Stock Split – is it good for you?

What is a stock split?
A stock split happens when a corporation decides to increase its number of outstanding shares. The price per share will be adjusted such that the market capitalization of the corporation stays the same. In effect, a stock split does not alter the financial position of either the corporation or the shareholder.

Example.
If an investor owns 100 shares of company ABC at a current market price of Rs.350, a 2 for 1 stock split will leave the investor with 200 shares. The new price per share after the split will be Rs. 175. Hence the total investment value will remain the same at Rs.35,000.

Why do stocks split?
Corporations announce stock splits to decrease share prices either to attract smaller investors or to keep their share prices at levels comparable to competition.

Is it good for you?
A stock split results in a lower share price and may attract more investors. This in turn creates a positive market sentiment that may drive the share price upwards. This is the rationale behind the strategy of investing in a share around the time of a split. Although there is data to support the theory that the stock price surges after a split, there is no actual change to the fundamental value of the company and so any investment made should be speculative rather than value based.

Financial Ratios – what do they tell you?

What are financial ratios?
Financial ratios are standard ratios that are calculated using information in a company’s financial statements. Information presented in financial statements can be non-standard and confusing. Financial ratios provide a structure to analyze and understand the information presented in a company’s financial statements.

What are financial ratios used for?
Financial ratios are used for a variety of different purposes. They are used by company management to understand the overall health and performance of a company. They are used to compare the performance of a company against the general industry performance. They are used to compare a company with its competitors.

Financial ratios are also used by investors to analyze a company’s performance and thereby assess its value.

What are the different types of financial ratios?
The following are some common types of financial ratios:
i) Profitability Ratios measure a corporations ability to maximize its profits. A higher ratio is a sign of a profitable corporation.
ii) Liquidity Ratios measure a corporation’s ability to generate cash to pay off its short-term debt. A higher value indicates higher liquidity and thereby a greater ability to pay off short-term debt.
iii) Activity Ratios measure the time taken to convert goods produced to either sales invoices or cash.
iv) Debt Ratios measure the proportion of a company’s debt in relation to its assets.
v) Market Ratios compare market parameters eg. price with book parameters, or parameters from financial statements.

Stock Valuation – A Primer.

What is stock valuation?
Stock valuation is the process of determining the fair value of a stock. Stocks analysts value a corporation’s stock based on its fundamental data and deduce a fair value for its stock price.

What is the purpose of stock valuation?
Stock valuation tells an analyst whether a stock is under-valued or over-valued and this information can is used in the trading of the particular stock.

What are some common stock valuation methods?
The following are some of the commonly used valuation methods.

i) P/E Ratio: The P/E ratio is calculated using the following formula: [share price/earnings per share]. This ratio is often used to compare a corporation with its peers within the same industry to determine whether its stock price is under-priced or over-priced.

ii) Discounted Cash Flow: Discounted cash flow or DCF is a popular valuation method used by analysts. In this method, a growth rate of a corporation is first calculated. This growth rate and the corporation’s current cash flows are used to make future cash flow projections.

The net present value or NPV of the corporation is then deduced using the future cash flowing and discounting it back to the present using a discount rate.

iii) Multiples: In this method a corporation’s value is measured as a multiple of earnings or cash flows or revenues. In some case multiples of comparable companies’ values can be used. The actual value of the multiple is dependent on the industry.

For eg. a corporation’s value can be three times its annual revenue. Here three is the multiple used to calculate the value.