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“A company’s stock price is said to reflect the present value of its expected future after-tax cash flows.”
Analyzing this statement is very important in analyzing investment decisions in growing companies and achieving risk-adjusted returns. The phrase “present value” asks us to consider the time value of money. This means that a rupee spent today is worth more than a rupee earned in the future. The value of money is determined by interest rates and people’s perception of the future.
When interest rates rise in an economy, the cost of capital for companies rises. Companies find it harder to raise capital and pay off debt. When people’s perception of the future is bleak, they become more hesitant to spend. This perception can be affected by war, economic recession, unemployment, and more. If people don’t spend, it becomes harder for growing companies to maintain momentum. All of this can affect how growing companies are valued.
The word “anticipated” implies uncertainty and the possibility of foresight. The anticipated industry expansion and the company’s future growth plans involve risks of uncertainty and things may not go as planned. Market trends in growing industries are constantly changing and technological innovations are possible. High levels of orders involve execution risk, significant capital expenditures contribute to increased operating expenses and revenue growth is dependent on several factors.
The term “after tax” suggests that there may be changes in government policy and budgetary allocations for certain industries. For example, the government has taken a hard line and imposed the highest GST rate on online gaming activities. Further, the Union Minister for Commerce and Industry’s recent comments expressing concern over the surge in e-commerce transactions also illustrate this point.
With regard to “cash flow”, it is important to consider that a growing business will need to continually invest in fixed and working capital from the profits it earns. For smaller businesses, investing large amounts in research and development may not be feasible, and even if they do make such investments, their realization in the future is uncertain.
As one market legend said, “It matters what stock you buy, but what price you buy it at matters even more.” Therefore, the valuation aspect cannot be ignored when pursuing growth. For valuation, you can use the PEG ratio (P/E ratio divided by the EPS growth rate) or the multi-stage discounted cash flow (DCF) method.
Investors often ignore risk-adjusted required rates of return and valuation parameters when investing in stocks of growing companies with an upward trend. However, such pursuit of growth can erode the margin of safety and increase the risk of large losses. Herd bias can affect the rationality of investment decisions and potentially lead to costly mistakes.
Investors should always make prudent decisions even during bull markets, avoid sudden price declines, and follow a disciplined investment approach to build a long-term compounding portfolio.
ETMarkets.comNifty had a stable week, closing at 24,823, up 1.15% from the previous week. Nifty is comfortably above its 20-day moving average and continues to form a pattern of higher highs and higher lows on the daily chart. The formation of a double bottom suggests that a gradual upward trend is continuing and a trend reversal is possible.
Global markets continued to remain positive, further boosting sentiment in the domestic market. The daily RSI is now above the 60 level, reinforcing the primary uptrend for Nifty. The key support remains at 24,500 while 25,000 is the immediate resistance. A break above this could push the index towards the 25,150-25,220 range.
India VIX fell 5.90% to 13.55, reflecting lower volatility. Overall, Nifty is expected to trade sideways with a positive bias.
