Question

Short Essay,

Explain how rational investors value assets (i.e., what factors they consider when pricing stocks, bonds, and other assets). Provide examples and other evidence to support your answer.  

Answer 1

Factors which rational Investors consider when valuing stock.

1. Debt to equity should be less 1.
2. Interest coverage Ratio should be more than 3.
3. P.E ratio is less than twice of the last three years average EPS growth rate.(valuation purposes)
4. Last three years average Return on Equity (ROE) and Return on Capital Employed (ROCE) both are greater than 20%.
5. Promoters pledge less than 10% of their total shareholdings, or there is a clear indication that it will fall below 10% soon. (better if it is NIL).
6. Last three years CAGR sales growth rate is more than 10%.
7. Last three years CAGR profit growth rate is more than 12%. I.e EPS Growth.
8. There must be High ROE & low P/B value Ratio. P/B below 3 is acceptable. It's it sector specific. Like that of Auto sectors is different from IT sectors(intangible assets).
9. operational and free cash flow per share for past three years are positive.

Also consider the Current Assets/ Current liabilities ratio (Current Ratio) more than 1-2.

See the Share holding pattern. If promoters share holding & Institutional shareholding increases then it is a good sign.

For Example:

Tata Elxsi/Indian Company/Listed in NSE, BSE.

Current Market Price: ₹ 775-800/-

Last 5 years
Average ROE= 35%
Average ROCE= 54%
CAGR sales growth= 12%
Average EBITA margin= 22%
Average PAT margin= 13%
CAGR EPS Growth rate = 25%
Debt to Equity Ratio =0 (Zero Debt Company)
Interest coverage Ratio of above 300.
FCF per share= 31.49 (31.3.2018)
EPS = 46.40 (TTM)
P/B value= 6.5 (IT sector Company)

Share holding pattern:
Shareholding pattern of Promoters in past 9 quarters same.
No pledged Shares.

The Tata Elxsi share had an excellent growth of 160% in past 5 years from ₹303 to ₹790. As it satisfies the above fundamental analysis.