Derivation of key parameters for the tactical screening:
- The required rate of return (equity) for a particular security will be based on its beta (as per CAPM rule), expected return on market and the risk free rate
- Justified or “fair” price to earnings ratio (“PER”) is computed based on its required rate of return, return on equity (“ROE”) and earnings growth rate
- Justified price to book ratio (“PBR”) is derived based on similar parameters as per justified PER
The following table shows that if the beta of a particular security is 1.0, the required rate of return is 7.32%. If the security’s beta is lower than 1.0, the required rate of return will be lower in tandem with a lower risk. To safeguard margin of safety, we have adjusted required rate of return upward to 8.0%.
With minimum ROE of not less than 10.0% and earnings growth rate of not less than 1.5%, we should expect a security with a beta of less than 1.0 to have a justified PER of at least 13.0x and justified PBR of at least 1.30x.
To search for potential undervalued securities, we propose the following screening mechanism :
- Exchange: Bursa
- Net earnings growth rate of not less than 2.0% for the past 3 years
- Beta not more than 1 time
- PER of less than 13.0x (past 2 years)
- PBR of less than 1.30x (past 2 years)
- ROE of not less than 10.0% (past 3 years)
- Current ratio >1.25x (past 5 years)
- Total Debt / Total assets not more than 50% (for past 5 years)
The search results are shown below:
It is crucial to remember that valuation is always driven by anticipation of future earnings, risk and growth rate. Screening results are based on historical results, of which we are making a very quintessential assumption that the future will not be far deviated from the historical trend.
DISCLAIMER: THIS IS A PERSONAL BLOG AND SHALL NOT BE RELIED IN WHATSOEVER MANNER BY ANYONE. ALL ARTICLES CONTAINED IN THIS SITE ARE FOR INFORMATION AND ILLUSTRATIVE PURPOSES ONLY AND DOES NOT PURPORT TO SHOW ACTUAL RESULTS. IT IS NOT, AND SHOULD NOT BE REGARDED AS INVESTMENT ADVICE OR AS A RECOMMENDATION REGARDING ANY PARTICULAR SECURITY OR COURSE OF ACTION. SOURCES USED IN THIS SITE HAVE NOT BEEN INDEPENDENTLY VERIFIED FOR ACCURACY, COMPLETENESS AND TIMELINESS. YOU SHOULD SEEK INDEPENDENT AND PROFESSIONAL INVESTMENT ADVICE IN REGARD TO YOUR INVESTMENT DECISIONS. THE AUTHOR MAY HOLD POSITIONS IN THE SECURITIES OR INSTRUMENTS MENTIONED ABOVE.