above Status Restaurant, Nariman Point, Mumbai - 400 021. India.
Telephone: +91-22-61434055. Fax: +91-22-22028550. Email: firstname.lastname@example.org. Website: www.equitymaster.com. CIN:U74999MH2007PTC175407