MRP of Stocks!

No More a Distant Dream...

An exclusive eBook that helps you to 'Take The Gamble out of Stock Investing'

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2010 MoneyWorks4me.com, All rights reserved

MRP of Stocks : No More a Distant Dream

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C h a p t e r

The Question That Stumped Me!

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THE QUESTION THAT STUMPED ME!

I honked the horn for the umpteenth time! Women!! How much time do they require to get ready!!??! It was one of those 'wonderful' days on which I had been persuaded (read emotionally blackmailed/pestered) by the missus to take her and my 7 year old son for shopping (Well, it was mostly her; my 7 year old's shopping consisted usually of just toys and chocolates). I thoroughly suffer these joint shopping sessions as do most men, I presume. Not only do you end up paying (un-willingly) for most of the stuff from your pocket but you also have to suffer the ordeal of roaming around hundreds of shops, carrying the large number of bags. And above all, you have to endure the never-ending arguments that she has with the shopkeepers about the clothes, especially their price. Now, believe me, I am not a sucker who would buy at any price that the shopkeeper demands. Infact, I am quite the haggler; so much that it could well be my middle name! But the missus is something out of this world! She makes me feel uncharacteristically extravagant, almost like I pay too much for anything and everything. Well, finally we got going and reached the nearby shopping mall. Surprisingly, my wife abandoned me and my son and decided to shop for some time on her own. She told me that she would call me once she was done and harped about how considerate she was for not making me roam around with her!I agreed immediately!
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THE QUESTION THAT STUMPED ME!

The day was turning out to be better than I thought. I decided to do some shopping of my own. I needed to buy some magazines and hence we walked into a book store. My son immediately ran to the toys and games section, while I looked around all the business magazines. He was back soon, having found some toy car that he had to have! Dad, I want to buy this car! he said. I was still engrossed in looking over the magazines and mumbled something about how he already had many toy cars at home. But Dad, all my friends have this car. It's the latest from the Hot Wheels series! Please, buy this for me na! I picked up the magazines I wanted and looked at him. It was going to be hard to convince him. Still, I tried. Have you checked its MRP? He turned it upside down to find where the MRP tag was. It's just 500 bucks! he finally answered. Just 500 bucks??!! Are you crazy? I couldn't believe my ears! Is it even worth that much? It's just plastic and metal. But Dad Listen son I began, before he could give any other reasons. Today, I am going to teach you something you will be thankful for, for the rest of your life.

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THE QUESTION THAT STUMPED ME!

Okay Dad, we won't buy the car. Please don't start lecturing! No!! Listen to me! Always, and I mean always, make sure that you check the MRP of anything you buy! And then make sure whether it is worth the price you are paying for it! I went on and on about how I always follow this principle whenever I buy anything. He pretended to listen but was visibly irritated, wishing I would stop! Nothing like a lecture to avoid spending on some toy car, I thought!! Suddenly, my cell-phone rang. It was my broker. My son took the opportunity to escape but soon returned with another toy in hand this time a robot! Meanwhile, my broker had news about some stock which was expected to surge in the next few days. Is it a good stock? I questioned him. Obviously! Have I ever recommended any bad stock to you? The quarterly results are going to be very good. The price will increase by atleast Rs. 15-20. The target is Rs. 150. Okay. And how much do you suggest I invest? Atleast a lakh of rupees. I am quite sure you'll get a decent return in a fortnight or so, and then you can pull your money out.

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THE QUESTION THAT STUMPED ME!

Okay. Sounds good! Buy it for me. I will send you the cheque. My son stood there, toy robot in hand and a smug look on his face. What? I asked him. What did you buy, dad? he questioned. Oh that! I bought a stock. Why? Did you check its MRP? You did not ask him, did you? And you always tell me to check??!! And is it worth the price you bought it for? It was his chance to get even. I was stumped for a moment. Here, I was trying to educate my son on how to understand the worth of anything and buy at the right price, but had myself just bought something blindly based on what my broker was telling me! Good!! You seem to have learned your lesson, Einstein. What do you want to buy now? I tried to divert the topic to the robot he wanted to buy. But somewhere, I realized he was right. I knew he was just getting back at me. The overt questioning of kids does get irritating most of the times, but this one really got me thinking. We never ask for the MRP of a stock, do we? Infact, I don't think we ever think about stocks having a MRP. But aren't stocks similar to any other thing we buy, the only difference being the value we get from these things.
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THE QUESTION THAT STUMPED ME!

