What does Warren Buffet’s technique say about investment in the scrips of Nepalese commercial banks?

Jeff Bezos; founder of Amazon asked one simple question to Warren Buffet,

“Your investment strategy is so simple, yet nobody follows it. Why?”

In reply, Warren Buffet said,

“That’s because nobody wants to grow rich slow.”

Warren Buffet has always been in a limelight for his growth value strategy in investment decision making. This strategy did not turn Buffet into a millionaire overnight; instead, it came with patience and persistence. Buffet’s strategy has been advocated by many analysts in the international market. Buffet’s investment strategies come with a number of financial tools. This article considered implying one of these tools in Nepalese secondary markets with respect to scrips of commercial banks.

Buffet’s gurus for investment success was his father; Howard H. Buffet, his first wife; Susan Buffet and most importantly, his professor; Benjamin Graham. Thus, in his for investment job, working for his guru; Benjamin Graham, Buffet learned a basic valuation technique. This technique considers two components while making a purchase decision in investment:

1. Price to earnings (P/E)
2. Price to book value (P/BV)

 Price to earning is a common financial tool that shows how much an investor is willing to pay for a return of Re 1. It is the ratio of current market price and earning per share of a company. Price to book value is the measure of current market price to the book value of a company. This means it is the price an investor pays for Re 1 of the book value in business.

Here is an example:

If Mr. Ss buys scrip of a commercial bank with P/BV of 20, it simply means that SS pays Rs 20 for every Rupee he would get back if the stock was liquidated right now.

In this reference, please remember, low P/BV means high safety. A stock is regarded to have a low P/BV if it measures below 1.5. High P/BV means low safety. A stock is regarded to have a high P/BV if it measures above 1.5.

Now, what did Buffet do with these two indicators P/E and P/BV?

Warren Buffet simply took a product of the two indicators: P/E and P/BV. If the product of P/E and P/BV is more than 22.5, it implies that the stock might be overvalued. On the contrary, if the product of P/E and P/BV is less than 22.5, it implies that the stock might be undervalued. These are exactly the types of stocks that Buffet eyed out for. The undervalued stocks have a low P/E meaning higher return whereas the lower P/BV meaning higher safety.

What do Nepalese commercial banks indicate?

The market price is the LTP of 10^th May, 2018; Thursday.

Surprisingly, the Buffet’s technique provides a different answer for Nepalese commercial banks. The major points are:

1. None of the Price to Book value ratio of the scrips of commercial banks is below 1.5. This denotes the scrips of commercial banks resemble less safety if Buffet’s analysis is to be considered.
2. The banks that are undervalued are Prabhu Bank Limited and Nepal Bank Limited. These scrips have a PE*BPV indicator less than 22.5. Prabhu has a PE*BPV indicator of 17.37 whereas NBL has the same indicator at 12.65.
3. Except the two scrips, all the remaining scrips of commercial banks are seen to be overvalued.

What comes into play while using PE*BPV technique?

Buffet used this particular technique assuming that the market will be closed for next five years. That means investors who opt for this method of valuation should discard all the panics that come with bearish trend. Instead, they should focus on a result after few years. The PE*BPV technique used by Buffet further considers four rules of investment decision as listed below:

Rule 1: A stock must be stable and understandable

Rule 2: A stock must have long run prospects

Rule 3: A stock must be well managed by observant leaders

Rule 4: A stock must be undervalued

What are your views on the Buffet’s technique? Do you follow Warren Buffet’s principles while you invest? Do you think it can be implied in the Nepalese secondary market? Which techniques do you use for your investment analysis?

 (Disclaimer:  Any kind of information that is provided in the article should not be used as a sole advice or recommendation by investors in order to design their investment portfolio. So, before taking steps for any kind of the information, the investors are required to base their judgment on their own financial analysis, appropriateness of the information and seek independent financial advice. The information of the company has been taken from the authorized sources such as website of the company, NEPSE, financial reports and press releases of the companies so, any changes not updated in these may differ in the analysis.)