Monday, November 07, 2005

Why look and why not look at EPS?

Earnings per share (EPS) is a critical element of share valuation. Most investors use a modified approach to EPS by measuring it with respect to the CMP of the scrip (P/E ratio). EPS and P/E together account for an estimation of the "TIME required" for the stock to reach the current market price of the stock.

E.g. SCI (Shipping Corporation of India) is valued at 151 rupees a share and has an EPS of 50 rupees. In time, the total earnings over the next 3 years should be equal to 150 rupees (ceterus paribus). In such a situation, examining the EPS is crucial. This has to be looked at in the light of the change in pricing of products of the company (a lowering of price without a corresponding decrease in cost will decrease profits and hence value added to the company books), change in competitive scenario, change in management, change in strategy etc.

Look at change in strategy. State Bank of India has realised the pressures of competition and is looking at all products in a very professional way. Their foray into assets with differentitated products is amazing and so is the span of products they are providing. They are not challenging private banks, but are trying to rake in more market share from "other" nationalised banks like Central Bank of India, Indian Overseas Bank, Bank of India etc.

Now lets examine the Grahamian prophecy of "not" evaluating the earnings per share. Graham feels that predicting the earings of the company i svery difficult and not prudent as it is guided by the whims and fancies of the management. Graham lived in a time when corporate governance was a nothing and majority owners used to treat companies as proprietorships, whose assets and resources could be used for one's own advantage. Graham didn't believe that people are honest enough to allow enough profits for disbursements to public (or people were more dishonest than honest. Remember the blog on "Conservatism and Suspicions"). Understand that Graham also lived through a major depression.

E.g. GTL Limited has 72 rupees in cash and is availbale at 107 rupees. Now that's intrinsic value. The EPS of GTL is however very very low.

A strong EPS was a bonus for Graham but a strong NCA was the clincher.

I personally have a stronger allegiance to NCA rather than EPS as the cushion provided by value intrinsic in a company is higher than that in the days to come. As they say, "a bird in hand is better than two in the bush"


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