We may buy vegetables for consumption, clothes because they make us look good whereas we buy stocks with the intention of getting good returns and making money. Almost every time, we check the price of everything and try to judge whether it is worth the price; everything except Stocks! The entire way back home I was lost in my thoughts. Only one question occupied my mind

Can We have a MRP for Stocks?

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The First Step Towards Finding The MRP

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THE FIRST STEP TOWARDS FINDING THE MRP

I HAD to find the answer to this question. And I knew just the person who could help me out. Rajiv Mehta! A college friend, Rajiv was the finance Guru of our batch. Infact, even the professors used to fear his questions sometimes! Post college, he had gotten into Investment banking and recently had started a web portal related to stock investing. I knew he was the man for the job and decided to pay him a visit on the weekend. Hey Rajiv, what's up? I greeted him, as he opened the door. It was good to see him after quite a few days. After exchanging the normal pleasantries and enquiring about our other friends from college, we got down to business. So, you said something about stocks and their price on the phone, right? asked Rajiv. I narrated him the entire incident that took place in the book store and how my 7 year kid had ignited my thought process to find the MRP of stocks. So, do you think it can be done, Rajiv? Hmmm sounds quite interesting you know. Actually, I think I do have a bit of an idea of how we can proceed with this. But Iguess we will have to read through some basic material first. Though, I was excited of getting a possible solution to the problem, his last sentence scared me! Coming from Rajiv, 'Reading some basic material' meant 'reading huge books with stuff that totally went above my head'. I bravely yet reluctantly agreed.

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THE FIRST STEP TOWARDS FINDING THE MRP

Immediately, Rajiv got 3-4 fat books (fatter than I had ever seen) from his study. He handed me one and started flipping through the pages of another book.

I would really like to say that I finished the entire book and found the solution but in reality, I dozed off after the first few pages. I woke up in some time only to see Rajiv had moved over to another book and was reading, unaware of my activities. I slowly picked up a Filmfare magazine lying nearby and started reading it. I was engrossed in reading gossip about Priyanka and Shahid when suddenly I heard the words, I think I got it! I looked up to see Rajiv beaming with satisfaction and joy; a look similar to the one he had when he had topped college. Hey, that's great!! I said. Tell me, how do we go about it? Yeah. Let's first understand how you invest in stocks. Rajiv got into lecturing mode!

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THE FIRST STEP TOWARDS FINDING THE MRP

Currently, you tend to go with the tips and recommendations of your brokers. Infact most of the people do this. But, this is almost like gambling with your stocks. You are just getting lured into buying and selling because your broker tells you to do it. He is telling you to buy it, because most of the other people are also doing the same. You are basically following the herd and buying stocks based on some short-term news. This can get you into deep trouble, my friend. I somehow remembered my childhood days when I used to listen to my dad lecture me when I did something wrong. Before buying a stock, he went on You need to first make sure that the company is a fundamentally strong company. Once you do that, the most important thing then is to know the worth of the stock. Let's call it, like you suggested, the MRP of the stock. It's very common sensical then, that like any other thing you buy, you never pay more than the MRP of the stock. It is the maximum price that you as an investor should be willing to pay for a stock. Understand? Yeah. Makes sense. But what is the basis to calculate this MRP? Yes, I am coming to that. There are many popular ways to calculate the right value of the stock -popularly termed as Intrinsic worth or fair value. Also, every model has its own basis for calculations Dividend discount model is based on dividends, Discounted cash flow is based on future cash flows etc. I got a bit apprehensive. This was starting to sound like a finance
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THE FIRST STEP TOWARDS FINDING THE MRP

lecture now. Thankfully, Rajiv kept the explanation very simple. But what we really need to do is, to look at the right value of a stock from the perspective of a common shareholder. I nodded my head in agreement.

