Saturday, October 25, 2008

NSE Update- price earnings ratio

Here is a thought. An asset bubble occurs when assets are valued way above their true value normally via lending. However, contained within the asset bubble, maybe an actual rise in value of the asset due to tangible improvements in the assets’ value. Take a house. The price of a house may rise because a general house price rise. Interest rates are low; banks are therefore offering cheap mortgages with high income multiples leading to huge uptake and therefore great demand that can be matched by new buildings. The price of a house can also rise because of improvements for example conversion of the garage into an additional room, addition of a swimming pool etc.

Once the bubble bursts, assets reveal their true value. The question is which of these two value are true for the NSE index shares. If the true value is the one we are seeing today, we are in a bad spot. However, I am more inclined to think that most companies' true P/Es are in the middle somewhere anchored by the growth in their profitability. The question then moves on as to whether in the face of a global slowdown (shrunk markets for our products, lower remittances, more expensive imports), their profitability will be sustainable in '09 and 2010.

Bottomline: Based on the above ,I predict that the NSE won't touch 5,000 before June 2009.


Ssembonge said...

Maina, NSE just broke through 4000 resistance. It will be a while before we see the 2006 IPO mania that drove the index past 5000. Investor apathy means that the downward trend will persist for a while.

bankelele said...

stock prices are based on companies who will sort themselves, and work to improve earnings (they can't control the NSE price)

but can we start payng attention to the real estate bubble here?

Maishinski said...

My take:
P/E is just one of many indicators...

Remember P/E is based on historical earnings; as they say, "Past performance should not be taken to imply or guarantee future performance".

Be sure the fundamentals haven't changed. Perhaps another reason for a focused, agressive but well-researched portfolio?

That is, of course, if you have the time, skills and sizeable risk appetite.

MainaT said...

Got you ssem. Thats why commented we'd have a U-curve with an l-shape type of recovery at the NSE.
Banks-stock prices are based on companies. some of the time. Real estate post coming up next month.
Maishinki-I could have used a fwd p/e; and many other factors, but the historic p/e is still the key signal in most markets.

Maishinski said...

@mainaT... Noted.

hmmm... If I understand correctly, a forward P/E extrapolates historical growth into the future.. right?

There's no substitute for rollin up the sleeves and analyzing financial statements, business plan, products, strategy, technical indicators, investor sentiment, industry developments, economic indicators etc...

Finally, I try to ask myself 2 questions: How to tell that my projection starting point is rock-solid in the first place? How do I know that last year's earnings were not a result of "Creative Accounting" techniques?

Companies don't just crumble overnight - yet people don't read the "notes" when going through financial statements. What were analysts saying about Bear Sterns/ Enron etc...

MainaT said...

Maishinski- My post was effectively about liquidity :-)
A formal reply coming up.