How I Value Nigerian Stocks With Earnings Per Share & 10-Year Bond Yield – This Short Term Trading Strategies Will Help You Find Undervalued Growth Stocks At Cheap Price
When it comes to stock investing, a lot of short-term traders make the mistake of buying stocks simply because the price is rising faster than the others. This method of stock trading will no doubt give you a quick return of 5-10% in a shorter time but can you absorb the downside risk? The same way the price rose faster, that is also how you will watch your portfolio lose its value faster with a bigger loss. One thing I discovered during my stock market investing journey was that just the way traders love to hold their winning stocks for a long time, they also find it difficult to sell a losing stock as they believed it will bounce back. But, you know what? this is the worst strap anyone can find himself.
This experience reminds me of how stuck I was in diamond bank’s shares, although I knew my mistake in that trade, no proper financial analysis to check whether I was buying at the peak price, after two (2) days, the stock fell by 16% but you know what? I wasn’t ready to let go due to the loss figure, it was high to let go. Anyway, I eventually sold the stock but here is the point, never buy a stock just because the price is rising, you may get trapped for a long.
This doesn’t mean that buying a fast-rising stock is bad, my point is it shouldn’t be the only reason, validate your pick first by learning how to pick the best-performing stocks, follow market news and determine their intrinsic value. I had already shared a detailed analysis of how I pick stocks to buy but the next key point is how to know what the stock is really worth. Understanding what a stock is really worth lets you to quickly see if the fast-moving price is an opportunity to buy more or stay off. The strategy isn’t 100% foolproof but it had helped me to screen stocks to avoid and wait for a pullback.
Let’s use Zenith bank, when I calculated the intrinsic value of the stock in 2017, I saw an opportunity to buy more units at N22 because the stock had an upside potential of 68%. Now, Zenith bank share is at N31.5 with another estimated 15% growth expected before I sell off. I will be sharing an analysis of this stock shortly.
Why should one bother about the intrinsic value of a stock before buying? The simple truth is, if you take just 5-10 minutes to estimate a stock’s value, you may not be 100% accurate but it will definitely help you know which stock has more upside potential than others. There are lots of stocks that were mispriced in the market due to massive sell-off, so due diligence is required to pick which stocks are fundamentally great but technically cheap.
Another reason is that I had bought shares in a company at peak prices and it was like the market was waiting for me before it fell by 13% in 2-3days; I didn’t know the stock was already overvalued but was carried away by the straight three weekly gain recorded, now imagine that I had estimated the value of such stock and timed my entry? it would have helped me avoid the stock and wait for a pullback.
When you buy a growth stock that is selling below the estimated value, you have a higher chance of making more money in the market.
My next question is, how do I estimate a stock’s value? I am not going to bore you with complex calculations since we are not investing for a long-term, but show you how I adopt the warren buffet approach to valuing a stock using the 10-year bond yield, a formula that uncovered Zenith bank, and UBA shares, my biggest stable portfolio winners so far.
My idea of valuation as a short-term trader hinges on finding an estimated price range of stock, then compare with the actual market price and find a perfect gap to leverage on. My advice is this, avoid stocks that are 5%-10% below or above their estimated value because of a margin of safety; you are calculating an estimated value so don’t buy when what you arrived at a figure already close to the market price.
Here is how & why warren buffet uses 10-year government bond yield:
If an investor decides to leave a risk-free investment like 10-year government bond for a riskier asset, it is wise not to accept a return that is lesser so he decided to use the yield as a basis for calculating the price he would pay for the asset. The big opportunities arose when he discovered stocks that sell below their estimated value due to temporary sell-offs and market news.
Recall that I mentioned Zenith Bank shares, here is how I picked the stock: The bank had an EPS of 4.11k and will release its full-year result soon. It is expected that latest EPS figure will stand at N5, the question is how much should I pay for the bank’s share to justify an EPS of N5? using the Nigerian government bond yield figure of 13%; the rate of return on a risk-free asset, I will divide the EPS figure by this risk-free rate which gives me N38 (N5/0.13).
