Relative Valuation techniques & the current scenario of Karachi Stock Market

Presented by : Arif Mustafa Ali fayaz Mir Murtaza

Introduction

• To understand the valuation techniques it is important to understand the theory of valuation.

• Every risk averse investor will first analyze the firm/stock it wants to invest in.

• So, its necessary to know the important characteristics of that stock/firm

Theory of valuation

• The value of an asset is the present value of its expected cash flows

• You expect an asset to provide a stream of cash flows while you own it

Valuation techniques

Equity Valuation

Discounted Cash Flow Techniques Relative Valuation Techniques

Present value of Dividends (DDM) PV of Operating cash flow PV of Free cash flow

Price/Earnings Ratio (P/E) Price/Cash flow Ratio (P/CF) Price/Book value Ratio (P/BV) Price/Sales Ratio (P/S)

Relative Valuation Techniques

PRICE – EARNINGS RATIO (P/E) • Value can be determined by comparing to similar stocks

based on relative ratios

• Relevant variables include earnings, cash flow, book value, and sales

• The most popular relative valuation technique is based on price to earnings(the earning multiplier)

Contd..

Relative Valuation Techniques (P/E ratio Contd..)

• This values the stock based on expected annual earnings

The price earnings (P/E) ratio, or

Earnings Multiplier EarningsMonth -Twelve Expected

PriceMarket Current

KSE past & current Scenario/trends

KSE Performance 2004-2008

2004 2005 2006 2007 20080

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KSE performance 2004-2008

KSE performance 2004-2008

Reasons for Hike in KSE 100

• State bank reduced rate of borrowing from 5% to 4 %.

• More money was available for borrowing.

• But the money didn’t regulated in trade and industry instead it was invested in the

risky stock market.

• hence, stock market raised to record making index levels.

Bearish trend – an aftermath to may 08 decline

Source: KSE annual report 2009

Scenarios lead to May 08 crash

• Depleting foreign Exchange reserve; Moody’s and S&P cut Pakistan ratings to record low( brought very near to the verge of default)

• Rising international prices

• Deteriorating macro economic situation

• Rupee falling against dollar resulting into capital flight.

• Political crisis.

Resulted into

• Foreign portfolio investors (FPIs) withdrew Rs 3.3 billion from equity markets in the week ending at May 9th , 08.

• FPIs executed investing and disinvesting in the same week for Rs 4.5 Billion and 7.8 Billion respectively.

• FPIs normally look for long term investments rather focusing on such short term transactions.

• Even stocks of the oil companies declined despite an increase in the crude oil prices.

Other factors contributing to the menace

• Deposed judges restoration in the same month darkened the KSE scenario.

• Proposition of CGT on KSE stocks further discouraged the investors.

• This also resulted into declined market capitalization by Rs 220 billion ( 5.5 % decline in comparison to a week ago level of stocks).

SBP Regulations and impacts

• SBP regulated banks to give 5% fixed deposit return effected the income of the banking sector.

• Brought down the earning to price ratio for investors Hurt badly the financial services sector at KSE.

• higher discount rate attracted the investors towards government instruments. ( an high of 1.5% to 12%)

May 08 – start of bearish trend

• 1st week of May ended up being known as the worst nightmare of KSE’s history.

• Rating agencies declared a growth rate of 5.5% for the coming years amid shying away of foreign investors from KSE.

• Insurance sector, commercial banks and cement sector marked by tremendous growth and stability loses 14.4% , 6.6% & 6.4 % respectively.

• KSE – 30 fell by 9.2 %.

Current market scenarioJanuary-March 2010

The market scenario of the past four months can be described in the four terms

1- Positive start 2- Slump

3- Mixed February 4- March Madness

Positive start

• Index gained 567 points and closed at 9954 on January 19.

• Reason being foreign buying interest in OGDCL, PPL and PTCL.

• Local investors usually trading in low tier stocks.

Slump

• KSE shed 374 points to 9579.

• Reasons being dull market environment, trading usually in lower tier stocks.

• Releasing of NRO causing political instability.

• No change in monetary policy also reduced investor confidence.

Mixed February

• Market remained stagnant mostly with no noticeable change. Market gained only 43 points during February to close at 9657.

• Trading in lower tier stocks, no reduction in policy rate by SBP, resulting in dull and low interest of investors.

• Market crawling towards 10000 points, due to payout announced by HBL and PSO. Again momentum lost due to resignation of Finance minister.

March Madness

• Sluggish start again due to circular debt issue of OGDCL, PPL and PSO.

• Market snapped out of sluggishness due to US-Pakistan strategic dialogue.

• Road show in New York by KSE managing director of KSE highlighting Pakistani equity markets resulting in speculation.

• KSE closed at 10137 , gaining 137 points.

April 2010.

• Market reached at 10416 points, highest level reached since last 19 months.

• Reasons:• Foreign investment in Oil , Gas and Chemical sector.

• 18th amendment to be presented.

• Withdrawal of decision of increasing power tariffs.

Factors that may effect future:

• Political turmoil regarding NRO and other issues.

• Uncertainty in implementation of CGT.

• Lack of electricity, water and gas are adversely and continuously affecting country’s economy and various industries e.g. Textile , Agriculture etc.

Thank You