GB2368687A

GB2368687A - Evaluation of securities

Info

Publication number: GB2368687A
Application number: GB0114497A
Authority: GB
Inventors: Herbert Charles Hiskett
Original assignee: Individual
Current assignee: Individual
Priority date: 2000-06-14
Filing date: 2001-06-14
Publication date: 2002-05-08
Also published as: GB0114497D0

Abstract

A computerised system for evaluating securities comprises the steps of estimating a P/E ratio for a security that will yield a predetermined rate of return on an investment in said security, inputting an actual historical P/E ratio for the security, determining a merit rating for the security as a function of the estimated P/E ratio and of the historical P/E ratio of the security; and displaying the merit rating in a perceptible form.

Description

EVALUATION OF SECURITIES

FIELD OF THE INVENTION This invention relates to a system for evaluating securities and, more particularly, to a system for evaluating the relative merits of a number of company shares, whether listed or not. The system extends to a method or evaluating securities.

BACKGROUND TO THE INVENTION There are many methodologies which can be used to evaluate share prices.

One such methodology, which is called technical analysis, is based on an assumption that prices tend to move in cycles, trains or patterns and that future movements of a particular share price can be predicted from a study of charts to of past behaviour.

Another methodology is based on an assumption that the present price of the share reflects all past information about that share, because it represents the sum of the opinions of a large number of analysts and investors. The current market price of the share is thus assumed to follow a Markov process, which states that future predictions of the share price can only be made on the basis of probability distributions.

A further methodology, referred to as fundamental analysis, is based on an assumption that a share does possess any intrinsic value that can be determined from a careful study of companys'past and current performance. In contrast to the second methodology above, fundamentalists operate under an implicit assumption that sooner or later the market price of the share will be left to move in a direction dictated by fundamental value. A question which plagues fundamentalists is how an investor or analyst should determined fundamental value in advance of such moves in a share price.

This invention is only concerned with fundamental analysis. In order to conduct fundamental analysis, it is first necessary to collect and examine information regarding past performance of a company, together with an assessment of its strengths and weaknesses. Software to perform such fundamental analysis is known in the art; such fundamental analysis packages provide information relating to share capital, major shareholdings, net asset value ("NAV"), earnings, profits before and after tax, and dividends, cash, loans, margins, return on equity, debt-equity ratio and many other ratios These fundamental analysis packages enable shares to be ranked according to any one or more of these variables at the instance of the analyst.

Fundamental analysis conducted in this way is defective because there is no consensus amongst analysts and investors as to what weight should be attached to each of the above-mentioned Criteria. Furthermore, the task is complicated by the fact that all the indicators relating to a particular share are not static, but rather moving either up or down There is general agreement amongst analysts and investors that the most significant indicator of a share's performance is an earnings trend of the underlying company. Most analysts, when reporting on the share, will make a forecast of earnings per share C'EPS") for it a current financial year and probably

for a year or two thereafter. The problem faced by such analysts and investors is how to translate that forecast into a valuation of the share. An often expressed opinion is that a standard method of valuing shares is not possible because of the number and variety of factors that have to be taken into account in such a valuation. Complexity of information should, however, not preclude a treatment of it in a standard manner. The same difficulties are faced when assessing the feasibility of a proposed new company project, whether intemat or external. The object, both in relation to a project and a share, is to determine its value as an investment. In the case of the former, the standard methodology is to forecast a cash flow for a period such as, for example, ten years, together with a valuation of residual assets at the end of the period. The internal rate of return caIRRII) of the project is obtained by discounting these figures. There is no reason why this method should not be used to determine the IRR of a share purchase. A procedure would be to discount the forecast flow of dividends for a number of years, together with the proceeds of a notional sale at the end of the period.

The problem with this approach is that the major factor in the calculation, especially with high-growth shares, is pricing the notional sale at the end of the period being assessed. It is illogical to produce the fair price of a share today by a process that is Critically dependent on an estimate of its value at some future time.

