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Making sense of P/E ratio – Plotting P/BV with ROE

February 17, 2014 Leave a comment

We have learnt about the price to earnings ratio in our Financial Analysis class and based on it we have often gotten into debates regarding the undervaluation or overvaluation of the subject companies with our colleagues. We are guided by our professors, textbooks etc. that one cannot look at the price to earnings ratio in isolation and reach to any particular conclusion from it.

To address this limitation the model we are going to discuss here is going to use two inputs P/BV and ROE.

Price to earnings ratio = Current market price / Earnings per share

EPS actually is return to the equity shareholders on the book value invested in the business.

Return to equity shareholders = Book value (total net worth) * Return on Equity (ROE)

Using the above two equations the formula for price to earnings ratio can re-written as –

 Price to earnings ratio = (Current Market price/ Book value per share)/Return on equity

P/E ratio has been dissected into these two components because analysis of these two factors historically has shown that the P/BV multiple very closely tracks the changes in the returns on equity. (Analysis shown below)


I took the Price to book value ratio and return on equity (%) of 50 companies forming the NIFTY index and plotted these values on a scatter plot and then generated the best fit line from the coordinates. With a little eye balling we can conclude that most of the coordinates lie close to the best fit line displaying that market is pricing most of the NIFTY 50 companies in line with their Return on Equity (%). Also we can see a strong R-square of 0.736.

From the above, intuitively we can conclude that the coordinates lying above the best fit line show the stocks which are valued above what markets actually generally expect and vice versa for points lying below the best fit line. And higher the distance of coordinates from the best fit line higher will be the extent of over/under valuation.

 Despite low ROE, market may value a particular stock at higher multiples as compared to the market in general because of reasons like high expected future growth and contrary to this higher ROE need not necessarily lead to a higher price to book value ratio because of risks associated with the business/company.

The above analysis can be done for different indices, sectors etc. depending on the requirement.

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Analysying and Valuing Fixed Income securities

January 7, 2013 Leave a comment

Analysis of RECL Tax – Free bonds

The effective interest rate analysis of the bond is as follows:

Income slab Income tax slab Effective Coupon
2 – 5 lacs 10% 8.578%
5 – 10 lacs 20% 9.650%
Above 10 lacs 30% 11.029%

Across all public as well as private sector banks the maximum annualised return offered on Fixed Deposits is 8.77% p.a.

And PPF offers a tax free return of 8.8% to its subscribers. So return on these bonds can be considered as pretty much competitive in comparison to the available fixed income option for retail investors.

NOTE: Although interest on application money (if refunded) is only 5% but it is not a matter of concern as investors can apply in the issue using ASBA facility.

Investors may not find this offering that attractive just by looking at the return offered by way of interest income only. The other factor which should be considered is making a profit by selling the security in secondary market. As per the term sheet the bonds will be listed on both BSE and NSE and have no lock in period.

Valuation of 10 year bond (using DCF method) @ (10 year reference rate of GOI security + applicable spread for relevant tenor on AAA rated security)

10 yr reference rate of G-sec: 8.36% p.a.

Credit spread applicable on 10 yr AAA rated bond: 66 bps

Hence, benchmark yield (Reference rate + Credit spread) = 9.02%

Bond 7.72% RECL 2022 10 year Tax free
Duration 10
Periodicity 1
Allotment Date (Assumed) 15-Dec-12
Maturity Date 14-Dec-22
Referance rate 8.84%
Coupon for calculating trading profit 7.22%


Income slab Income tax slab Effective Coupon Effective Coupon for calculating trading profit Valuation @ Benchmark yield
2 – 5 lacs 10% 8.578% 8.022% 93.60
5 – 10 lacs 20% 9.650% 9.025% 100.03
Above 10 lacs 30% 11.029% 10.314% 108.30

Note: For the above valuation the coupon has been considered as 7.22% rather than 7.72% p.a. because as stated in the offer documents the coupon of 7.72% is only offered to primary retail investors. For all the investments made through secondary market the coupon will be 7.22% p.a.

Scenario analysis of various possible benchmark yields –

Benchmark yield
Tax Bracket 8.90% 8.93% 8.96% 8.99% 9.02% 9.05% 9.08% 9.11% 9.14%
10% 94.34 94.16 93.97 93.79 93.60 93.42 93.24 93.05 92.87
20% 100.80 100.61 100.42 100.22 100.03 99.84 99.65 99.46 99.27
30% 109.11 108.91 108.70 108.50 108.30 108.09 107.89 107.69 107.49

From the above analysis it can be construed that investors have significant opportunity of making trading gains by applying in the public issue.

