4:59 pm

พอดีเพิ่งเคยเห็นใน paper ของ J.P.M ครับ จึงเกิดความสงสัยว่ามันมายังไง

Implied Value of Growth = 1 - Earning Yield / Cost of Equity

ไม่เคยเห็นในตำราเล่มใดเลย รบกวนผู้รู้ช่วยตอบทีครับ

10:15 am

August 18, 2009

ผมเจอนี่ครับตัวแปรคล้าย ๆ กัน สมการต่างกันนิดหน่อย

**Implied Growth Rate = Cost of Equity (Discount Rate) – Earnings Yield of the stock**.

http://www.marketphilosopher.c.....stock.html

**Tuesday, September 20, 2011**

** The simplistic way of spotting an undervalued stock for a common investor **

**Whatever is the norm, the SECRET sometimes lies in thinking about its reverse**

The scientific way to find an undervalued stock is to estimate its future cash flows and discounting them (at the rate of Cost of Equity) to arrive at their present value (fair value) to see whether the Current Market Price (CMP) of the stock is overvalued or under valued relative to its fair value. This is nothing but the Discounted Cash Flow Analysis (DCF)). But there is an easier way for an ordinary investor.

The SECRET lies in doing the reverse engineering of the DCF – i.e. ascertaining the Implied Growth Rate (IGR) in earnings that the current market price of the stock is factoring in. That is, finding out at what rate its current earnings/cashflows have to grow in future till perpetuity to justify the current market price. If the implied growth rate is lower than what you think it should realistically be, then the stock is undervalued. If the implied growth rate is higher than what the stock is truly capable of, then the stock is overvalued. If the implied growth rate is negative, then the stock is severely undervalued and you should look to buy among such stocks. Shares of most Indian State Owned Banks and Tata Motors are currently pricing in negative implied growth rates. In my opinion they are attractive buys. The key assumption here is that the earnings and cashflows are the same.

**IMPLIED GROWTH RATE (IGR) IS THE MANTRA**

I believe that the Implied Growth Rate (IGR) in earnings till perpetuity is the most simple and effective tool available to common retail investors to determine whether a stock is overvalued or undervalued. **Of course, it is rather an oversimplistic way of looking at things and can be theoretically challenged on several counts but it does give a bird's eye view of what growth expectation the current market price of a stock is factoring in and help the common retail investor in taking a decision to benefit from serious mispricing, if any, in the market place either in times of panic or euphoria as the case may be.**

The formula is:

**Implied Growth Rate = Cost of Equity (Discount Rate) – Earnings Yield of the stock**.

The assumption here is that earnings are the same as Cash flows. This may only be true for debt free Companies in sectors such as IT, Consumers, 2-wheelers and Car manufacturers like Maruti Suzuki which generate free cash flows on a secular basis. It may also be true for Banks though they have to retain the earnings to shore up the Capital Adequacy Ratio. However, the assumption may not work for several manufacturing Cos which have debt to be repaid or capital expenditure to be incurred (to sustain future growth) and hence such Cos will most certainly command a lower implied growth relatively speaking. Also, the assumption of uniform Cost of Equity for all Companies can also be challenged**.**

**Cost of Equity (Discount Rate)**: the yield on risk-free 10-year Government bond + Equity Risk Premium (the excess return over the yield on the risk free Govt. bond that is sought by investors to compensate for the risk of investing in equities). In India the Cost of Equity is normally 13% (8% being the average 10-year Govt. Bond yield and 5% being equity risk premium).

**Earnings Yield:** Earnings per Share (EPS)/Current Market Price of the Stock (CMP). (Actually, Earnings Yield is nothing but the inverse of the Price Earnings Ratio (PER) which is CMP/EPS. Higher the Earnings Yield, lower is the PER).

Example:

Let us assume, the CMP of a stock is Rs.60, and its EPS (net profit/number of shares outstanding) is Rs. 3. Its earnings yield would be 5% ((3/60)*100) and the PER is 20 (60/3). Assuming the Cost of Equity or Discount Rate to be 13%, the Implied Growth Rate in earnings that the Current Market Price of the stock is factoring in is 8% (13-5).

