Quick assessment of a share

By Dr. Dietrich Meinert


Consider the following factors:

Gearing

This is the relationship between the company's own money and outside money, also called debt-equity ratio.

In calculating this ratio, one takes the figure for long-term liabilities, plus the figure for amounts due to bankers and short-term loans and other liabilities excluding deferred tax. The result of that figure is then expressed as a percentage of the interest of members of the company.

Gearing also shows the degree of flexibility of a company: If the gearing ratio is relatively low, then the group has borrowing facilities to finance opportunities that may arise from time to time.

A highly geared company will make more profits in good economic times, but if it is too geared and the economy turns down, there is a greater risk of a collapse.

A company that makes a long-term investment on short-term borrowed money is taking a large risk because the short-term lender can call in his money and leave the company holding the baby.

Turnover

Turnover figures should increase by no less than the inflation rate otherwise it reflects a danger signal in that it shows that business is going backwards in real terms.

Dividend yield & Earnings yield

However the most important indicators in the assessment of a share, are the Price/Earning (PE) ratios - or Earnings Yield (EY) - and the Dividend Yield (DY).

Bull and bear phases

During a bull run the PE is favoured and during a bear phase the DY becomes the "braking pedal" as it were.

The PE ratio is calculated by dividing the ruling price by the Earnings Per Share (EPS) or, alternatively, 100 divided by the EY of a share.

General guidelines to assess a share according to the PE or EY are:

PE EY

under 10 highly recommended 10 over

10 worthwhile 10

14 - 15 normal 6.7 - 7

over 15 expensive 6.7 under

Exception to the above guidelines are expandingeloping companies and, of course, mines.

A PE of, say, 6.8 means that if earnings were to remain static over the foreseeable future it would take nearly 7 years to repay your investment out of earnings.

The Dividend Yield (DY) of a share is calculated by dividing the dividends declared over the past year by the current share price * 100. It is an important measure of the shares value.

 

Dividend cover

However another interesting indicator is the Dividend Cover. Here one divides the dividend per share into the earnings per share - or EY divided by DY.

A high Dividend Cover gives confidence that the dividend can be maintained when there is a downturn in earnings. So, for example, a Dividend Cover of 2 or more can be regarded as a healthy figure.

 

Discount rate

Another strategy that could be considered when assessing a share is the Discount Rate. If the DY of a share stood at a discount of 20% to the 12-month interest rate offered by banks/building societies, on buying, that share should be regarded as fairly prices. To be on the safe side, 10-15% would be better.

As an example, just before the big crash in 1969, banks and building societies offered 6.5% for 12-month investment periods, whereas shares in the top class range only offered a DY of around 1.3% - a Discount Rate of 80%!

 

The formula to calculate the discount rate is:

100 - (DY divided by the 12-month interest rate * 100)

In hindsight it would have been prudent to bail out of such shares when the Discount Rate stood between 70 - 75%.

Overbought/Oversold

Last but not least, is to assess whether a share is Overbought or Oversold. A good way of doing this is to divide today's ruling price with that of 40 trading days ago and if the result is 0.8 or less, then the share is Oversold: if it 1,25 or more, then the share is Overbought. However it is recommended that this indicator should only be used as an additional point of interest.

Finally, long-term investors should select shares for purpose and thrust. Strictly avoid a mere collection of shares (even of the so-called 'blue chip' shares) and I strongly recommend investors to buy shares according to portfolio percentage range/ratios. I also advise investors to limit a portfolio to not more than 20 shares. Statistically it has been proven, that spread will cover all the general risks.

Stock Exchanges tend to move in cycles but irrespective of how circumspect one invests, no shares will escape the ravages during a crash! However, this does not mean that the shares one holds are necessarily "bad" shares and in time they should recover to new heights.

To decide when to buy or sell a share depends on timing and the best way to assess this, investors should use a share analysis program on their computer.

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