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Recent public issues have not been able to maintain their issue price in the secondary market. Expolanka, the most recent issue which was priced at Rs 14 has fallen to as low as Rs 12 odd. Hydro-Power Free Lanka (HPFL) which was issued at Rs 15 is trading at Rs 13 odd. Free Lanka Capital Holdings which was priced at Rs 5 is now trading at Rs 4/50.The market price of Union Bank issued at Rs 25 is falling close to it. Why is this so? I think it is because the companies issuing these shares have overpriced them. They have failed to take into account that investors have alternative sources of investment like government bonds which yield over 8% and fixed Deposits which give 10-11%.
Accountants value the companies using the Net Asset Value and the Earnings Per Share. Suppose a company’s net worth is say Rs 10 million and the company’s profit after tax is Rs 1 million and the prospective investor (not a trader who wants to make a quick buck by buying and selling in the secondary market in a short time) wants 9% return per year. How should it be priced? The dividend yields are very low being about 2%. So how can he get 9% unless the share is properly priced to give him such a return? This will depend on the issue price. How can the issue price enable an investor to earn 9%. Accountants pricing new issues go on the Net Asset Value of the company. They seem to take into account the market’s price to book value where the company’s worth is taken as its net asset value times the Price to Book Value. Of course in the case of Take-over’s & Mergers since the controlling interest is acquired it is usual to value the company at 2-3 times its net asset value. But this is for special circumstances and is not applicable for a minority share holder who buys only a few thousand shares.
Company Accountants also use the past earnings per share to value the company. But there is no guarantee that future earnings growth will be the same as the past. There is the risk that it may not be so and hence any earnings growth assumed should be discounted for the Risk factor at least using the variance of past earnings. Also how many years’ earnings should be taken into account? The future is so uncertain that even 10 years may not be a certain economic life for a business. Investors in government bonds don’t buy long term bonds exceeding 5 years. So the maximum period that should be taken into account is perhaps 10 years. If we use the Price Earnings ratio for valuation then I think a PE ratio of 10 is about the most that will enable the investor to make a return of 9%.
Consider the example given here where the company is worth Rs 10 million and earns Rs 1 million profits after tax. Then if the company’s share is priced at Rs 10 it will give a return of 9% for 11 million ( net asset value plus one year’s future earnings) divided by 1million will give a return of 9%. To generalize I think the company valuation should be on the basis of its current net asset value plus earnings for x number of years discounted for both a risk factor and the interest rate. I think recent issues have been priced at market PERs and market Price to Book Values.
Accountants value the companies using the Net Asset Value and the Earnings Per Share. Suppose a company’s net worth is say Rs 10 million and the company’s profit after tax is Rs 1 million and the prospective investor (not a trader who wants to make a quick buck by buying and selling in the secondary market in a short time) wants 9% return per year. How should it be priced? The dividend yields are very low being about 2%. So how can he get 9% unless the share is properly priced to give him such a return? This will depend on the issue price. How can the issue price enable an investor to earn 9%. Accountants pricing new issues go on the Net Asset Value of the company. They seem to take into account the market’s price to book value where the company’s worth is taken as its net asset value times the Price to Book Value. Of course in the case of Take-over’s & Mergers since the controlling interest is acquired it is usual to value the company at 2-3 times its net asset value. But this is for special circumstances and is not applicable for a minority share holder who buys only a few thousand shares.
Company Accountants also use the past earnings per share to value the company. But there is no guarantee that future earnings growth will be the same as the past. There is the risk that it may not be so and hence any earnings growth assumed should be discounted for the Risk factor at least using the variance of past earnings. Also how many years’ earnings should be taken into account? The future is so uncertain that even 10 years may not be a certain economic life for a business. Investors in government bonds don’t buy long term bonds exceeding 5 years. So the maximum period that should be taken into account is perhaps 10 years. If we use the Price Earnings ratio for valuation then I think a PE ratio of 10 is about the most that will enable the investor to make a return of 9%.
Consider the example given here where the company is worth Rs 10 million and earns Rs 1 million profits after tax. Then if the company’s share is priced at Rs 10 it will give a return of 9% for 11 million ( net asset value plus one year’s future earnings) divided by 1million will give a return of 9%. To generalize I think the company valuation should be on the basis of its current net asset value plus earnings for x number of years discounted for both a risk factor and the interest rate. I think recent issues have been priced at market PERs and market Price to Book Values.
