Corporate earnings drive the market. It’s that simple. While short-term
factors, such as the influx of money into the market, or even shocking or tragic
events, can have an effect over the short term, ultimately, it is earnings that
drive a company’s stock price. Understanding this fundamental principle can help
you make long term investment decisions. Peter Lynch, The Fundamentals of
Investing.
Although we are about to talk on technical investing (also called speculation), I still used the above quote to make a point. The point is: in the long run those who invest in the long term do better in average percentage terms than those who speculate (unless you control a huge amount of funds AND can pull off a coup like Soros did). Usually it is not as straight forward as that, but I seem to follow a simple rule; if you have a lot of money to invest, invest fundamentally (In the long term). But if what you have is relatively small, horn your speculating skills.
Truth is; it is a lot easier to speculate in the Nigerian Stock Exchange than many other places in the world. Nigerians are very emotional people, and when it comes to money, they are hysterical! Buying cheap and selling astronomically is very common on the NSE.
I leave the reader to determine what a lot of money is and what it’s not. Like I said earlier, it is a relative thing.
1. Impressive Quarterly Earnings Relative to Current Price
The earnings per share (EPS) of a company is a derived figure that plays a very important role when speculating in the Nigerian Stock Exchange. Indeed, a lot of people have made money just by paying attention to this figure alone. Some Nigerian stock “specialists”, such as Hope Eno, even consider the EPS of a company the fundamental basis of speculating. Though the EPS of a company does not paint the entire picture of the company’s financials, over half of the time it gives an approximate guide; just enough to speculate at least in the Nigerian Stock Exchange for now. However, it is worthy to note that knowing the present earnings per share is NO substitute for indebt perusal of a company’s financials which gives a broader margin of safety.
Comparative Analysis: Over time, experience has taught me that for greater percentages of the time, prices compete on the NSE by comparative analysis. What this simply means is that; in speculating the movement of a share price, one usually just needs to compare derived figures such as the EPS with that of other companies preferably in the same industry. An example would be more illustrative:
Earlier in the year (February 4) I was running through the stock listing page in Stocks Watch magazine when I noticed an amazing difference in price between Ekocorp and Evans Medical. Ekocorp was selling at N1.92 while Evans Medical was at N6.83; a whooping 256% difference. Now this is the shocker: they had the same third quarter earnings at 0.34! This was a no-brainer! Any one can predict that the share price of Ekocorp will eventually try a match up with Evans Medical, all other things been equal. Although this is not always the case, it turned out to be true. Ekocorp went on up to sell at an all time high of N6.78 and by the week ended April 27, it sold at N6.11!
Is it really that Simple? In the NSE it could be that simple save for a little more watchfulness. In the example above, it would pay a little better if you knew what was driving the price of the reference company, in this case, Evans Medical. If there are no positive news (to be discussed later) that might have caused an increased interest in the stock of Evans Medical that would increase demand and subsequently drive the price, you might have found yourself a winner as was the case above.
How to Calculate the EPS of A Company: The calculation of the EPS of a company is pretty easy. It is given simply as:
------------------- (divided by) --------------------
Total Number of shares held by shareholders
Therefore, for a company like Dangote Sugar Refinery Plc, whose annual report I have in my hands now, with a Profit after tax of N16,657,066,000 and total number of shares held by shareholders of 10,000,000,000, its EPS is simply given by:
-------- (divided by) --------
10,000,000,000
Advantages of Learning to Use the EPS of A Company
1. It gives you an idea of when to get in and when to get out. E.g. in my example above, Ekocorp didn’t go up 256% in an unbroken run, occasionally it fell short of expectation before moving up again. However with the price of Evans Medical to guide you, you could sleep easy knowing it hasn’t achieved its full potential. Note that it is always better to sell (speculatively/technically) before the stock achieves its “full potential.” This is because at that point a lot of other speculators will like to sell too. This causes a glut, excess supply, thus driving down the price.
2. With results being released quarterly and various companies having different year ends, the opportunities for positive speculation are bountiful.
Knowledge of both the EPS and year ends of various companies provides a powerful tool for the speculator in the Nigerian Stock Exchange. In the corporate world, companies have the liberty to choose their year ends e.g. Wema bank plc has its in March, Guinness has its in June and PZ industries has its in May. Hold that in mind. Quarterly results are results released every quarter i.e. every 3months (a quarter of 12months/1year). Thus the random year ends of various companies means results (thus EPS) are released almost every month. This creates a dynamic market for speculators (read opportunities).
3. After the release of the 1st and 2nd quarter results of a company, the EPS gives you the opportunity to take position in the medium term if the outlook gives a good sign. An example will be more illustrative: Recently UBA released its 2nd quarter results and the EPS was derived to be N1.20 (its share price is held at N37.99). Now, Zenith with a 3rd quarter EPS of N1.64 is selling at over N45.00. (Does this give an idea of where UBA will be in coming months?). UBA needs to add an EPS of 0.44 to its present N1.20 to match up Zenith in earnings. You can BET* UBA will do better than that. Considering its 1st quarter EPS of N0.63, 0.44 is a piece of cake under present circumstances. So if it’s going to match up in earnings then why not in price?
As an exercise consider the 3rd EPS of Intercontinental Bank Plc against that of Guaranty Trust Bank at this date. What do you find?
4. You could tell when the company is overpriced.
Yes, by comparing the price of a company against that of other companies with similar EPS, you could get an idea of when the company is busting the “Price fabric” at the seams. In clear terms; when the company’s price is over that of its peers.
Interested in knowing more about EPS and related ratios? You could begin your research by reading the articles in the EntrepreNoir’s Library. Remember the bottom line given by Peter Lynch: … ultimately, it is earnings that drive a company’s stock price.
The BET* here shows a certain degree of risk. Invest at your discretion. Every thing written here is for educational purposes only. The writer will take no responsibility for loss of resources as a result of the utilization of the information on this page
Awaken the EntrepreNoir Within; promoting financial literacy one article at a time.
