X

Sign up for Equitymaster's free daily newsletter, The 5 Minute WrapUp and get access to our latest Multibagger guide (2017 Edition) on picking money-making stocks.

This is an entirely free service. No payments are to be made.


Download Now Subscribe to our free daily e-letter, The 5 Minute WrapUp and get this complimentary report.
We hate spam as much as you do. Check out our Privacy Policy and Terms Of Use.
Beware! Some numbers that can fool you - Views on News from Equitymaster
 
 
  • PRINT
  • E-MAIL
  • FEEDBACK
  • A  A  A
  • Dec 9, 2009

    Beware! Some numbers that can fool you

    Numbers rule the financial world. Anything to do with the world of finance and the first thing you have to deal with is a fortress of numbers. For the layperson or amateur, it can be quite an intimidating task. It is not surprising then that many an unsuspecting investor finds himself frequently misguided by this deceptive characteristics of numbers.

    Lest you become one of them, we present to you some common illusory or confusing situations involving numbers. And how to untangle yourself from the mess. After all, as an investor, the last thing you would want is to make in investing decision on the basis of some such number only to later realize that things were not what you earlier thought they were.

    Low base effect: Year on year growth figures are most often used by analysts and media to express the growth of something. Growth in GDP, car sales, company earnings, revenues, inflation, share prices, IIP, stock indices etc are all frequently measured and published. Since the 'growth' factor is given so much of attention and importance, a good growth figure or a bad one may often push you to make an investing decision.

    But caution is required in interpreting a growth number. A growth number is arrived at in the following way -

    If earnings of a company in the September quarter last year were Rs 5 m and are Rs 9 m this year, you would get a year on year (YoY) growth figure of 80%. But the most important thing to remember about this '80%' is that it was arrived at by a division calculation in which the denominator is the previous period's figure. Thus, if the previous year's figure is one which is affected by some abnormal phenomenon, the 'growth' figure itself may end up being one which distorts the true picture. It is essential then that one not look at only the growth figure independently to arrive at its meaning, but also study the usefulness and relevance of the other two figures involved in the calculation - the numerator and the denominator.

    Very high or low P/E ratio: The P/E (price to earnings) ratio is one of the most popular tools to gauge how expensive or cheap a stock is. But if you have the habit of only looking at the single P/E ratio number and passing a judgement accordingly, you will need to approach things a little more carefully. This is somewhat an offshoot of the earlier point. The P/E ratio is arrived at by dividing the price of a stock by its earnings per share (EPS).

    Thus, having a long hard look at the quality of the EPS that goes into the calculation is extremely important. The company may have had an exceptionally good year or an exceptionally bad year. Or it may have had some non recurring gain or loss during the period. These factors can cause the P/E ratio to look unduly low or abnormally high. And thus make the stock look too cheap or too expensive respectively even though that might not actually be the case. Here again, one needs to closely study the quality of the EPS figure that goes into the calculation. This is the only thing that will help one decide how seriously that P/E ratio figure should be taken.

    Gauging your returns - Point to point v/s CAGR: 'Returns' are foremost on an investor's mind. But when it comes to calculating how good or bad one's returns have been, investors frequently find themselves at a loss. There are two popular methods. One is the 'point to point' method where you just divide your gains by the initial amount you invested to get your returns. So say you initially invested Rs 1 lakh, and are now getting back Rs 1.5. Your gains in this case are Rs 50,000 and your point to point return would be 50% (50,000 divided by 1 lakh).

    The other method is the compounded annual growth rate or CAGR. Its calculation is as follows -

    {(Ending value/beginning value) raised to (1/number of years)} - 1

    So if your 1 lakh became 1.5 lakh after 5 years, your CAGR return according to the above formula would be 8.4% annually. This means that if you had made 8.4% returns in a year on the 1 lakh you invested and reinvested the initial amount and the year's return to earn another 8.4% the next year and so on, you would end up with Rs 1.5 lakh after 5 years.

    Whether point to point or CAGR is a better way to gauge your returns depends on your ultimate objective. However, it must be noted that CAGR gets the all important element of time value of money in the picture, which is important when judging your investing returns.