Analysts and financial writers repeatedly refer to"value"stocks, unlocking "value", embedded"value"and the like. It is never explained what the word "value"means, or how it can be measured. The private Investor thus has no rational or authentic basis for his investment decisions.

OBJECT OF THE INVENTION In accordance with this invention there is provided a system and method for evaluating securities that will, at least partially, alleviate the above-mentioned difficulties and disadvantages.

SUMMARY OF THE INVENTION In accordance with this invention there is provided a system for evaluating securities, comprising : a computation facility instructable by a user to estimate a price-earnings ("P/E") ratio for a security that will yield a predetermined rate of return on an investment in said security ; input means for inputting an actual historical PIE ratio for the security; merit assessment means operable to determine a merit rating for the security as a function of the estimated P/E ratio and of the historical P/E ratio of the security; and output means for displaying the merit rating to the user in a perceptible from.

Further the features of the invention provide for the computation facility to be a computer workstation, for the computer workstation to operate under control of a stored program, for the stored program to estimate the P/E ratio as a function also of a last reported diluted headline earnings per share of the security, for the stored program to estimate the P/E ratio as a function also of a predetermined dividend cover, preferably about 2, 5 times, for the stored program to estimate the P/E value also as a function of a predetermined growth in earnings per share of the security for a period after the last historical reporting period, for the predetermined growth in earnings per share to be attenuated by a predetermined attenuation factor in each successive reporting period, and for the reporting period to be a year.

Still further features of the invention provide for the computation facility to compute the estimated P/E ratio, P/Ek for the security according to the recursive equation :

PEk= (gk+ 100) (1 + PEk-1 C) Where k= 1, 2,..., n C (100 + R) and PE. = 100/RC,

R = a prescribed desired percentage return on an investment in the share, E = a last reported diluted EPS, C = a predetermined level of dividend'cover at a predetermined level of growth under investigation, G = and estimated growth rate in EPS for a year following the last year of reporting, g = an estimated attenuation ratio of the growth in EPS looking forward, and n is determined by means of the formula : n=) nG/) ng = logi0 G/logiog Yet further features of the invention provide for the computation facility to estimate a PIE ratio for a plurality of securities that will yield a predetermined rate of return on an investment in each of said plurality of securities, the input means to enable the input of an actual historical P/E ratio for each one of the plurality of securities, for the merit assessment means to determine a merit rating for each one of the plurality of securities as a function of the estimated P/E ratio and of the corresponding historical PIE ratio of that security, and for the output means to

display the merit ratings of the plurality of securities to the user in a perceptible form In a ranked configuration. There is also provided for the input means to be a keyboard, for the output means to be any one of a display monitor or a printer, and for the stored program to be a spreadsheet.

The invention extends to a method for evaluating securities, comprising the steps of : Estimating a price-earnings ("P/E") ratio for a security that will yield a predetermined rate of return on an investment in said security; Inputting an actual historical P/E ratio for the security; determining a merit rating for the security as a function of the estimated P/E ratio and of the historical PIE ratio of the security ; and displaying the merit rating in a perceptible from.

There is further provided for estimating the PIE rating and determining the merit rating by means of a stored program executing on a computer workstation, for estimating the P/E ratio as a function also of a last reported diluted headline earnings per share of the security, for estimating the P/E ratio as a function also of a predetermined dividend cover, preferably about 2,5 times, for estimating the PIE value also as a function of a predetermined growth in earnings per share of the security for a period after the last historical reporting period, for attenuating the predetermined growth in earnings per share by a predetermined attenuation factor in each successive reporting period, and for the reporting period to be a year.

