All high EPS stocks are good for investing? Not really. But if the same high EPS stock, also exhibit low PE ratio and high EPS growth rate, then it becomes interesting, right? Read more about low PE stocks here…
Investors looking at EPS alone is not so useful. But looking at the historical EPS growth rates (in last 3/5/10/15 years) is more useful.
Out of my four important value indicator of stocks, EPS growth rate is perhaps the most important.
In this blog post I will share a list of high EPS stocks, with their PE ratio and EPS growth rates.
But before that lets get some basics refreshed about price valuation of stock using ratios.
It is not easy to value stocks.
In this article we will see four easy to use value indicators of stocks.
These four value indicators in isolation may not be very effective.
But all these four value indicators in coalition becomes very effective. My personal favourite is EPS growth rate.
Value Indicator #1 – Book Value Ratio
Indicator to use to analyze price valuation of companies with respect to it book value is PB ratio.
This shall be the starting point of stock valuation for investors.
Step-1: In order to get a feel that whether a stock is overvalued or undervalued, try to look at its Price to Book Value ratio (P/B).
As a rule of thumb, P/B ratio of less than 1.5 is considered good.
First step us to list down stocks (top 500 in terms of market cap) and then indicate their P/B.
Screen out all stocks that that P/B ratio of more than 1.5.
The balance list of stocks that remains shall be interesting for you.
This screening acts as first filter. It removes those stocks whose market price is possibly overvalued.
Please remember that after application of this filter, the list will not be any more exhaustive.
It filters out nearly 50% of all overvalued shares. Now the balance 50% shall be screened as following.
It is important to understand why P/B ratio is such an important value indicator that it should be applied in step 1.
This value indicator is mainly used by defensive investors.
P/B ratio gives a hint that, at time of companies liquidation (worst time), whether the stock has potential to return at least the part of the shareholders invested money.
Liquidation is a moment in a company where all companies assets are sold in the market to generate funds to pay back dues of the creditors.
Paying back dues primarily means, debt repayment and payment to preferential shareholders.
When a company is declared bankrupt, its assets are valued and sold in the open market to generate funds.
After paying back all the creditors, if some money is left, then it is distributed among common shareholders.
These generated funds will be used to pay its creditors. How?
See this formula:
Total Assets = Book Value + Debt.
When all assets of companies are sold, it is assumed that, the generated fund will be good enough to pay back all its debt. Plus, there will be some surplus.
This surplus will be equal to the book value.
In the backdrop of liquidation, what P/B says about stock valuation?
When P/B ratio is too high, the money received by shareholders after liquidation will be very low in yield.
Step-2: For defensive investors, it become again more important to look at the company’s debt levels.
As a rule of thumb, debt/equity ratio of less than 1 is considered good.
High value of debts means, in moments of liquidation, most portion of generated funds will be used to pay back the debts.
Less will remain to be distributed among shareholders.
Further screening of stocks in terms of debt/equity level is also essential.
Value Indicator #2 – Companies Profit:
Indicator to use to analyze price valuation of companies with respect to it profits is PE ratio.
The importance of use of P/E ratio is two folds. By using P/E ratio investors can compare two different companies.
This comparison gives an idea about which stock is overvalued as compared to the other.
So step-3 in this value analysis will be to mark P/E ratio of screened stocks (step-1 & step-2).
The lower the value of P/E the better.
As a rule of thumb, P/E ratio of less than 15 is considered good.
Is is also important for investors to compare the P/E of one company with other companies in the same sector.
If suppose your company X has P/E ratio of 10 and other companies of its sector has P/E ratio 18, it means that X is undervalued.
But the difference of 10 and 18 is very alarming.
In this case investors must immediately look at the Sales growth rate and EPS growth rate of company X (for at least last five years).
If Sales and EPS has been decreasing since 5 years it clearly hints that the company is losing its market hold.
This can be one reason why X has such low P/E ratio.
But if it sales and EPS growth is positive, then X will be truly undervalued.
Value Indicator #3 – Profit Growth
Indicator to use to analyze price valuation of companies with respect to it profits growth potential is PEG ratio.
In step-3 we discussed why it is important to look at EPS growth rates of companies.
Step-4: EPS growth rate is the most useful value indicator available with investors.
But EPS growth rate alone does give us an idea of whether stock is overvalued or undervalued.
This is the reason why EPS growth rate is used in conjunction with P/E ratios.
What EPS growth rate does is to justify the P/E ratio levels. What does it mean?
As a rule of thumb, we know that P/E ratio of 15 is acceptable. But even P/E ratio of 15 needs to be justified.
This justification will come from EPS growth rate.
The capability of the company to increase its EPS year after year makes it less susceptible to risk.
Hence investors pay higher price to buy this stock.
Suppose a stock has P/E multiple of 15. Its EPS growth history is as below:
|Annualized EPS growth rate since 2007 to 2011 is 15% per annum|
- P/E ratio of this share is 15 and
- EPS growth rate if 15%.
The ratio of P/E ratio and EPS growth rate is 15/15=1.
The ratio of PE with EPS growth rate is called as PEG ratio.
As a rule of thumb, PEG ratio of less than 1.0 is considered good.
The ratio of 1.0 means that, even if the P/E multiple of a stock is as higher than 15, still higher EPS growth rate compensates for the risk taken by investors.
Investors can pay high price for stocks if they have a feeling that the value of the company is going to grow fast in future.
There is no better indicator like EPS growth rate that can justify high P/E ratio.
Value Indicator #4 – Dividend History
Indicator to use to analyze price valuation of companies with respect to it dividend is PEG ratio.
Step-5: This is my personal favourite.
There can be no better value indicator that dividend yield.
Dividends is the actual cash earning investors make by investing in shares.
If a stock that we are buying is paying you healthy returns as dividends then nothing like it.
Suppose I bought a stock at $10 per share which pays me annual dividend of $1 per share.
It means I am making 10% annum return from dividend alone.
In this case why I will care about risky capital appreciation.
If the fundamentals of a company is very strong, then dividend income can be very predictable.
In simplified words, ‘buying stocks of companies at market price which yields dividends over 4.5% can be considered as a good buy’.
These four value indicators of stocks works as a magic formulae if considered in combination.
In isolation they are helpful but will not give a complete picture.
These are quick value indicators that can for sure give you some quick insights about stocks that you want to buy in a flash.
I know some may say that if this is so easy then why everyone is not using this trick?
Let me tell you that not many stocks will be available in the market satisfying all these four value parameters.
So timing the market becomes more critical than these calculation itself.
Investors are asked to wait like a hawk to track the movement of price that make them the most preferable stocks in terms of the above discussed four parameters
High EPS stock with their PE & EPS Growth rates
|4||Info Edge (India)||21,780.64||16.54||108.02||176.06||38.08|
|5||Jubilant Life Sciences||12,428.71||52.27||15.00||137.40||33.90|
|8||Tata Power Co.||17,716.27||13.03||5.01||145.28||95.22|
|14||PNB Housing Fin||15,055.15||61.64||14.60||38.70||21.85|
|16||Bharat Financial Inclu||13,125.32||61.97||15.02||30.06||26.12|
|25||Wabco India Ltd.||12,328.93||166.23||40.12||31.25||15.84|