Stock market correction is not new phenomena. The economy moves in the cycle as so is stocks markets. There are always pick and trough formation in both economy and the stock market. Here is the incidence that accommodated me with the idea about stock market correction.
Nowadays you know most us are online and we keep connected through social media. Be it Facebook, LinkedIn, WhatsApp or whatever. There are good things and there are not so good things about social media. It’s up to us how we use it. Please don’t get confused. I’m not here to discuss this.
Actually, we have a stock market WhatsApp group with all our college friends, few are in Bangalore, others working different parts of India and the rest of the world. One fine day one of our friend sent a message in the group with the image of some fund, said “Do not invest in mutual funds as PE value is very high, the market is overvalued. Refrain from investing in mutual funds now. Wait for PE value to come down”.
This message has created the negative vibe in the group and one of other friend said, “Wondering if it’s beginning of 2008-09 like correction?”
In fact, these messages triggered me to write this article to clarify a few aspects of PE ratio, stock market correction, and investments strategy.
What does PE ratio indicate in the stock market?
Let’s first understand what is the meaning of PE (Price to Earnings) ratio? In simple words, PE is the price what I pay for an asset, which has the potential of future earnings.
Let me clarify with an example. Suppose a situation in which the HR of a company does many rounds of interview and hires a candidate for the position. Let’s assume they fix a salary of INR 80000 as the monthly remuneration for that candidate.
From the organization point of view, the organization’s expectation is to earn INR 5-6 lakh equivalent productivity from the candidate month on month basis. If the candidate is doing a productivity of INR 2-3 lakh per month, then his/her PE is high. However, if the candidate is executing a productivity of INR 7-8 lakh, then it is low PE.
For the organization under consideration, the low PE employee is a good investment. Similar is the case when you come to the stock market for investing in shares of the company. Thus, the P/E ratio can be calculated as Market Value per Share/Earnings per Share
How to calculate the PE ratio of a share?
Let us consider another example, now from two auto companies, say it Maruti and Mahindra and Mahindra. Maruti share price is INR 8000 per share and earning per share (EPS) is INR 255. Whereas, Mahindra and Mahindra share price is INR 893 and EPS is INR 36. Let us now calculate the PE value of both the Indian stocks.
Maruti PE = 8000/255 = 31.37, and
Mahindra & Mahindra PE = 893/36 = 24.8
Is stocks with low PE good for investment?
With the above example we learned that Mahindra PE is low, so we can invest in this stocks. How do we know that it’s a low PE? For this, we need to compare the stocks PE with the PE of industry under which that company operates.
The current auto Industry PE is 28.60 (as on 25th Sep 2018). Hence Mahindra stock PE is lower than Industry PE and easy to decide. But wait, is PE only the deciding factor to buy a stock or invest in mutual fund?
There are many other important ratios’ which we need to consider. Similarly, if you want to find two/ three pharma companies like Cipla, Sun Pharma, you need to select pharma industry PE.
What other factors do you need to check in stocks during the stock market correction?
Let’s go back to the example of the hiring process. Does HR decide the candidate’s remuneration package only on technical expertise? Of course, not. It’s based on so many other key factors, like the candidate’s experience, communication, presentation skills, behavior, attitude, problem-solving ability, and team building/managing skills and so on.
Similarly, PE is one important aspect among the so many factors for making the investment decision. Few of them I list below for your reference, that you must consider during any stock market correction phase –
- Reserves and liabilities of the company
- Book value per share
- Dividend Yield
- Return on net worth
- PEG ratio.
Why you must consider investing in mutual funds and not any single shares?
Technically these ratios will help one to make investment decisions. But practically does common investor has time to go through all these ratios? Most of them find it difficult. Again I will take an example of the hiring process, technically when you hire a candidate through the interview process, you felt the candidate is suitable for this position. But its right only when practically he fulfills the requirement.
What the organization does to fulfill a project or work. It builds a team, a group of employees suited for the objective. Fulfilling the objective is more important for the organization, rather than who will contribute or who not? The team will consist many staffs who usually complement with each other. Some will be very disciplined, they follow all the compliance. Someone is good at creating an innovative idea. Others will be good at building a team.
As a team, they can accomplish a project in a stipulated time. The Team manager/ project lead’s job is to build such a team and monitor the project and performance.
Similarly, when it comes to investment, the investment objective is more important. The time periods in which we want to reach our financial goals are important. That’s why it’s better to invest mutual funds with the collective group of stocks, across many sectors which will complement with each other and help us to reach financial goals. The financial advisor’s job is to build a portfolio of funds, suitable for investors goals, regularly monitor and do the changes if required.
Stock market correction – what it ought to mean to an investor?
And coming to stock market correction. Corrections, in general, are common, in our day to day life be it profession or business, corrections will take at some point in time. Markets are also not different. In fact, corrections do provide us with higher growth. Don’t worry about stock market corrections. Take a help of the good Financial advisor who will educate investors throughout the investment journey and helps you to fulfill your dreams and goals.
Thank you for reading this blog. For any questions and discussion, you can connect me through MoneyDial.
Disclaimer: – The purpose of this blog is educating investors. I don’t recommend any investments. For doing investments please do consult authenticated advisors. Mutual funds are subject to market risk, please read the offer document carefully before investing.