IF you are going to play poker you must know the math to help determine the odds that make the winning hand. For the stock market, you need the factors that will determine the price of an issue.
Stock market analysis experts call the process the “price discovery.” This is a matter of looking at the variables that determine what is a good price. By The Book, “Buyers and sellers arrive at a transaction price for a specific asset at a given time.”
However, the idea that there is some sort of supply/demand factor based on—from The Book—“numbers of buyers and sellers, size of the orders, liquidity and valuation perceptions” does not entirely hold up.
Look at it this way. Walk into the t-shirt section at SM department store. You will probably find 500 shirts in your size. You could buy enough that you could wear a new t-shirt every Saturday for the next 10 years. Assume an average price of P300 and while P150,000 is real money, it is not like a choice between a “lifetime” supply of t-shirts and a new car. From your view as a consumer, there is virtually an unlimited supply.
Based on the idea of supply and demand pricing, P300 might seem a little high.
But SM could be selling 1,000 t-shirts a day. True, but they sell those shirts one by one just as shares are in the stock market. Stock pricing comes down to one person hitting the “buy” or “sell” button just like one person buying a t-shirt.
Having an unlimited supply of t-shirts, SM sets the price based on whether people are buying the product, the same way a seller of stocks will raise or lower the price depending on the buying interest.
Stock market investors go through mental gymnastics to get to the point of “valuation perceptions” as to whether the stock price is “worth it.” Using all the various fundamental analysis valuations, they conclude that the price is too high-avoid-or too low-buy and buy now.
The price-to-earnings ratio or PER is most popular as it values the company’s profits in terms of stock price. In simple terms, it is how many years of earnings to equal the current stock price. A PER of “15” means the company will take 15 years of earnings per share to equal the current stock price.
Here are some examples of PER at the end of 2017: SM Investments-36, Jollibee-38, Ayala Corp.-22 and Ayala Land-26. Which has the best “value”? Then you should look at earnings growth.
But the reality is that the Japanese stock market went from a PER of 20 and was still going strong when the PER hit 80. It topped out at 120. We see local issues that have not made any money for a decade and then deliver profit for two years selling at a PER of 600 with the stock price up 300 percent for 2018.
The rational is that there are positive expectations for the future. Of course, it often comes down to: “If it is the third telco” or “If the government allows casinos.”
Remember those SM t-shirts? All different quality, all different styles, and many different prices. So you decide based on how good your barkada think you will look in the shirt you finally buy.
You can do all the number crunching you want—and you should—just like you did with that t-shirt. But as with the shirt looking good, it comes down to answering one question: Which stock will I be able to sell to someone at a higher price in the future?
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E-mail me at mangun@gmail.com. Visit my web site at www.mangunonmarkets.com. Follow me on Twitter @mangunonmarkets. PSE stock-market information and technical analysis tools provided by the COL Financial Group Inc.