    High growth rates / upward trend of earnings: When judging the growth potential of a company which has been growing consistently over the past few years, it is tempting to extrapolate that growth into the future too while valuing the company. This can be very dangerous and one should be particularly wary of doing so when times are good. One needs to put a lot of thought into exactly why the company's earnings have been growing and the sustainability of that growth. It is indeed a difficult task to do so. But nonetheless, one of utmost importance. This is where the qualitative analysis of the company and its business will come to the forefront and deserves careful scrutiny by the investor.

    Price of a stock: Many lay investors think the absolute price of stock conveys how attractive it is. For example, a stock worth Rs 25 would be considered to be cheap. Whereas a Rs 1,000 stock would be considered to be expensive. Nothing could be more further from the truth. A stock's attractiveness is gauged through other methods and ratios like price to earnings (P/E), price to book (P/B), dividend yield, discounted cash flows etc. While we will not get into the details of each of those, if you are one of the above, we suggest you do some quality reading on the above methods before forming any opinion about the price of a stock.

    Billions and millions: Many find themselves utterly confused about the interchangeability between million, lakh, billion and crore. So here's a quick note on the conversion. 1 million is equal to 10 lakh. And 1 billion is equal to 100 crore. This nomenclature is only to do with the grouping of numbers, and has nothing to do with currency. Hence, converting rupees to dollars should not be mixed with converting from one thing to the other as shown above.

    We hope the above discussion has helped give you a good head start in minding your way in the confusing world of numbers that finance is built on.

     

     

    Equitymaster requests your view! Post a comment on "Beware! Some numbers that can fool you". Click here!

      
     

    More Views on News

    How to Ride Alongside India's Best Fund Managers (The 5 Minute Wrapup)

    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.

    You've Heard of Timeless Books... Ever Heard of Timeless Stocks? (The 5 Minute Wrapup)

    Aug 19, 2017

    Ever heard of Lindy Effect? Find out how you can use it to pick timeless stocks.

    Why NOW Is the WORST Time for Index Investing (The 5 Minute Wrapup)

    Aug 18, 2017

    Buying the index now will hardly help make money in stocks even in ten years.

    Trump Takes a Beating (Vivek Kaul's Diary)

    Aug 18, 2017

    Donald J Trump, a wrasslin' fan, took a 'Holy Sh*t!' blow on Tuesday.

    How To Read Your Mutual Fund Account Statement Correctly (Outside View)

    Aug 17, 2017

    PersonalFN simplifies the mutual fund account statement for you.

    More Views on News

    Most Popular

    Demonetisation Barely Made Any Difference to Tax Collections(Vivek Kaul's Diary)

    Aug 7, 2017

    The data tells us quite a different story from the one the government is trying to project.

    A 'Backdoor' to Multibaggers: It's Like Investing in Asian Paints Ten Years Ago(The 5 Minute Wrapup)

    Aug 10, 2017

    Don't miss these proxy bets on growing companies or in a few years you will be looking back with regret.

    Should You Invest In Bharat-22 ETF? Know Here...(Outside View)

    Aug 8, 2017

    Bharat-22 is one of the most diverse ETFs offered so far by the Government. Know here if you should invest...

    Signs of Life in the India VIX(Daily Profit Hunter)

    Aug 12, 2017

    The India VIX is up 36% in the last week. Fear has gone up but is still low by historical standards.

    7 Financial Gifts For Your Sister This Raksha Bandhan(Outside View)

    Aug 7, 2017

    Raksha Bandhan signifies the brother-sister bond. Here are 7 thoughtful financial gifts for sisters...

    More
    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: info@equitymaster.com. Website: www.equitymaster.com. CIN:U74999MH2007PTC175407
     

    Become A Smarter Investor In
    Just 5 Minutes

    Multibagger Stocks Guide 2017
    Get our special report, Multibagger Stocks Guide (2017 Edition) Now!
    We will never sell or rent your email id.
    Please read our Terms

    S&P BSE SENSEX


    Aug 18, 2017 (Close)

    MARKET STATS