Suppose, you have invested in a stock, keeping a long-term holding period in mind. As a shareholder, the current price of the stock is the investment you have made in the stock. What would be the ways you will earn returns on this investment? he quizzed me. Umm... I guess the returns I get is the price appreciation that happens in the stock. So, if I buy a stock for Rs. 50 and sell it for Rs. 100, my return is Rs. 50. I answered. Well, you are almost right. But there is another way in which you earn returns and that is through dividends. So to summarise, there are 2 ways in which you earn return while investing in stocks.
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THE FIRST STEP TOWARDS FINDING THE MRP

(a) Future Sell Price: The Price at which you sell the stock. Here, you will benefit if the stock price appreciates. (b) Future Dividends: Dividends which you will receive in future Rajiv, you could easily become a professor, you know! I joked. Yeah, I know. Now keep quiet and listen. he replied, sounding least interested in my comments. Now, let's understand how much returns you expect when you invest in stocks. What kind of a minimum rate of return are you expecting when you invest in stocks?, once again he questioned me! Let me think. I guess something like 12%-15% every year. I anyways make around 7%-8% by investing in fixed deposits. Around 10%-11% by investing in some corporate bonds. So, considering the additional risk involved in stock investing, I would say something like 12%-15% minimum., I replied. Yeah. Absolutely right. So, let's take it as a 15% return year on year, every year or as they say in finance a 15% compounded annual growth rate (CAGR), when you invest in stocks! I nodded. Now, suppose the MRP of a stock is Rs. 100 and you buy it at MRP. Assuming the 15% expected rate of return, what should the price of the stock be after 1 year? he asked. This was easy, Rs. 115. I said. Correct! And the price next year? I racked my brains and said, Around Rs. 132.
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THE FIRST STEP TOWARDS FINDING THE MRP

And, how did you find the second year price? Well, it's the basic compounding formula, isn't it? So, for the first year the price is 100 x (1.15) 1 , then the second year the price is 100 x (1.15) 2 and so on. Right. So, similarly after say 5 years, your stock price should be equal to something around Rs. 200. Now, suppose if you had the future price of your stock in your hand, could you calculate the MRP? Yeah. It is just reversing the equation. Instead of compounding, I just discount the future price at my expected rate of return i.e. 15%, right? Yup. So, if you knew that the future price of the stock is going to be Rs. 200 in 5 years. You can discount it at your expected rate of return of 15% for 5 years to arrive at the MRP. Obviously, we have not considered dividends here. If you include dividends, it is the Future Price plus the future dividends discounted at 15%. Got it? Yes. I replied. So to calculate MRP, I would need to know what my expected rate of return is let's keep it at 15% , the future price of the stock and the future dividends. So, the formula for calculating MRP becomes

MRP =

Future Price + Future Dividends (1 + Expected Rate of Return)

n

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THE FIRST STEP TOWARDS FINDING THE MRP

Crux of the Matter:

The intrinsic worth or MRP of a stock is the maximum price that you should pay for it. MRP depends on the price for which you can sell the stock in the future and the future dividends you earn. To arrive at it, we consider an expected rate of return of 15% and use it for discounting the future price and dividends.

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C h a p t e r

Understanding Earnings Capacity To Arrive At The MRP

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UNDERSTANDING EARNINGS CAPACITY TO ARRIVE AT THE MRP

Slowly, the things were starting to get clearer. One thing was for sure, we were slowly but steadily getting the method to find the MRP for the stocks. So, we know the expected rate of return which is 15% CAGR. Now, we need to know, how to calculate the future price and future dividends, right? I asked Rajiv. Yes. Now, the thing about stock markets is that they tend to behave erratically in the short term, right? You never know what is going to happen tomorrow. A new government gets elected Boom! It rises. The weather department forecasts less than normal rainfall for this season Bang! It crashes. To add to this Foreign Institutional Investors (FIIs) keep on pumping money in and out of our markets as they please, making us all the more confused about where the market is headed. Correct. In such a scenario trying to make a quick buck by investing in some hot stock usually leads to losses. Just last month, I lost betting on a stock which was supposed to go up due to reports of some new order but ultimately didn't. I told him about my tragedy.

