As engineers we keep ourselves too busy (and occupied) in creating something useful and valuable for the society and the world at large, while we see people earn insane amounts of money by in and buying shares of the same companies where people like us word hard to make it profitable and innovative. Sure, we get our salary, awards and satisfaction (and hopefully some ESOP), however, we should not lack in financial knowledge, especially the technical analysis, that is required to know which stock is valuable (at current level) and may invest some loose change (or certain amount that is anyways not going to be touched given our simple, busy as well as productive lifestyles) for the future-self and hedge some of our job volatility.

Stocks 101

First, however, we have to understand some jargon (to avoid getting overwhelmed later) and get it it out of the way. It is extremely simple for us in Engineering and Technical fields (graduating with Mathematics and Physics etc) because we understand the core concepts and build our understanding instead of just cramming stuff in our brains.
What is/are:

  • Securities: Investments that can be traded in a secondary market (stocks/bonds etc).
    • Equity securities: Shares of a company or of a Mutual Fund (traded on Stock Exchanges).
      • IPO: When company sells stock for the first time (Initial Public Offering)
    • securities: Loans (Bonds) made to an entity (evaluated by rating agencies).
      • Corporate Bond: Loan to a company
      • Sovereign Bond: Loan to a country
        • AAA vs Junk Bonds: of bonds ranging from safest to most risky.
    • Derivative securities: Exercising/Trading/Betting on the value without buying underlying stock/bond/asset (by paying some small fee) and has various sub-categories like Margin Trading, Futures Contracts, Asset-based, Auction-rate and many crisis relate to this category you can read about if you want.

Instead of buying a company (because not many can afford that), you can by a part of a company (invest in a ) by considering its fundamentals (the important financial ratios, described later) are strong and then:

  • Let it passively grow in value over a long term
    • You do this (by investing some amount you can risk) while you work on your Engineering projects. Your projects are actually the work due to which such companies grow in value through innovation, satisfying customer needs and contributing positively to the society.
  • Actively trade it in the market
    • You don’t do this. As you understand it is mostly a brain-wrecking continuous looking at a trading-terminal (during which time you could have actually produced something of value) and is also a positive-feedback loop which can go in either direction without any regard due to market dynamics and herd mentality of traders (you can make it work for your benefit, btw). You also know this is a zero-sum game such that when you make a profit, someone/somewhere has to have made a loss (or vice-versa most of the times). However, based on your time horizon and risk, you can sometime use this method if you are confident.
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Ratios and basic valuation method

Here I depict and go through with you to get you up to speed in no more than 1-hour with the compressed tutorial of stock valuation. By the time you go through this, you would be ready with your own excel-sheet where you can feed in some inputs (company numbers) and get the output (valuation) to take an informed data-driven decision.
Stock valuation and Technical Analysis
You can ask me to send you this excel sheet, of use the following formulae:

Stock

Column A: Company Name
Column B: Current Share Price

Earnings

Column C: Earnings per share (Get from Quarterly / Yearly Report)
Column D: PE ratio (Column B / Column C) should be upto 15
Column E: Intrinsic EPS (Column C * 15)

Assets

Column F: Book Value per share (Get from Quarterly / Yearly Report)
Column G: P2BV ratio (Column B / Column F) should be upto 1.5
Column H: Intrinsic BVS (Column F * 1.5)

Value of Stock

Column I: Value of Stock (Column D * Column G) should be upto 22.5
Column J: Minimum Intrinsic Value (Lesser of Column E or Column H)
Column K: Valuation % ((Column J – Column B)/Column J) * 100

Decision

Now, looking at the numbers in the columns:

  • If “K” is highly -ve, the stock is trading at a much higher rate than its intrinsic value. Should probably stay away from buying at this time & rate until super confident on the further future growth and risk.
  • If “K” is positive (or slightly negative) it is usually priced below its real value and probably a good time to get into this stock after going through other health-checks and revenues of the company.
  • If “K” is highly positive, it is suspicious why the other traders are not buying this stock even when it is available at a good rate. Is there something wrong with the management, political climate, market/sales dropping or any other disruptions. Be very cautious and study further to get confidence about the company.
  • Same is true with “E” and “H”. Instead of looking at -ve, here you compare the value with the current market price (“B”). If either one of them is higher, it means the stock has enough intrinsic value (either in assets or in profits) and can be a good to buy and keep long-term. “J” is just a minimum of “E” and “H”.
  • Values in “D” and “G” you can check if these are lesser than 15 and 1.5, it is a good value for money. It basically means the share price is no more than 15 times the profits or 1.5 times the assets, either one or both to be valuable.
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This was just to get some idea of the scalar number (stock price) and have a method/model to find its intrinsic value. As you know, a stock priced at 500 is no better or worse than one priced at 150. It is the % change that matters, so a Rs 500 stock going to Rs 1000 would double your investment, while a Rs 150 stock going to Rs 300 would also give you the same returns. The above excel tries to bring in “some” evaluation of the stock price Rs 500 or Rs 150, and give some confidence about the “current” value the stock being over-priced or under-priced. Based on that you can take a decision to invest in that particular company or not and based on your time-horizon and risk profile.

Important considerations

  • Healthy Balance-sheet
    • Check Assets, Liabilities, Shareholder equity
    • Check leverage (borrowings should be low)
    • Working (Current assets – current liabilities) should be low
  • Strong return-ratio
  • Robust cash-flow
  • According to Dr Vijay Malik
    • Self-sustainable growth rate (SSGR) and Free Cash Flow (FCF)
    • Good Management taking not against minority share holder
    • Good return on capital (to fund operation, expenses and pay investors)

Khandelwal analogy

  • Balance-sheet = Engine
  • Profit/Loss statement = Dashboard
  • Cash-flow = Fuel
  • Management = Driver
  • Competition = Traffic
  • Business = Car

I will keep you posted (if you subscribe to this ) as I detail the Financila Ratios and explain the chart above. See you soon!

Dig further before buying/committing

  • What is the company business
  • How does it make money
  • Is there any outstanding dilution
  • The debt-to-equity and other ratios
  • What is its return-on-equity
  • Expected earnings-per-share for 5-10 years (future)
  • Current earning yield vs Treasury yield and growth rate
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Where does the money go in a market crash

https://www.quora.com/Who-gains-the-billions-lost-in-a-stock-market-crash-Where-does-the-money-from-the-pension-funds-go
Note: I am an and this is purely based on what I am exploring. You can comment with any suggestions.


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