Market edging lower

Just like I thought it would, stock prices edged lower when trading shifted to speculative stocks. This action of the market was further fueled by the selloff in regular stocks as they all still appeared comparatively on the high side.

As you may notice in last week’s trading, the top constituent stocks of the benchmark index continued to be the target of investors’ selloff.

Over the news during the week, too, the bond-buying program of the US Federal Reserve was again reported to be finally terminated even sooner than October. This caused the otherwise bright and bullish disposition of local investors to be dimmed and turned bearish at the week’s end.

As a result of these developments, the market ended with a weekly loss of 61.19 points or 0.88 percent when it settled at 6,901.09 at the close of trading last Friday.

More on key ratios

To continue with last week’s review on the importance of the bottom-up approach and its fundamental method of stock selection to guide market decisions, we’re already done with earnings and earnings per share (EPS), profit margins, return on equity (ROE) and return on invested capital (ROIC), and the price-to-earnings ratio or PER.

Today, we’ll take up the next four major factors of fundamental valuation, namely price-to-earnings growth or PEG, price-to-sales ratio (PSR), price-to-book ratio (P/B), dividend-payout ratio and dividend yield.

The PEG ratio is used to determine a stock’s value while taking into account the company’s earnings growth, for with the growth rate, a different story can unfold about the stock’s valuation; the PEG ratio is calculated by dividing the stocks PER by its expected 12 months growth rate (PEG = PER/annual EPS growth rate).

A common rule of thumb is that the growth rate should be roughly equal to the PER and, thus, the PEG ratio should be around one (1).  A relatively low PEG ratio indicates an undervalued stock and a PEG ratio much greater than one (1) indicates an overvalued stock.

The PEG ratio is said to be very informative when used to assess fast-growing and cyclical companies, for in this ratio you get an understanding of the company’s earnings, growth expectations and whether it is trading at a reasonable price relative to its fundamentals.

The next ratio is the PSR.  It’s a valuation ratio that compares a company’s stock price to its revenues. It can be calculated either by dividing the company’s market capitalization (stock price x number of shares outstanding) by its total sales over a 12-month period, or on a per-share basis by dividing the stock price by sales per share for a 12-month period (PSR = stock price/sales per share).

A low ratio may indicate possible undervaluation, while a ratio that is significantly above the average may suggest overvaluation. By the way, the PSR ratio is also known as “sales multiple or revenue multiple.”

Another fundamental valuation factor is the price-to-book value ratio or P/B: This is used to compare a stock’s market value to its book value. It can be calculated as the current share price divided by the book value per share, according to the previous financial statement (P/B = stock price/ total assets – tangible assets and liabilities; tangible assets are physical fixed assets like machinery, buildings and land, and current assets such as inventory).

In a broader sense, it can also be calculated as the total market capitalization of the company divided by all the shareholders’ equity.

The last for the review in this issue is dividend payout ratio (DPR) and dividend yield (DY).  In simple terms, DPR is the percentage of earnings paid to shareholders in dividends. It can both be calculated as DPR = yearly dividend per share/ earnings per share or dividends/net income.

A stable dividend payout ratio indicates a solid dividend policy by the company.  A reduction in dividends paid is looked upon poorly, that the stock price usually depreciates as investors seek other dividend-paying stocks.

Like the other ratios, the significance of a company’s DPR is most relevant when used to compare companies in the same sector.

Dividend yield or DY, on the other hand, shows how much a company pays out in dividends each year relative to its share price (DY = annual dividends per share/price per share).

In the absence of any capital gains, the dividend yield is the return on investment (ROI) for a stock.

As explained, the ROI serves as a tool to help investors gauge the profitability of an investment.  In particular, it reveals the earnings the investor receives for each peso invested. As such, it allows the investor to easily compare multiple investments. For example, if someone has several investments of varying amounts, it may be difficult to determine the most effective investment at first glance the ROI provides an objective measurement of profitability. This may explain why it’s very popular and considered a versatile and simple metric of profitability.

The formula is expressed as follows: ROI = total proceeds obtained from selling the investment – cost of investment over cost of investment; the result is always expressed in percentage or ratio. Thus, if you invest P100 and makes a profit of P50, the ROI  for the investment is 50 percent (ROI = P150 – P100/P100 = 0.5 or 50.0 percent).

Bottom line spin

Again, we’ll continue next week and finish the review of the rest of the key ratios used in stock selection in bottom-up investing.

As for this week’s market, it may again attempt to challenge the psychological level of the benchmark index of 7,000.

However, taking into account what the market did last week, it might again fail to advance as evident signs on the overbought condition of the market continue to prevail.

The writer is a licensed stockbroker of Eagle Equities, Inc..  You may reach the Market Rider at [email protected] , [email protected] or at www.kapitaltek.com