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UNDERSTANDING EARNINGS CAPACITY TO ARRIVE AT THE MRP

Exactly!! The market tends to behave erratically over the short term but over the long term, it usually is correct about which stock is good and which is not. Like Benjamin Graham said, 'In the short term, the market acts like a voting machine while in the long term, it acts like a weighing machine. Dude, who is Benjamin Graham? He looked at me in disbelief. He is one of the Guru's of stock investing! The world's most renowned stock investor Warren Buffet regards him as his Guru. How do you not know him? He looked angry, but went on, Anyways, so what you need to understand is that you are going to make money only when the stock price goes up. The stock price is going to go up over the long term, consistently, only when the company performs well, consistently. Yes. Correct. And to judge whether the company will perform consistently, you need to get an idea about its capacity to earn profits, or from a shareholders perspective at what rate this company can grow its earnings i.e. EPS. So, the bottom-line is you have to ascertain the earnings capacity of the company to get an idea about its MRP. Yeah! So, the basis for the MRP is the earnings capacity of the company? I repeated. Right. To put it into perspective from a mathematical basis, the future price is equal to the future EPS multiplied by the P/E multiple that the stock will command in the future. You do know what P/E means, don't you?

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UNDERSTANDING EARNINGS CAPACITY TO ARRIVE AT THE MRP

Obviously. I attended a few of our lectures you know! I also look to always buy low P/E stocks whenever I can Now, that is not always a good thing you know, but we will talk about that some time later. So,

Future Price = Future EPS + Future PE

And to get to the future EPS we once again go back to our compounding equation. Suppose the current EPS or the TTM EPS as it is known is Rs. 10. Now, the key point here is to have an idea about the expected EPS growth rate for the company. So, suppose your expected EPS growth rate is 18% the EPS after say 5 years becomes around Rs.22

10 x (1.18) = Rs. 22
Yes, Got it. But how can you find the expected EPS growth rate? As far as I understand this is the key step here. As we discussed, it indicates the earnings capacity of the company which is the basis for finding the MRP. Right. he said. Now, the expected EPS growth rate depends on 2 things:

1) The prevailing market conditions i.e. whether the company is present in a growing or stagnant industry, the demand for the company's product/service

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UNDERSTANDING EARNINGS CAPACITY TO ARRIVE AT THE MRP

2) The company's own capability to grow and make the most of the opportunities in the market: This can be gauged by looking at its sales, earnings and book value growth rates in the past (yo-y and CAGR), its average return on equity(ROE), average return on invested capital (ROIC). Woah!! Seems pretty complicated! Actually, it isn't! But for the sake of not confusing you, let's not get into it for now. For the time being, just keep in your mind that there is a method (which is not complicated) to get a pretty good estimate of what the expected EPS growth rate will be, okay? Yeah! Thanks a lot! I smiled. So, using the compounding equation, we can calculate the Future EPS. Now, we need the future PE. As far as future PE is considered, one way is to look at the historical average PE that the stock has commanded. But look at minimum 6 years. So, you get a better estimate. Also, look at the PE commanded by other players in the industry. This will help you to narrow down on a figure. Rajiv, but aren't we predicting a lot of things here? I mean, the expected EPS growth rate is an estimate, the future PE is an estimate. We could turn out to be wrong, quite a lot! Yes, you are right. All these are estimates. Infact consider any method for that matter, predicting the value of a stock involves a lot of estimates. But remember we are not trying to predict how much the EPS will be in the next quarter.

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UNDERSTANDING EARNINGS CAPACITY TO ARRIVE AT THE MRP

Let's take an example which will make it very clear what I am saying. Did you watch the India versus Australia Test match? Yeah...I did. I answered getting a bit confused as to where Rajiv was heading. Okay. Now, can Tendulkar score in ODI you predict how many runs will Tendulkar score in his next inning or his next ODI? I thought for a moment. That's a tough one! I mean, it can be anything from 0 to 200, right? Very low chances of being right in predicting his exact score for the next match. Exactly!! said Rajiv getting excited. Now, can you predict how much will he score on an average in a series of 5 ODIs? I guess something like 50 odd based on his lifetime average. Going by his current form, he may well do better but I guess he will average atleast around 50 something. Good. Now you arrived at that figure by looking at his past record, right? Tendulkar's average stands somewhere around 5055. So you can be pretty certain that if you take a sufficiently long duration, he will tend to score similarly on an average. In a match he can get out on a duck due to an awesome delivery but that doesn't happen every day! 17
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UNDERSTANDING EARNINGS CAPACITY TO ARRIVE AT THE MRP