There is still further provided for computing the estimated P/E ratio, P/Ek for the security according to the recursive equation:

PEk= (gk+100) (1+PEx-iC) Where k= 1, 2,.... n C (100 + R) and PEo= 100/RC,

R a prescribed desired percentage return on an investment in the share, E = a last reported diluted EPS, C = a predetermined level of dividend cover at a predetermined level of growth under investigation, G and estimated growth rate in EPS for a year following the last year of reporting, g = an estimated attenuation ratio of the growth in EPS looking forward, and n is determined by means of the formula : n=InG/Ing=log10G/log10g There is yet further provided for estimating a P/E ratio for a plurality of securities that will yield a predetermined rate of return on an investment in each of said plurality of securities, for inputting an actual historical P/E ratio for each one of the plurality of securities, for determining a merit rating for each one of the plurality of securities as a function of the estimated P/E ratio and of the corresponding historical PIE ratio of that security, and for displaying the merit ratings of the plurality of securities in a perceptible form in a ranked configuration.

BRIEF DESCRIPTION OF THE DRAWINGS They preferred embodiment of the invention is described below, by way of example only, and with reference to the accompanying drawings in which: Figure 1 is functional block diagram of a system for evaluating secunties, according to the invention; and Figure 2 is an example of a merit rating for a plurality of securities, In a perceptible form, produced by the system of Figure 1.

DETAILED DESCRIPTION OF THE INVENTION Referring to Figure 1, a system for evaluating securities is indicated it generally by reference sign (1).

The system (1) comprises a computer workstation (2) having a display monitor (3), a keyboard (4) and a telecommunication link (5) to a real-time online database (6) of securities data such as share prices, and the like. The computer workstation operates under control of a stored program in the form of a spreadsheet program such as Microsoft Excel which is available from the Microsoft Corporation of Settle, USA. The spreadsheet program runs a spreadsheet designed to evaluating each one of the plurality of securities such as listed shares, the operation of which will be described In more detail in the description that follows.

In order to evaluate any one of the shares, the following input parameters are required: R = a prescribed desired percentage return on an investment in the share, say 13 percent.

E : : : a last reported diluted EPS C a predetermined level of dividend cover, say 2, 5, at a predetermined level of growth under investigation.

G = and estimated growth rate in EPS for a year following the last year of reporting. g = an estimated attenuation ratio of the growth in EPS looking forward.

The price of the share is normalized at a price of 100 currency units, for convenience.

The spreadsheet computes an estimated PIE ratio, P/Ek for the share according

to the following recursive equation :

PEk= (9k+ 100) (1 + PEk. 1 C) Where k=1,.... n C (100 + R) and PE. = 100/RC

and n is determined by means of the formula : n=hG/ing = logio G/logiog The spreadsheet program can be utilised to evaluate the plurality of shares simultaneously. In order to do so, the above input parameters must be entered for each one of the shares and evaluation The spreadsheet program then calculates an estimated P/E ratio for each one of the plurality of shares according to the recursive equation presented above.

In order to utilise the system (1) more effectively to rank of the relative worth of the plurality of shares, It is necessary for a user to enter the above-mentioned input parameters in respect of each one of the plurality of shares under investigation. The spreadsheet and produces and estimated PIE ratio for each one of the plurality of shares as described above. The user is also required to enter, In respect of each one of the plurality of shares under investigation, and actual P/E ratio for the last reporting penod or, alternatively, price and earnings data from which the P/E ratio may be computed. The spreadsheet computes a merit rating for each one of the plurality of shares, which is simply a ratio of the estimated P/E ratio and the historical P/E ratio of the share. The spreadsheet also produces a ranking of the plurality of shares under analysis in accordance with the respect of merit ratings.

Referring to Figure 2, a printed output of an evaluation of a plurality of shares is presented. The output consists of a table, the columns of which input data or the results of the analysis described above. The columns are labeled by means of letter, for convenience. Column A indicates the names of the plurality of shares and column B is the corresponding ruling market prices. Column C represents the last reported annual diluted headline earnings per share. Column D is the true current PIE ratios for the plurality of share which are obtained by dividing the ruling market price (Column B) by the headline earnings per share (Column C). Column E is an estimate of the growth rate, G, in EPS for the current financial year Column F is an estimated attenuation ratio, g, of the growth in EPS looking forward. Column G are the values of n for each one of the shares, as determined according to the above equation. Column H are the estimated P/E ratios computed by the spreadsheet according to the recursive equation described above, and column I is the merit rating for each one of the plurality of shares, computed as a ratio of the estimated P/E ratio (Column H) divided by and the true current P/E ratio (Column D) of the share. In the printed output, the shares are ranked in order, from those with highest merit rating to those with the lowest merit rating at the bottom of the list.

