We have just seen a bear market and will now, hopefully, see the beginning of a bull market. But was it really a bear market that we have just seen? Practically speaking, a bear market is one which makes people lose a lot of money and makes people lose confidence in the markets. That has happened, so yes, this was a bear market. Technically speaking, a bear market is one which makes a pattern of lower highs and lower lows. So, while a pattern of lower highs and lower lows is visible on the daily charts, it is still not there on the weekly charts. So, we can say that, technically, we are still in a bull market.
When a bull market starts, blue chips are the first ones to go up. After a while the blue chips become expensive and then the midcaps improve and finally, when even the midcaps become expensive the demand increases for small caps. But why does this happen? Just because a blue chip or a mid cap stock has gone up, would you buy a small cap? The reason most people give is that they are better off buying a larger quantity of the small caps rather than a small quantity of a blue chip.
When a bull market starts, blue chips are the first ones to go up. After a while the blue chips become expensive and then the midcaps improve and finally, when even the midcaps become expensive the demand increases for small caps. But why does this happen? Just because a blue chip or a mid cap stock has gone up, would you buy a small cap? The reason most people give is that they are better off buying a larger quantity of the small caps rather than a small quantity of a blue chip.
Let’s say you are of the view that software stocks will do well and want to invest in some software stocks. If you have Rs.20000 to invest, would you rather buy 12 shares of Infosys at 1650, which is giving you over 20% growth, or would you prefer to buy 150 shares of Ramco Systems, which is a loss making company for the last five years, at the price of Rs.136/-? Are you more comfortable buying a quality stock which is expensive or would you rather buy a loss making company which is cheaply available? Would you rather buy a Sony Television for Rs.25000/- or would you buy 5 televisions assembled by your next door neighbour for Rs.5000/- each?
Well, when you want to make money, you have to buy quality stocks. Even 12 shares of Infosys are more likely to deliver better profits than 150 or 200 shares of a company which has been making only losses since the last five years. Does that mean that you have no choice? In fact, you do have choice. When you are selecting a stock first zero in on to the sector/industry you want to invest in. Once you have decided the sector, look at the top 10 companies in that sector. Look at their last five years profit statements. If they have been giving good returns consistently in the last five years, then buy the cheapest of the lot. But how do you decide which is cheapest? The price? No, by way of price, company X may be cheapest of the top ten. But that still may not be the cheapest. The cheapest is which has the lowest Price to Earnings Ratio (P/E). We work on the assumption that similar companies in the same industry should have a similar price to earnings multiple. P/E is the current traded price divided by its Earnings Per Share (EPS). EPS is calculated by taking the profit before interest, depreciation and taxes and dividing it by the total number of equity shares issued.
Let us understand this more deeply. Let us say there are two companies A and B. For convenience sake, let us keep the numbers small and easy to understand. Let’s say A is a large company and has made a profit of Rs.1000/- this year while B is a slightly smaller company and has made a profit of Rs.800/-. Let us say company A has issued 1000 shares and B has issued 400 equity shares. So, the EPS of company A will be Rs.1/- per share (1000/1000) while that of company B will be Rs.2/- per share (800/400). This means that company B is making a profit of Rs.2/- on every share while company A is making only Rs.1/- on every share. So, while company A is making more profits on the whole, it is making lesser profits on each share issued.
Let us look at the price in the markets. Company A is trading at a price of Rs.40/- per share, company B is trading at Rs.50/-. Let’s calculate the P/E now. Company A has a P/E of 40x (40/1) while B has a P/E of 25x (50/2). So while company A may be larger and is making more profits in money terms its price is 40 times its earnings while company B’s price is only 25 times the earnings. This shows that even though the price of A is cheaper, company B is cheaper in terms of P/E. So, from this example, it is clear that it makes more sense to buy company B rather than company A.
So, that is all about EPS and P/E. While I have made every effort to make it as simple as possible, I know a lot of the readers will find some grey areas in this article. I encourage you to please post your comments by clicking on the comments button below in case you still have any doubts regarding these terms.
Well, when you want to make money, you have to buy quality stocks. Even 12 shares of Infosys are more likely to deliver better profits than 150 or 200 shares of a company which has been making only losses since the last five years. Does that mean that you have no choice? In fact, you do have choice. When you are selecting a stock first zero in on to the sector/industry you want to invest in. Once you have decided the sector, look at the top 10 companies in that sector. Look at their last five years profit statements. If they have been giving good returns consistently in the last five years, then buy the cheapest of the lot. But how do you decide which is cheapest? The price? No, by way of price, company X may be cheapest of the top ten. But that still may not be the cheapest. The cheapest is which has the lowest Price to Earnings Ratio (P/E). We work on the assumption that similar companies in the same industry should have a similar price to earnings multiple. P/E is the current traded price divided by its Earnings Per Share (EPS). EPS is calculated by taking the profit before interest, depreciation and taxes and dividing it by the total number of equity shares issued.
Let us understand this more deeply. Let us say there are two companies A and B. For convenience sake, let us keep the numbers small and easy to understand. Let’s say A is a large company and has made a profit of Rs.1000/- this year while B is a slightly smaller company and has made a profit of Rs.800/-. Let us say company A has issued 1000 shares and B has issued 400 equity shares. So, the EPS of company A will be Rs.1/- per share (1000/1000) while that of company B will be Rs.2/- per share (800/400). This means that company B is making a profit of Rs.2/- on every share while company A is making only Rs.1/- on every share. So, while company A is making more profits on the whole, it is making lesser profits on each share issued.
Let us look at the price in the markets. Company A is trading at a price of Rs.40/- per share, company B is trading at Rs.50/-. Let’s calculate the P/E now. Company A has a P/E of 40x (40/1) while B has a P/E of 25x (50/2). So while company A may be larger and is making more profits in money terms its price is 40 times its earnings while company B’s price is only 25 times the earnings. This shows that even though the price of A is cheaper, company B is cheaper in terms of P/E. So, from this example, it is clear that it makes more sense to buy company B rather than company A.
So, that is all about EPS and P/E. While I have made every effort to make it as simple as possible, I know a lot of the readers will find some grey areas in this article. I encourage you to please post your comments by clicking on the comments button below in case you still have any doubts regarding these terms.
Happy investing!!!
2 comments:
Guess bear run is one we get to see in a recessive mrkt like US...which is very soon will get into recession...also I feel that the duration of bearish market is far longer than what we are experiencing in Indian stock market which is actually not bearish but just correcting itself.
But good article and very well written..easy to understand. Keep up the good work!!
Couldn't agree more with you. But that is a primary bear market. An intermediate term bear market lasts usually between 3 weeks to 6 months. And yes, it could be called a correction to the primary trend.
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