In the above example, if the EPS of the stock is Rs. 7.80, its earnings yield would be 13% ((7.8/60)*100) and the PER would be 7.69 (60/7.80) and the Implied Growth Rate in Earnings would be 0 (13-13). Here, the Cost of Equity and the Earnings Yield are the same (13%) corresponding to a PER of 7.69X. Which also means that stocks that have an earnings yield of more than 13% (or PER of less than 7.69X) are pricing in negative Implied Growth Rate or de-growth in earnings till perpetuity (see below).

On the other hand, if the same stock had an EPS of Rs. 9, its earnings yield would be 15% ((9/60)*100) and the PER would be 6.67X (60/9) Since the Discount Rate is 13%, the Implied Growth rate would be -2% (13-15).

If the current market price assumes an implied growth rate in earnings which is more than what the company can realistically produce, then the conclusion is that the stock is overvalued. Whenever there is a bullish frenzy in the market, the implied growth rate tends to be excessively high. Stocks that are pricing in relatively high Implied Growth Rate in earnings carry responsibility to deliver the expectations and are prone to disappointments (of course the market may choose to accord high Implied Growth rates to dynamic companies that have high quality of management, competitive advantage and secular growth businesses or to those whose current base is small base but the addressable market huge or those in early stages of business cycle).

On the other hand if the current market price of a stock assumes an implied growth rate in earnings which is less than what the company can realistically produce, then the conclusion is that the stock is undervalued. Whenever there is pessimism in the market place, the implied growth rate tends to be low. A zero implied growth rate or negative implied growth (de-growth) is normally a sign of extreme fear/pessimism in the market place or excessive undervaluation. Such stocks are more likely to deliver pleasant surprises. (The exception here is metals/commodities whose earnings can be extremely volatile due to cyclicality of the metal/commodity prices).

It always makes sense to buy stocks that are pricing in low/negative implied growth rate, and sell stocks that have high implied growth rate.

Flaws with the above analysis:

The major flaw is the assumption that EPS and Cashflows are the same, which will not be the case for all the Companies. . Also, the assumption of uniform Cost of Equity for all Companies can also be questioned (Certaintly, one can use differential Cost of Equity rates for different Cos/Sectors depending on individual cases).

However, it must be noted here that we are not trying to arrive at the fair value of a stock. We are only trying to find out what implied growth rate in earnings till perpetuity the CMP of the stock is pricing in as it will give us an idea regarding the extent of pessimism/euphoria built in the stock prices**. **This information does help the investor in taking a decision to benefit from serious mispricing, if any, in the market place either in times of panic or euphoria as the case may be.

Of course, sophisticated investors may go deep and calculate the implied growth rate in free cashflows (instead of earnings).

**Conclusion:** Stocks that have an earnings yield which is equal to or higher than the Cost of Equity are pricing in zero or negative Implied Growth and are more likely undervalued. In other words, stocks that are trading at a PER of 1/Cost of Equity or below are undervalued. In the case of India the Cost of Equity is 13% and hence stocks that have an earnings yield of 13% or above (or trading at PER of 7.69X ((1/13)X100) or below) are likely undervalued. Investors must look to buy among such stocks.

**In other words, an earnings yield of 13% or PER of 7.69X (1/13) should be ordinarily the floor valuation for a stock. Shares of most Indian State Owned Banks and Tata Motors (TTMT IN) are currently offering an earnings yield of more than 13% (PER of less than 7.69 and hence trading below the floor rate) and appear to be severely undervalued.**

Of course, the implied growth rate analysis only works effectively for secular/quasi secular growth Cos (e.g IT, Banks, Auto, Consumer, Pharma and Telecom) and not necessarily for Commodity stocks as their earnings are/can be highly volatile.

**Analogy - Philosophically speaking: **

Religiousness for an Investor is nothing but DCF consciousness.

Ego for a stock is nothing but Implied Growth Rate in Earnings till perpetuity that is factored in the current Stock Price.

Higher the Stock price, higher is the Implied Growth Rate and higher the responsibility for the stock to deliver the grow expectations = Higher the Ego.

Lower the Stock Price, lower is the Implied Growth Rate = Lower the ego.

Negative Implied Growth Rate = Absence of Ego = State of Godliness or Nirvana = Severe Undervaluation. You should look to buy such stocks because you are tempted to say “Tujhme Rab Dikhta Hai” (I can see God in you) to the stock.

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