It will be appreciated by those skilled in the art that the relative merit ratings of the plurality of shares under investigation provide an investor with the relative merit of the shares with a view to achieving in the prescribed desired percentage return, R, on an investment in any one of the shares. A typical output of the spreadsheet program is illustrated in Figure 2. An investor will tend to purchase shares with highest merit ratings and sell off those with smallest merit ratings. As long as the earnings and growth input parameters for the shares are unchanged, as a share becomes cheaper, it will move up in the merit ratings, or downwards when it becomes more expensive. The effectiveness of the system (1) in analysing securities such as shares depends on the quality of the input parameters G and g that are selected for each one of the plurality of shares.

Numerous modifications are possible to this embodiment without departing from the scope of the invention. In particular, a different recursive equation may be utilised to compute an estimated P/E ratio for each one of the plurality of shares. Further, a different merit rating may be utilised in assessing the relative merit of the shares, such as an absolute value of the difference between the estimated and the reported PIE's. Still further, the stored program that controls the operation of the computer workstation (2) may be a bespoke executable computer program instead of and Excel spreadsheet. The ruling market prices and the last reported headline earnings per share may be automatically downloaded from the real-time online database (6) of securities data along the telecommunication link (5), or may be entered manually be a user if this facility is not available.

The invention therefore provides a system and a method for evaluating securities that provides an authentic evaluation of any security based on a forecast of its earnings growth trajectory.

Claims

CLAIMS 1. A system for evaluating securities, comprising : a computation facility instructable by a user to estimate a"P/E"ratio for a security that will yield a predetermined rate of return on an investment in said security; input means for inputting an actual historical P/E ratio for the security; merit assessment means operable to determine a merit rating for the security as a function of the estimated P/E ratio and of the historical P/E ratio of the security; and output means for displaying the merit rating to the user in a perceptible from.
2. A system as claimed in claim 1 in which the computation facility is a computer workstation.
3. A system as claimed in claim 2 in which the computer workstation operates under control of a stored program.
4. A system as claimed in claim 3 in which the stored program estimates the P/E ratio as a function also of a last reported diluted headline earnings per share of the security.
5. A system as claimed in either one of claims 3 or 4 in which the stored program estimates the P/E ratio as a function also of a predetermined dividend cover for the security.
6. A system as claimed in claim5 In which the dividend cover is about 2,5 times
7. A system as claimed in any one of claims 3 to 6 In which the stored program estimates the P/E ratio also as a function of a predetermined growth in earnings per share of the security for a period after a most recent historical reporting period.
8 A system as claimed in claim 7 in which the predetermined growth in earnings per share is attenuated by a predetermined attenuation factor in each successive reporting period.
9. A system as claimed in either one of claims 7 or 8 in which the reporting period is a year.
10. A system as claimed in any one of the preceding claims in which the computation facility computes the estimated P/E ratio, P/Ek for the security according to the recursive equation:

