The simplest way to get a read on investor’s expectations of a business is to look at its Price to Earnings Ratio (PE Ratio).
The price-to-earnings ratio indicates the rupee amount an investor can expect to invest in a company in order to receive one rupee of that company’s earnings.
A high P/E implies that investors have high expectations of what a company can achieve compared to a company with a low P/E ratio.
Let’s examine this for 3 companies that all saw a substantial rise in stock prices, last year in 2019.
Avadh Sugar & Energy
Avadh Sugar & Energy shares had a really impressive year in 2019, the stock was up 54%. Sugar stocks were trading in the positive zone in December last year. Indian sugar mills had produced 77.95 lakh tonnes of sugar till December 2019, which was 30 percent less compared to the sugar production of 111.72 lakh tonnes during the same period of the previous year.
But we could tell from its P/E ratio of 4.87 that sentiment around Avadh Sugar & Energy wasn’t particularly high. We can see in the image below that the average P/E (13.5) for companies in the food industry is higher than Avadh Sugar & Energy’s P/E.
While the EPS (Earnings per share) growth last year was strong, the significant debt levels reduced the number of options available to management. The low P/E ratio suggests the relative market expectations were muted, implying this level of growth will not continue.
Read more here and here
Tanla Solutions saw a substantial rise in share price last year. The stock hit a record high of Rs 76.45 on 28th June 2019.
The IT software products firm launched Trubloq, the world’s first blockchain-enabled commercial communications stack, on February 26, 2019 to comply with the new Telecom Regulatory Authority of India (Trai) regulation. It tied up with six Telecom operators’ viz., Airtel, Vodafone Idea, BSNL, Videocon, MTNL & Tata to launch Trubloq.
P/E was 23.4 which was above average (16.2) in the IN market.
Falling earnings per share were probably keeping traditional value investors away, but the net cash position means that the company had time to improve, and the high P/E suggests the market thinks it will.
Read more here and here
Vera Synthetic had a massive gain of 170% in 2019!
The company P/E of 43.78 indicates some degree of optimism towards the stock. You can see in the image below that the average P/E (10.0) for companies in the luxury industry is a lot lower than Vera Synthetic’s P/E.
Vera Synthetic’s P/E tells us that market participants think the company would perform better than its industry peers, going forward. Shareholders are clearly optimistic, but the future is always uncertain.
Vera Synthetic saw earnings per share decreased by 3.2% in 2019. But it has grown its earnings per share by 25% per year over the last five years. Vera Synthetic’s P/E was 43.8 which is way above average (13.0) in its market.
The recent drop in earnings per share might keep value investors away, but the net cash position means the company has time to improve, and the high P/E suggests the market thinks it will.
Momentum, Value, Growth, and Volatility are traditional factors that affect performance. As an example of each, PE is a factor used to identify value, the 3-month price change for momentum, EPS growth for growth, and the standard deviation of price change for volatility. However, the factor-based investing is based on research which is 30-50 years old.
There are newer ways to deliver returns and we focus on using alternate data to find such upstream indicators and measure them closer to the source. Can you measure retail footfall by counting cars in the parking lot from satellite images? Can you calculate crude shipments by measuring the sinking depth of oil containers on the sea? These are some of the new age questions data science is solving for us.
Moreover, value is a reflection of what is valuable. There is nothing absolute about it. Value is siphoned away from incumbents to innovators. In this pipe, the customer benefits. Using the traditional balance sheet ratios as a way of finding value is decades old and might not work when the creation and destruction of value are happening through innovation instead of competition. With our research, we heavily use our own alternate data to find indicators of value which is not balance sheet based but we aim to measure exactly where value is being created.
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