Tuesday, 14 August 2012

Balance Sheet Pt-5

At the outset let me say that this is going to be a long post. Let us start by putting a question? How do we know how much value the company has as per its accounts? There is a parameter which may be used to answer this. It is the Book Value of the company.

Book Value : It is given as the total assets of the company by the number of common shares. It gives the value the company carries per share. It can also be obtained by the shareholder equity by number of shares.

To get a more safe view of the book value, all liabilities, depreciation and intangible assets like goodwill, brand value etc. are deducted from the total assets.

Though the book value should not be the sole criteria for investments, it serves as a simple parameter to measure companies.

A company having a low market price but high book value means that it has large assets and presently undervalued. On the other hand if the market price is high than the book value then the share is trading at a premium. This may be because of past-performance of the company, increased goodwill or positive future outlook. The ratio of market price to book value is generally known as the Price to Book Ratio or P/B ratio.

Next let us ask, is the company employing its resources efficiently? The parameter which answers this question is called Return on Assets.

Return on Assets (RoA) : It signifies the efficiency of the company to generate income by deploying its assets. More sales using assets proportionally increases the RoA.

Increase in RoA directly reflects on an increase in its share price and Return on Equity (RoE).

Investor’s Line of Thought

An important part of the process of learning to invest in stocks is to have a right approach to the stock markets. We should know how as a stock investor we should evaluate a company before investing.

There are hordes of companies which are listed on the stock exchanges and some of them are really worth. Generally the individual investor gets to know about the company through TV programmes on business, newspaper articles, finance websites, personal finance analysts, financial advisers, friends, colleagues etc.

When you get to know about a prospective company the first thing to look out for is the sector/industry to which it belongs. Get to know the relevance, growth prospects, the future outlook of the sector as a whole. Are the present Govt. policies etc. favourable to the sector? Are the national and sometimes global changes going to affect the sector’s growth positively or negatively? All this and more can be found out with a little study about the sector from the Internet, newspapers and TV programmes.

Once you are sure that the sector as a whole has a promising future, then its time to zero-in on the company concerned. Look out for the past performance of the company. Is it a young enterprise? How are the peers doing? Sometimes the company which was initially suggested to you and which initially prompted you to do the research, may not be as good as it sounded but you may stumble upon one of its competitors which is really doing well. Keep in mind all that we covered in our earlier posts while researching the company and try to evaluate it on those parameters.

Then its time to time the market. Look out for dips in the sensex and when the market goes down. This is the time to invest in your stocks and take your picks. Don’t worry about the short term fluctuations. Invest for the long term. Provided your study was thorough and you have backed up your decisions with true facts, your investments will certainly give you rich returns and dividends.