He will make up for it in the next match and the average will be close to 50. The same is the case with any fundamentally strong company. We do not try to estimate how much it will grow in the next quarter, but over a long term. Provided your company is a Tendulkar, the chances of you being right about its earnings capacity over the long term are very high. I was almost surprised by the analogy. It was so simple yet so correct. Over a long term the past performance and class did make a difference. Rajiv continued, Also, remember we are not trying to find the exact price here. We are trying to get a ball-park figure. A few bucks here and there are okay. Also, our estimates are based on analysis of past performance and future growth prospects. Definitely past performance cannot give a guarantee of future performance but it does give a pretty good idea about the future. It is also true, that nobody can predict the future accurately. That's why we also try to keep our estimates on the conservative side. You also took Tendulkar's average as 50 not 60 or 70 going by his current form. For a company, if it has managed to grow its earnings by 20% every year for the last 10 years, most probably this growth rate will slow down in the future as the company becomes larger. We can then consider something like 15%-17% as the growth rate. Also, later I will tell you another trick to ensure that your capital remains protected, in case your estimates turn out to be wrong. A trick given by none other than Benjamin Graham and Warren Buffett. Clear?

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UNDERSTANDING EARNINGS CAPACITY TO ARRIVE AT THE MRP

Crystal clear. I replied! So, once you know the future EPS and future P/E, calculating the future price becomes pretty easy. And once we know the future price, we have the MRP, right? Is that it? I asked getting excited, wondering whether we had completed our quest to find the MRP of a stock.

Crux of the Matter:

You need to ascertain the earnings capacity of the stock to arrive at its MRP. This earnings capacity measured through the expected EPS growth rate depends on the market conditions and the company's own ability to grow and make the most of the opportunities. The future selling price of a stock depends on the future EPS and the future PE that it will command. To estimate the EPS growth rate or the PE multiple we look at the historical performance of the company as well as analyse the future growth prospects. Past performance cannot give a guarantee of future performance, but it does give important clues for the future.

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C h a p t e r

THE FINISHING TOUCH TO MRP MARGIN OF SAFETY

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THE FINISHING TOUCH TO MRP - MARGIN OF SAFETY

Not yet. We still have to learn about future dividends. You forgot kya? said Rajiv. Oh! It almost went out of my mind. Yeah. So, how do we calculate the future dividends? Rajiv started explaining, A company will usually maintain the level of dividends that it has paid out in the past. Over a period of time as profits increase, it will increase this level gradually. We can consider the historical dividends paid per share as the base figure for calculating the future dividend. Okay. So, we take either the historical average or the current Dividend per Share (whichever gives a better picture) and grow it with the expected EPS growth rate to calculate future dividends. Can you explain this with an example? Yeah. Say company ABC has a face value of 10 and a dividend percentage of 30% for the current year. So, its current DPS is Rs. 3. Now, if you expect EPS to grow at a 20% CAGR then its dividend in the next year will be 3 x (1.20)1 = Rs. 3.6. Again, you keep on growing this for say, the next 4 years. Now, you have the dividend from Year 1 to Year 5. You add them to get the total of the future dividends paid. Easy, isn't it? So, in this case the future dividend component for the 1st year is Rs. 3.6, for the 2nd year is Rs. 4.3, for 3rd is Rs. 5.1 and so on;

