1. How to Track Stock Investment Performance for Future Investments

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Published: 03rd April 2015
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Ram is furious that his stock’s price tumbled after announcement of results. He is not mad because the stock prices went down but because he felt the announced results were excellent and would warrant a sharp upturn in price. He argued with his friends about the stupidity of price determination in stock markets and concluded that the markets lacked fairness or proper stock performance analysis methods. Looking up the historical stock quote prices gave no indication of the current scenario. He is so convinced that arbitrariness prevails in stock markets and there is no room for rational thinking.

Shyam is agitated too because his stock’s price went sharply up after he sold them. He is frustrated because the company announced dismal results and he looked forward for a big correction in stock price following the announcement. On the contrary, stock price went up after announcement of poor results. This was despite his spending enormous amount of time using many stock portfolio tracker systems online and doing stock performance analysis every now and then. Shyam is now so very convinced that the market follows no sensible logic and the stock prices tend to move in tandem with market operators’ moves.

Ram and Shyam are the names assumed for an average investor in India today. Many investors tend to believe that riding a wave is best solution in stock markets than attempting to trace historical stock prices and put valuation models to work. Dealers at brokerage houses, who are paid a salary linked to the revenue generated, endorse this in full glee. For them, the more people trade for shorter duration, the better.

In markets that are characterized by more than 95% trading volumes and only 5% or less in delivery backed trades, it is hardly surprising that vast number of participants have turned themselves into day traders or position traders in derivative market. While screen based trading has laid a level playing field for all brokers, fierce competition among brokerages has led to development of an undesirable trend of enticing gullible investors into day trading or derivative trading by the dealers of several brokerage houses.

With more and more number of players taking ultra-short term stands on companies, volatility in prices is on the rise. Majority of such positions are meant to be closed after the event like announcement of results by companies, and are impacting the price discovery process of shares. Often cumulative effect of such unwinding positions lead to distortion in price discovery process. This group of short term traders bet on events or news for short times and they move on to some other share, post event.

When an informed investor analyses the results or event and decides to buy or sell the stock based on results from his stock portfolio trackers and his stock performance analysis, he is confronted with deluge of short term traders who could effectively move the price against the ideal direction. Investors with sound logic also tend to question their own prudence based on the divergence between their estimation and actual. However, if one could extend the scope of observation beyond a few days window before and after the event, they might prove to be accurate in their performance analysis.

Vivekam took up the task of checking the claims and counter claims of relevance of historical stock prices and reported results on the subsequent prices of stocks. How to Track Stock Investment Performance for Future Investments assumes significance in the light of divergent views on impact of working results and / or relevance of them on prices. Historical stock prices and the working results of respective companies needed to be checked together to deduce a conclusion one way or other. Vivekam undertook the study of about 5,000 companies over 12 years (48 quarters) to see a pattern in the historic stock price behavior. In order to be more accurate, Vivekam compiled Trailing Twelve Months (TTM) values of all companies so that the prices of relevant period can be compared with latest 12 months working results of companies.

At the end of study, Vivekam could establish irrefutable evidence that the stock prices do reflect the latest working results, when extrapolated in a scientific manner. To Track Stock Investment Performance for Future Investments, Vivekam collected the date of announcement of quarterly working results for all companies for all quarters. Then assuming that the impact of announced results can only be had from such date of announcement, Vivekam predicted the price ranges for all stocks based on latest reported TTM numbers. To arrive at a price range in which a stock should ideally be trading, Vivekam took the discounting factor of last 5 days before announcement of working results. The rationale behind being, the enthusiasts of companies begin to build up estimates and influence stock’s price most on these days, when the results are about to be announced. With latest discounting factor available, the only thing Vivekam needed was the latest working results. As soon as the numbers are announced, they are captured and extrapolated for determination of future stock price ranges.

However, in cases where companies report losses for a given period, the calculation of discounting factor becomes tricky. Vivekam strongly believes that every listed company will have some business value assigned to it shares in addition to some multiple for profits, if any. Hence to help in valuation process of stocks, Vivekam deploys several statistical tools and measures to determine the business value of stocks for that quarter, immediately on announcement of working results. To calculate business value, Vivekam considers book value of assets, market assessment of assets, cash flows, fresh capital infusions, rights announcements etc. Subtracting the business value from stock’s price will provide a portion that is considered sensitive to profits earned by company. Hence, in Vivekam’s estimates, estimated prices of stocks are not always doubled, when the profits reported double for a given company.

Vivekam carefully studied (and keep studying) the average volatility of stock price from its mean to compute Standard Deviation of such stock for every quarter. Once the Standard Deviation, working results and the latest multiple given to such stock in previous quarter’s last 5 days are available, Vivekam proceeds with determination of price range that holds good till announcement of next quarter results. When prices were estimated and tested for all 12 years, 82% times, the actual prices of stocks moved within the range predicted proving the soundness of logic of price determination. Large cap stocks have moved within the range in more than 90% occasions lending credibility to the whole process.

Vivekam’s process can be explained in following few lines.

Stock price = Business value per share + profit sensitive portion
Discounting multiple = Profit sensitive portion / TTM profits of preceding quarter
Standard Deviation = Standard deviation of a stock price between two quarterly results announcements.

Fair value for next quarter = Updated business value + (Latest TTM profit *Discounting multiple of last 5 days)
Highest expected value = Fair value + (3 * Standard deviation)
Lowest expected value = Fair value – (3 * Standard deviation)

Once price ranges are determined, one should buy a stock if it is trading below the minimum expected price or close to minimum expected price. Since the fair price is higher than the current prevailing market price, the chances of making profits improve significantly. Considering the fact that 82% of all companies and 90% of large cap stocks adhere to the price pattern set as above, the investors would do well in the long run. They can also be sure of their approach since all relevant data pertaining to companies was captured and used before investing.

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