Should you buy those shares you've got your eye on?

“What shares are cheap currently?”

“The share is cheap now; the price is only R100!”

“Surely one can’t buy that share now, it’s up almost R50 for the year!”

These are some of the comments/questions we are faced with from the public while golf, flying or just chatting at a restaurant. The answer to all these types of questions are far more complicated than one would think.

Below we look at the methods to value a share.

Operating Profit Margin is an important ratio in valuing a share. The measures how much profit is being made by the core business of a company. Total revenue less direct costs give operating profit which is then divided into revenue as a percentage. This model excludes indirect costs such as Tax, Interest and other non-direct costs.

This is then compared against previous year’s results and competitors to see how well a company is converting revenue to profit.

PE Ratio

There are many, many ratios available, but perhaps the most famous is Price-Earnings (PE) Ratio. This is simply the share price divided by earnings per share (EPS).

Example: A share trading at R100 with an EPS of R10 would have a PE of 10 and this means at current earnings it would take 10 years to pay of the share price with current earnings.The Price-Earnings Growth (PEG) Ratio is the PE divided by expected EPS growth in the following year.

By this measure, we can realise if the current PE is expensive or not due to the potential growth in said company. 

Another famous ratio is Dividend Yield. Should a company decide to pay some of its profit to shareholders through the form of a dividend. Example: a company with a share price of R100 pays a R2 dividend, this would be a Dividend yield of 2%.

A higher yield does not necessarily mean a cheaper or better company as some company as some growing companies prefer to rather reinvest profits in their growth.

Assets and Liabilities

Investors need to review Income Statement along with Company’s Assets and Liabilities to understand the company’s financial position. All may look good with profitability, earnings growth, PE, PEG and dividend yield but if it has too much debt and at financial risk this could mean a poor investment.

Important aspects in this regard are Debt to Equity Ratio which is a company’s interest-bearing debt less cash as a percentage of Equity. The Current Ratio is very useful as it measures current assets (convertible into cash in less than 12 months) against current liabilities (payable in 12 months or less).

Price to Book Ratio which is a company’s total assets minus tangible assets and liabilities. If a company is being traded below its book value, it can possibly be considered good value.

The above is certainly extensive and is not the total basis on which an investment decision is to be made, it merely offers an example into the complicated answer to the easy question. “Should I buy X share?”  

• Brett Johan Birkenstock is an analyst and director at Overberg Asset Management, an authorised financial service provider (No 783).

Disclaimer: The above article does not constitute financial advice and is not a recommendation. Investors must always seek the advice of professionals and trade with caution. Under the ECT Act and to the fullest extent possible under the applicable law, Fin24 disclaims all responsibility or liability for any damages whatsoever resulting from the use of this site in any manner.