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THE FINISHING TOUCH TO MRP - MARGIN OF SAFETY

in the 5th year it is Rs.7.5. And the number we want is the sum of these 5 numbers which comes out to around Rs. 27? I verified while entering the numbers in a calculator. Yup. Correct! So, we have the future price, we know the future dividends, and we can now calculate the future price. And then from our MRP formula and 15% expected rate of return we can arrive at the MRP. So, that's it then! I said getting excited. Almost. We still have a couple of important things to cover. said Rajiv shutting a few of the huge books. And, what are those? Remember, I mentioned to you that there is a trick to ensure that you do not lose your entire capital if your estimates do not turn out to be right or if the market behaves erratically? Oh...Yes! The trick given by our guru, Benjamin Graham, right? I said, noting the satisfaction on Rajiv's face that I had made Benjamin Graham Our Guru! Yeah. The trickrather the rule that he suggested is something we practice whenever we buy almost anything and everything, except stocks! Graham said 'Always buy a stock with a margin of safety i.e. at a discount to its intrinsic worth' in our case its MRP! I understood why Rajiv said 'we practice this whenever we buy anything'. We are constantly on the lookout for discounts!
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THE FINISHING TOUCH TO MRP - MARGIN OF SAFETY

We eagerly await a sale to shop for clothes; we bargain with the doodhwala bhaiyya to give us a lower rate for the milk and even with the vegetable seller to reduce the price of the onions and potatoes! But we never think of a discount on a stock, do we? So, what kind of a discount are we looking for exactly? I questioned understanding the importance of why we need to buy stocks at a discount? Ideally, we should be looking to buy at a discount of 50% to the MRP. Doing this will minimize your risk to a great extent and will protect us from the inherent volatility in the stock markets. Okay! But is it possible to do that? I was a bit apprehensive. I mean right at the start you mentioned that we should look for a fundamentally strong company, right? So, is it possible to get such a margin of safety for such good companies? Wouldn't these companies be the most widely tracked companies in the market? Yeah. You are right. But as I also said, the market behaves erratically in the short term. So, say a company or industry is facing some problems currently, the market tends to over react and the price of the stock drops considerably. Take the example of the telecom sector. In the last few months with the intense competition and price war going on, many telecom stocks dropped like anything!
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THE FINISHING TOUCH TO MRP - MARGIN OF SAFETY

True, that the industry is going through a tough phase! But which industry doesn't? The best companies survive and move on, stronger than before! But the market freaks out! And people start selling like anything! But this is the time to buy these companies; obviously, after doing a thorough analysis. I sadly remembered my broker advising me that I should sell a telecom stock I owned because the industry was doomed, which I did immediately. Even the market leaders were available at bargain prices some days back! said Rajiv. The trick thus is to buy when everyone else is selling and sell when everyone else is buying. Although this is easier said than done! Also, if you have a very strong company and you are okay with a lower discount, you can think of buying it when it is at, say, a 30%-35% discount! And keep in mind you can always find a diamond in the rough - a fundamentally strong company available at a 50% discount - because the market has not noticed it! But you have to be sure of it. Either way buying at a healthy discount will ensure that your risk is minimized. Got it? I agreed completely with Rajiv. As simple as it sounded, it made perfect sense!

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THE FINISHING TOUCH TO MRP - MARGIN OF SAFETY

Crux of the Matter:

Future Dividends can be found by growing the current dividend per share at the expected EPS growth rate. Once you find the MRP, make sure that you always look for a margin of safety i.e. a 50% discount on a stock's MRP. This will minimize your risk and protect you from the inherent volatility in the market. The market gives you many opportunities to buy fundamentally strong companies at a 50% discount to their MRP.

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C h a p t e r

Putting It Into Practice

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PUTTING IT INTO PRACTICE

Yes. But when do I sell it? I raised another doubt. Yes. That is one of the most important parts of investing, isn't it? If you do not sell your stock, you don't make any returns. So, the rule for selling is, if you buy a stock at a 50% discount to its MRP, you should sell it off, if it goes well above its MRP and you have made more than 20% CAGR? This confused me a bit. Isn't MRP the intrinsic worth or fair value of a stock? We also said that if we buy at MRP we can expect a 15% return year on year, every year? Yes. Correct. But keep in mind, if the stock's price goes well above its MRP or intrinsic worth, the upside left is minimal. Even if it goes still up, the price movement then is being determined by sentiments and not by fundamentals or earnings. Your risk then increases because you never know when it might reverse and start falling. And remember prices fall faster than they rise! So, if you have bought the stock at a 50% discount and have gotten your 20% CAGR, better get out. No point in being greedy. Keep the stock on your watchlist and when it falls below your MRP, you can think of re-entering the stock! But how 20% CAGR? It is simple. If we buy a stock at the MRP and it grows exactly as per our expectations, we can expect 15% returns. But because we buy it at a 50% discount to MRP and sell only when it crosses the MRP, we get more than 20% returns.
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PUTTING IT INTO PRACTICE