As with all trading calls, there are few concerns associated with these trading call too. These are enumerated below:

1. November inflation data is still awaited and will be released on 12 December 2012, if there is a rise in inflation rate in November over October 12 there can be increase in yield on 10 year GOI security which will in turn result in increase in benchmark yield thereby bringing down the valuations. October inflation figures saw a downtrend and WPI was seen at a 10 month low.

2. Rising fiscal deficit is also pushing inflationary expectations up. Here is the excerpt from a statement made by RBI deputy governor Subir Gokarna on 03 Dec 12 –

"Fiscal deficit is somewhere in the region of 5.5 per cent or so. The government estimates that it will bring it to 5.3 per cent, but quite some distance from the 2.5 per cent- benchmark achieved in 2008,"

"That’s creating some stresses from the inflationary point as well as from the point of resources going into finance government consumption,"

3. Mid quarter review on monetary policy is also due on 18th December 12 and it is yet not clear that whether RBI will go for the rate cut or not. In case of rate cut yield on 10 year GOI security will ease and will result in increased valuations for this bond. Other way round is also possible.

On an overall basis the bond seems to be a good option for investments by retail investors. And pro rata allotment can be expected if application is made as oversubscription will be there.

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New ISCA Module for Final Nov 10

July 29, 2010 4 comments

Institute has finally announced that its New ISCA module will be applicable in Final New Course Nov 10 attempt.

Check the official notification at

It reads as follows:

Revised study material on Final (New) Course, Group –II, Paper 6: Information Systems Control and Audit – (29-07-2010)

The study material of Final (New) Course, Group –II, Paper 6: Information Systems Control and Audit (ISCA) was revised and printed in March, 2010. Students are advised to go through this revised study material of ISCA which is applicable for Nov 2010 examination. The printed copy of the study material is available at the sales counter of the Decentralised Offices. For the facility of the students, the soft copy of this revised material is also available on the Institute’s website under BoS Knowledge Portal which can be downloaded free of cost. Print and view facility is also available.
Board of Studies

You can also download the soft copy of the module from the following link:

Amendment in TDS provisions wef 1.04.2010

June 3, 2010 1 comment

The Central Board of Direct Taxes (CBDT) have amended the Rules relating to TDS provisions date and mode of payment of tax deducted at source (TDS), TDS certificate and filing of ‘statement of TDS’ (TDS return) vide Notification No.41/2010; SO No.1261(E) dated 31.05.2010. The amended rules will apply only in respect of tax deducted on or after 1st day of April 2010.

Forms for TDS certificate have been revised to include the receipt number of the TDS return filed by the deductor. Now the Tax-deduction Account Number (TAN) of the deductor, Permanent Account Number (PAN) of the deductee, and Receipt number of TDS return filed by the deductor will form the unique identification for allowing tax credit claimed by the taxpayer in his income-tax return.          

Government Authorities (Pay and Accounts Officer or Treasury Officer or Cheque Drawing and Disbursing Officer) responsible for crediting tax deducted at source to the credit of the Central Government by book-entry are now required to electronically file a monthly statement in a new Form No. 24G containing details of credit of TDS to the agency authorised by the Director General of Income-tax (Systems). 

Due date for furnishing TDS return for the last quarter of the financial year has been modified to 15th May (from earlier 15th June). The revised due dates for furnishing TDS return are

Sl. No. Date of ending of the quarter of the financial year Due date
1. 30th June 15th July of the financial year
2. 30th September 15th October of the financial year
3. 31st December 15th January of the financial year
4. 31st March 15th May of the financial year immediately following the financial year in which deduction is made


Due date for furnishing TDS certificate to the employee or deductee or payee is revised as under

Sl. No. Category Periodicity of furnishing TDS certificate Due date


1. Salary       (Form No.16) Annual By 31st day of May of the financial year immediately following the financial year in which the income was paid and tax deducted
2. Non-Salary

(Form No.16A)

Quarterly Within fifteen days from the due date for furnishing the ‘statement of TDS’



Articleship Vacancy


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with Post qualification/ experience of 3 to 15 years in the field of –

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Presentation on AS-30,31 & 32

Recently CACTUS organised a 6 Hour seminar (open for all CA Final students) on recently introduced Accounting Standards 30,31 & 32 (Financial Instruments). The seminar was conducted by reknowned Central-India Faculty Sarthak Jain Sir.

We would like to share with all those who were not able to attend the seminar a comprehensive and self explanatory presentation covering all the basic concepts of the vast AS which are relevant from the view point of examination

Click here to download the material. AS 30_31_32 FORMATTED

PCC Nov 09 First Rank Holder

February 2, 2010 3 comments

Professional Competence Examination Results

ROLL Number



Rupali Gupta

Group I

Advanced Accounting


Auditing and Assurance


Law, Ethics and Communication






Group II

Cost Accounting & Financial Management




Information Technology and Strategic Management






Grand Total


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