As at when I estimated this bank’s stock again, the market price still sits at N31per share which presents a further 15% upside potential. I had first valued the stock when it was selling for N22.
One thing you must know when valuing a stock as a short-term trader is that the yield on government bond reflects the current economic risk. The yield tends to rise when economic risks are extreme; this is evident in the average FGN bond yield in 2017; the 10-year bond yield reached a high of 18% as economic risk from falling oil prices, higher exchange rate value and rising inflation worsened. The government uses this high-level yield offers to lure local and foreign investors looking for fixed income investment opportunities.
But, as oil price surges to the north, the yield nosedived to a 4 year low of 13% as the government borrowed less from domestic lenders and issued more Eurobond at a lower rate.
The real effect of economic risk is that, when it is high, bond yield follows to compensate risk takers which eventually affect stocks value as analyst re-price their portfolio holdings.
I can even relate this to our local stocks, as the yield on long-term securities fell to a 4-year low of 13% from an all-time high of 18%, re-valuing securities using their expected EPS gives rise to a high estimated value lower than the market price.
Let’s look at the EPS figure of some selected stocks and their current market price.
Using my simple method of valuing stock as a short-term trader looking for a consistent 15-25% upside potential in 1-3 months, let us look at each of the stocks’ estimated value (our current 10-year bond yield is 13%):
- Dangote Cement: N104 (13.53/0.13)
- GTBank: N37 (4/0.13)
- Nigerian Breweries: N31 (4.05/0.13)
- Zenith Bank: N39 (5.09/0.13)
- Stanbic IBTC: N33 (4.34/0,13)
- Wapco: N86 (11.27/0.13)
- UBA: N17 (2.28/0.13)
Now let’s also look at the current market price of these listed equities:
So what did you see from these simple metrics? For me, I see Zenith Bank, Wapco and UBA as potential picks. The reason is simple, they currently trade below their fair value when you divide their EPS figures by 10-year FGN bond yield at 13%. Please note that I didn’t say best stocks to buy, I used the term potential because one, two or all may not be the best pick as you would have to check their growth rate. A stock is cheap for a reason, so make sure the fundamentals are great before buying.
You may ask, does it mean other stocks are not a good buy? No! but I feel that buying growth stocks that trade below their fair value increases your chance of making more money than buying at a higher price per share.
The year to date performance of Zenith, Wapco and UBA are 22%, 16.51% and 15.53% respectively, which isn’t a bad return in 7 weeks.
It still doesn’t mean that GTBank, Stanbic IBTC, Dangote Cements are not a good buy, but your decision to buy depends on a popular growth metrics called PEG.
PEG means price earnings to growth rate. a simple way to check whether a stock EPS growth rate in 3-years will continually support the upside potential. It also shows whether a price is far higher than what you should pay.
Let’s look at Nigerian Breweries, the share price is already at an all-time high of N128, a price-earnings ratio of 31 that reveals what investors perceptions about the stock are; they are willing to pay 31 times the current value. The question is does the company has an EPS growth to support and justify that expectation?
This next snapshot of the company’s five-year financial statement has a lot to reveal:
This is the summary of the Nigerian Breweries financials from 2013-2016:
- profit after tax fell from N43b to N28b in 3 years.
- EPS, our main figure, also fell from N5.63 to N3.53 representing 31% decline in profit attributed to shareholders.
I really do not expect anyone to buy this stock except there was an additional information that could turn the company around, besides, a look at the weekly chart below reveals that investors have been selling their shares in the company. The company might have reported a disappointing quarterly result that led to this drastic fall.
I used Nigerian Breweries stock to let you know that before buying a stock at a price higher than the fair value, confirm that the expected growth rate outweighs the price-earnings ratio. As a rule of thumb, your price earnings to growth result shouldn’t exceed 1 if you must take the risk.
The strategy to valuing stock that I shared here works well when a company is close to releasing her full-year audited result or have already released its interim result for the half year; you can then use your intuition to estimate its full EPS figure.
On 10-year FGN bond yield, check BusinessDay Nigeria for latest figure.
As of this writing, Zenith Bank, and UBA stocks are part of my equity portfolio.