I slowly digested what Rajiv was saying. It seemed a bit confusing at first, but after taking some time to understand it, it was pretty easy. This is great Rajiv. It is making perfect sense. Atleast, now there is a way to be sure of what could be the worth of the stock! Yes. It is definitely a good method but before you start putting it into practice, you must also understand its benefits and shortcomings. So let's start with the benefits? What do you thing are the biggest benefits of this method? For me it is the simplicity of the method. It is not based on complicated formulae which nobody understands and which make it virtually impossible to understand how the value has been calculated. This method is simple to understand, logical and also very do-able! I answered confidently. The ease with which I had understood valuation, which I considered impossible to understand before, had really been a revelation. Yes. That is true. But remember, that it is almost impossible to find the exact worth of a stock, be it any method. What the MRP concept gives you is an estimate of the stock's worth based on rational expectations of returns and the earnings growth of the company. It's like you can never tell what's the exact weight of a person, but you can definitely say whether he is thin, fat or just right! So, don't be worried if you are off by a few bucks here and there! In the long term these small variations won't matter! Yeah. It is like, before I was walking in the dark completely unaware of what might lie in front of me.
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PUTTING IT INTO PRACTICE

With the MRP, I atleast have a flashlight which can help me find my way! I replied excitedly. But what are the shortcomings of the method? Yes. Coming to that, as I said, we would be better off putting in conservative estimates for the growth right? Yes, I replied. Rajiv responded, So, one disadvantage could be that your MRP figure could end up being on the conservative side. Also you tend to sell once the stock goes above the MRP and is fully priced. So, you may miss out on the rally which happens sometimes even if the stock is above MRP. But as I said, this rise will not be based on the earnings but on sentiments or news and hence you are better off not going for it. You would anyways be sitting on handsome profits. Also you can tweak the rule a bit, once you get better at using the method. Rajiv continued. So, if your stock crosses its MRP and is quoting considerably above the MRP, say 20% or more, you can definitely consider selling. However, if it has just crossed its MRP and is close to its full value, you can consider holding if you are still comfortable with the company and are sure that it still is a wonderful prospect for the future. Also, make sure you are not in need of funds or you do not have another strong company quoting at a great discount to its MRP. Clear? Yes. These seemed to be the intricate details that I needed to practice, once I got the hang of the method. But atleast, I now knew for sure, that I wasn't going to buy anything that my broker suggested, blindly. 26
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PUTTING IT INTO PRACTICE

Before I could thank Rajiv for everything, my cell phone rang. It was my broker. Speak of the devil!! Hello Sir, how are you? Relaxing on the weekend? he sounded cheerful than usual. I am fine. Aapne kaise yaad kiya Sunday ko?

What is the MRP of the Stock??

Sirjee, ek naya stock hain! Its quoting at Rs. 175. Great company. It is going to get a big order in the next week. Target 200 sure shot within the next 2 weeks. I called you first. Thought, it is an ideal stock for HNI like you. I looked up at Rajiv. He was looking at me, a bit bemused. I smiled at him and confidently asked my broker, Forget all that! First tell me

What Is The MRP Of The Stock??

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MoneyWorks4mes Checklist
Things to look for when you invest in a company:
1. Business which you understand 2. Strong Financial Performance (Look at NetSales, EPS, BVPS, ROIC, Debt to Net Profit ratio) 3. Sustainable Competitive Advantage (Brand, Patents / Secrets, Pricing power, Monopoly etc.) 4. Credible and Trustworthy Management 5. The Intrinsic worth i.e. MRP of the Stock 6. Whether the stock is available at a discount to the MRP
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