ASSESSING STOCKS VIA FINANCIAL PERFORMANCE METRICS

Before investing in stocks, it is of the utmost importance to understand the financial performance metrics of a company. I share here a glance at such important indicators in an intuitive manner, based on information collected and collated online.

Suppose two individuals started a company. The company had a total of 10,000 shares which were worth 100,000 MYR in total. This implies that each stock was worth 10 MYR. The two individuals contributed equally at 50,000 MYR and received 5,000 shares each. Note here that 5,000 shares are synonymous with 50 lots. This gives:

Suppose further that three months, that is, a quarter later, the company made a net profit of 3,000 MYR. As the total number of shares was 10,000, the earnings per share (EPS) would be 3,000 MYR/10,000 shares = 0.30 MYR. Now, assuming the company earned 3,000 MYR for each of the rest of the quarters in the year, the amount earned would be 3,000 MYR x 4 quarters = 12,000 MYR and the EPS would be 12,000 MYR/10,000 shares = 1.20 MYR. We now have the following table:

On another note, most companies give out dividends to their shareholders. A company that gives consistent and reasonable dividends can affect investment decisions tremendously as it can be a sign of a financially healthy and disciplined company that can provide investors with long-term returns. In this case, if half of the earnings in the first quarter were given out as dividends, which equates to 3,000 MYR x 0.5 = 1,500 MYR, then each share would receive 1,500 MYR/10,000 shares = 0.15 MYR. This amount is called the dividend per share (DPS), which can be calculated annually, quarterly, or monthly, depending on how frequently a company pays dividends.

For simplicity let us assume the company did not pay dividends for the rest of the quarters, which signifies that the dividend yield (DY) was only at 0.15 MYR/10 MYR x 100 = 1.5%. Each of the two individuals would receive 0.15 MYR x 5,000 shares = 750 MYR as the dividend payout of the year. In general, companies with 3% to 5% of DY are considered good. Nonetheless, companies usually do not use a large portion of their earnings for dividend payouts as they need the funds for purposes like the expansion of their businesses. At this point, we have the following table of metrics:

It might also be of interest to shareholders to know how long will it take for them to break even, which is a situation in which the investors have neither made a profit nor incurred a loss. The calculation here is simple. The stock price was 10 MYR. The EPS was 1.20 MYR. This gives 10 MYR/1.20 MYR = 8.33 which implies that investors would break even in around 8 years and 4 months of time, assuming the EPS remains constant and the stock price follows the same trend. The number shown here is called the price-to-earnings ratio (P/E). Updating the table yields:

It might also be of interest to know how much the two individuals can get back in return should the company go bankrupt. Suppose they used the initial capital of 100,000 MYR to purchase equipment for their business and borrowed another 40,000 MYR from the bank. Intuitively, the former is the asset, and the latter is the liability. They further had intangible assets valued at 15,000 MYR. Taking the total assets minus the total liabilities and intangible assets would give 100,000 MYR - 40,000 MYR – 15,000 MYR = 45,000 MYR which is the net tangible asset (NTA). As there were 10,000 shares in total, the NTA per share would be 45,000 MYR/10,000 shares = 4.50 MYR. The NTA per share is a vital indicator as a company with a higher NTA would have a higher probability of issuing bonus shares for having more accumulated profits.

When it comes to the capabilities of a company to make profits, one ought to look at the return on equity (ROE). As the value of total assets minus total liabilities is 100,000 MYR – 40,000 MYR = 60,000 MYR and the net earnings in a year were 12,000 MYR, the ROE would be 12,000 MYR/60,000 MYR x 100 = 20%. To make informed investment decisions, one has to consider the scale of the company and analyze its ROE over several years, as a single-year ROE may not reflect its long-term profitability. Analyzing ROE over a longer period, for instance, 3 to 5 years, can provide a more accurate picture of historical performance and aid investment decisions. Our final table consisting of all the key performance metrics is as follows:

As a concluding remark, investing in stocks can be a profitable long-term strategy, but it requires meticulous analysis and research to make informed decisions and mitigate potential risks.