Page 180 - DCOM507_STOCK_MARKET_OPERATIONS

Unit 9: Fundamental Analysis 3: Company Analysis

to know outcomes indifferent situations. It answers the question – what happens to the Notes
outcome, if one or more variables influencing it change?
All that is to be done is to set up the formulae

Sales × Margin (%)
For example, EPS =
No. of shares outstanding
MPS = EPS × P/E

Now, data relating to variables viz., Sales, profit margin, number of shares outstanding
and P/E ratio are generated along with their probability distributions as in the case of
decision tree.
The formula is applied to compute MPS under varying conditions. Computer programming
will help analyse security values rapidly and accurately.
Self Assessment

State whether the following statements are true or false:
5. The false economic value or extrinsic value of a share of common stock, like the value of
bond or other assets, is equal to the present value of all cash flows from the asset.

6. The decision tree of security analysis ends with sale.
7. Trend analysis is a time series analysis that prohibits identification of seasonal, cyclical
and erratic fluctuations of the variables under consideration over a time period.

9.3 Determining Earnings – Multiplier (P/E) Ratio

So far, the focus has been on determining Earnings Per Shares (EPS). This is to be translated into
market price per share (MPS). As such, most of the fundamental security analysis work centres
on determining the appropriate multiplier.
Research Findings: Bing carried out a survey of practitioners’ stocks evaluation methods and
found that several approaches were in vogue. He found that analysts (1) used time horizon from
1 to 3 years and (2) preferred to use several techniques in combinations. Seventy-five per cent of
the analysts followed rules of thumb to normalize P/E ratios.

1. They compared current actual P/E with what they considered normal for the stock in
question.
2. They compared price times estimated future earnings (1 to 3 years out) with what they
considered normal for the stock in questions.
3. They compared the multiplier and growth or earnings of individual stocks with industry
group multiple and earnings growth.
With and Kisor based on their study of a number of stocks, opined that differences in P/Es
between stocks were due to projected earnings growth, expected dividend payout, and variation
in rate of earnings growth or growth risk. Bower and Bower came up with similar conclusion.
They divided risk into marketability of stock, price variability, and conformity with market
behaviour. Malkiel and Cragg found positive effect of earnings growth on P/E. They further
found that dividend payout effect was not clear.

LOVELY PROFESSIONAL UNIVERSITY 175