In the last article, we used Price Earnings Growth (PEG) ratio to identify reasonably valued companies. Moving forward, once a target company is identified, a smart investor should judge its future growth by estimating its EPS growth and also evaluate its business outlook. Read on to learn easy work steps to accomplish this.
Let’s first start with growth estimate. For educational purpose, we have selected EPS data for previous six quarters for four companies (see table).
Divi’s Lab’s (API pharma) and Sportking India (cotton textile) have strong quarterly EPS, growth making them attractive. Asian Paints (paints) has reported strong year on year growth. From this data, it is possible to guesstimate next 12 month EPS. A quick 12-month forward EPS for Sportking would be Rs 216 (Rs 59 and Rs 49)*2) and for Divi’s forward EPS can be assessed at Rs 84 (Rs 21 *4). This simple estimate represents strong EPS growth over previous 12-month periods. Companies in strong growth can be easily identified from result announcements. For ease of reference, an algorithm-generated list of such strong performers is also available at Equitylevers Finance Lab.
The second task of assessing business outlook can be daunting for the uninitiated. But since we have already established that Asian Paints, Divi’s and Sportking are attractive from a PEG and growth perspective, we mainly need to ensure that there is no negative news for the company or sector which can stall its strong growth. This is easier than learning everything about a company. A quick Google search should bring out negative news very quickly for most companies.
For Divi’s, you will read a lot of positive news about their API business and for Asian Paints the company management provides news updates on continuing strong growth. Notably, material negative news will be almost negligible. Sportking is a small company and not well-researched, but we will have already noted that its growth trend is very strong and its valuation (PE at 12 times and PEG at 0.005) is cheap. This by itself is very attractive for investors to jump in.
From Sportking annual report, you can learn that its textiles businesses are in a sweet spot due to strong exports and due to problems in alternative cotton-producing regions like Uighur in China. As confirmation, each of these three companies has shown strong price performance on the back of their earnings growth. Markets adjust to opportunities very fast and it is sensible to buy into these companies as soon as first evidence of growth and positive reasons are established. In the next article, we will focus more on data patterns that help pick winners.
Badri Narayanan
badri@equitylevers.com
Equity investor and Founder, Equitylevers Finance Lab