Question

Question attention to the news that Dongguk Corp. may report an earnings surprise thanks to the booming demand for netural gas p pe as50ciated with rising shale gas production judgement through a price multiple comparison method, Mr Kim chooses to deploy PER (Price-Earnings Ratic) computed PER= per share stock price of Dengguk Corp. (November 1, 2019) /expeced per share ret income for the fiscal year of 2019 For comparison purpose, Mr. Kim selects 5 firms that belong to the same Dongguk Corp, that average PER us ng above formula, A3 a resuit, Mr. Kim gets a multiple of 15 for Dongguk Corp, whereas the average multipie tnose five firms is 12. Based on this mu tiple comparison, stock market everprices the shares of Dergguk Corp. and gives up investment Dongguk Corp. shares. Requirement 1 If you are a financial analvst. investment advice to Mr. Daniel Kim? (12 points) Requirement 2: The method of price multiple comparison, as expla.ned above. has implementatior problems as well as concep:ual problems. Incicate onc cach

Answer 1

1. My investment advice to Daniel Kim are as follows:

1. Try and invest in companies which have very high corporate governance
2. While undertaking PER analysis, consider the denominator (income) on the basis of income expected over the next 12 months and not the preceding 12 months.
3. Bench marking of PER should be done with companies in similar business and not among companies of same group
4. Consideration for the term of your investment is critical and one must be clear of the tenor for which the investment is being done.
5. Along with PER, one should also do cash flow analysis which provides the real picture of the company operations
6. Consider only that component your total net worth into such stock investment which you would be happy to risk
7. Read a lot about the company operations before investing
8. Understand the sector/industry and its trends before investing
9. Understanding the leverage of company while buying its stock is very necessary
10. Do not base your investment only on stock tips and views of others. Build you own knowledge and understanding
11. Post investment, one should keep oneself updated with the developments in the company of investment.
12. Prior to any investment, one should first undertake a proper allocation exercise of one's wealth into different investment buckets such as real estate, stocks, debt instruments, mutual funds etc

2. The method of price multiple comparison as mentioned in the question has implementation as well as conceptual problem.

Conceptual Problem: The conceptual problem in the above is that PER ratio for investments are generally to be done considering the earnings of the next 12 months. Elaborating it further, PER should be calculated as PER=per share stock price of Dengguk Corp. (November 1, 2019) /expected per share net income for the fiscal year of 2020. This is important as the investment is basis the assessment of how much income the company is going to make in the future and not of how much it has made in the past. Since, the above assessment is being done in November, that means majority of the year has passed already.

Implementation Problem: The implementation problem is that while using the PER methodology, one needs to compare companies working in the similar filed of business. Hence, while comparing PER of Dongguk Corp, one needs to compare its PER with other companies involved in the business in natural gas and shale gas. One cannot compare the PER with 5 other firms of the same Dongguk Corp group.