PEk= (g+ 100) (1 + PEk-1 C) Where k = 1, 2,..., n C (100+R) andPEo= 100/RC,

R = a prescribed desired percentage return on an investment in the share, E = a last reported diluted EPS, C = a predetermined level of dividend cover at a predetermined level of growth under investigation, G = and estimated growth rate in EPS for a year following the last year of reporting,

g = an estimated attenuation ratio of the growth In EPS looking forward, and n is determined by means of the formula : n = tnG/in g = log 10 G/log io9
11. A system as claimed in any one of the preceding claims in which the computation facility estimates a PIE ratio for a plurality of securities that will yield a predetermined rate of return on an investment in each of said plurality of securities.
12. A system as claimed in claim 11 in which the input means enables the input of an actual historical PIE ratio for each one of the plurality of securities.
13 A system as claimed in claim 12 in which the merit assessment means determines a merit rating for each one of the plurality of securities as a function of the estimated PIE ratio and of the corresponding historical P/E ratio of that security.
14. A system as claimed in claim 13 in which the output means displays the merit ratings of the plurality of securities to the user in a perceptible form in a ranked configuration.
15 A system as claimed in any one of the preceding claims in which for the input means is a keyboard.
16. A system as claimed in any one of the preceding claims in which the output means is any one of a display monitor or a printer.
17 A system as claimed in claim 3 in which the stored program IS a spreadsheet.
18. A method for evaluating securities, comprising the steps of : estimating a PIE ratio for a security that will yield a predetermined rate of return on an investment in said security ; inputting an actual historical PIE ratio for the security : determining a merit rating for the security as a function of the estimated P/E ratio and of the historical P/E ratio of the security; and displaying the merit rating in a perceptible from.
19. A method as claimed in claim 18 in which the P/E rating is estimated and the ment rating is determined by means of a stored program executing on a computer workstation.
20. A method as claimed in either one of claims 18 or 19 in which the PIE ratio is estimated as a function also of a most recent reported diluted headline earnings per share of the security.
21 A method as claimed in anyone of claims 18 to 20 in which the P/E ratio is estimated also as a function also of a predetermined dividend cover.
22. A method as claimed in claim 21 in which the dividend cover is about 2,5 times.
23 A method as claimed in any one of claims 18 to 22 in which the P/E value is estimated also as a function of a predetermined growth In earnings per share of the security for a period after the most recent reported historical reporting period.
24. A method as claimed in claim 23 In which the predetermined growth in earnings per share IS attenuated by a predetermined attenuation factor In each successive reporting period.
25. A method as claimed In anyone of claims 18 to 24 in which the reporting period is a year.
26. A method as claimed in any one of claims 18 to 25 which includes the step of computing the estimated P/E ratio, P/Ek for the security

according to the recursive equation :

PEk= (gk+ 100) (1 ++PEk. iC) Where k= 1, 2,.., n C (100 + R) and PE 100/RC,

R = a prescribed desired percentage return on an investment in the share, E = a last reported diluted EPS, C = a predetermined level of dividend cover at a predetermined level of growth under investigation, G = and estimated growth rate in EPS for a year following the fast year of reporting, g = an estimated attenuation ratio of the growth in EPS looking forward, and n is determined by means of the formula : n = fn G/in g = log 10 G/log 109
27. A method as claimed in any one of claims 18 to 26 that includes the step of estimating a P/E ratio for a plurality of securities that will yield a predetermined rate of return on an investment in each of said plurality of securities.
28-A method as claimed in claim 27 in which an actual historical PIE ratio for each one of the plurality of securities is input.
29. A method as claimed in claim 28 in which a merit rating for each one of the plurality of securities is determined as a function of the estimated PIE ratio and of the corresponding historical PIE ratio of that security.
30. A method as claimed in claim 29 in which the merit ratings of the plurality of securities is displayed In a perceptible form in a ranked configuration.
31-A system for evaluating securities, substantially as herein described with reference to and as illustrated in the accompanying drawings.
32. A method for evaluating securities, substantially as herein described with reference to the accompanying drawings.

33 An apparatus adapted and arranged for securities evaluation, said apparatus comprising a computation facility (e g CPU) Instructable by a user to estimate a"P/E"ratto for a security that will Yield a predetermined rate of return on an investment In said security, input means for inputting an actual historical P/E ratio for the security, ment assessment means operable to determine a ment rating for the secunty as a function of the estimated P/E ratio and of the historical P/E ratio of the security, and output means for displaying the ment rating to the user In a perceptible form