Financial tools that investors should apply to investment decisions

The early parts of this century were painful years for most foreign investors with world markets falling significantly. I believe it is important that investors pay more attention to the fundamentals when making their investment decisions. The purpose of this article is to highlight the main financial tools that investors should apply when making investment decisions.

PRICE EARNINGS RATIO
The most important ratio that investors should look at is the Price Earnings (P/E) Ratio. In layman’s terms this is the share price divided by the profit per share. The P/E Ratio of a Company should be compared against other companies in the sector and against the market as a whole. I also believe a good test is to compare the P/E Ratio of a company with other similar companies quoted on other international stock exchanges.

The P/E Ratio to be used in investment decisions should be the prospective P/E Ratio and not the historical P/E Ratio. Unfortunately in most of the financial press the P/E Ratio stated is the historic one that may not reflect the future prospects of a business. Hence investors should look at the P/E Ratio based on current and future earnings and not the previous year’s figure.

An illustration of how an investor could properly carry out this exercise is as follows: A food retailer has a Prospective P/E Ratio of 10 times. It is currently expanding into all towns in Cyprus by opening new supermarkets. Its main competitor in Cyprus is estimated to have a Prospective P/E Ratio of 15 times. When one compares the rating to other international quoted businesses in the same sector one has found that these businesses command a P/E Rating of 20 times. This information would appear to indicate that the investor should seriously consider an investment in this company since there is a case to suggest it is under valued.

NET ASSET VALUE (NAV):
A useful ratio for the evaluation of investment companies is the net asset value per share. In Cyprus most companies disclose their NAV on a two weekly basis whereas some companies go as for as to disclose the figure on a weekly basis.

In my opinion, those companies that have an NAV that is lower than the share price should be tread on carefully by investors since they have a higher risk. The opposite is true for investment companies that are at a huge discount to their NAV.

Though there are many strategies that investors should follow, I tend to follow a strategy where I would buy investment companies if they were at a discount to their NAV of at least 20%. I tend to find that the downside is restricted if investors follow such a policy. If the market were in a bear market phase (i.e. falling market), I would widen the discount to say 30%. If in a bull market then the discount could be narrowed to say 15%.

EARNINGS PER SHARE (EPS):
Another tool that should be used by investors is to look at the track record of the company concerned. By this I mean the growth (or lack of it) in Earnings per share. A good management team should be able to register a solid annual increase in EPS of say 15% per annum. It should be able to do this on a consistent basis.

The problem facing Cypriot investors is that there are many companies that have listed on the Cyprus Stock Exchange that have registered massive jumps in their earnings in 1999-2000. Prior to this they were producing low earnings. What should investors do in such cases? In my opinion investors should look at the Prospective EPS and the anticipated growth over the next few years.

There are also a number of non-financial factors that need to be considered before making investment decisions. These include the track record of the management team, the prospects of the Company and its industry, the state of the economy etc. Some of these factors have already been mentioned in some of my past articles.

CONCLUSION:
In my article I have deliberately tried not to overload investors with too much information. This I believe is the duty of financial experts to analyse. However I do believe that investors need to know the basics such as P/E Ratios, Net Asset Values etc before making investment decisions. I believe it is time that Cypriot investors should do a lit a bit of research before making investment decisions.

Disclaimer: No responsibility for loss can be accepted to any person acting or refraining from acting as a result of material in this article.