My goal is simple. I am here for you, the average middle-class investors, with the only objective of helping you make more money from the secondary market. Have you seen your portfolio decreasing in its value ever since NEPSE had hit an all-time high of 1,888 on the 27th of July 2016 which closed on 1881.45? You're not alone in this. There is a way to minimize losses incurred with the help of an effective concept, i.e. Weighted Average Cost of Capital (WACC).
The value of my portfolio has reduced by an average of over 50% as well. This is an over-exaggeration on my part so as to be relatable with you but you get the point. But does this really need to be this way? Is there no way whatsoever to make money in the current bearish market trend? Today, I've come across an interesting analysis and I wish to share my findings with you.
What is WACC?
The Weighted Average Cost of Capital (WACC) is a calculation of a firm's cost of capital in which each category of capital is proportionately weighted. Even though the definition sounds complicated, this concept is really effective when it comes to minimizing losses in the stock market.
When we purchase any scrip continuously in the bullish market without focusing on the price of the scrip, the WACC of that scrip increases continuously. Similarly, when we purchase any scrip continuously in the bearish market without focusing on the price of the scrip, the WACC of that scrip decreases continuously.
We can take the advantage of WACC especially when the market is bearish. In the bearish market, the price of any company starts to free fall. Then, when we keep purchasing stocks that is decreasing in value, we decrease the effective purchase price of the stock, which makes it easier for us to book bigger profit when the market is bullish.
Analyzing NABIL and CBL:
For this analysis, I've chosen two commercial banks, one with higher investor confidence and the other one with relatively lower investor confidence. These companies are Nabil Bank Limited (NABIL) and Civil Bank Limited (CBL) respectively.
The bases for this analysis are mentioned in the points below.
1. The shares of these companies were bought at the peak of 1881.45 on the 27th of July 2016.
2. The total amount of investment is Rs. 2,00,000, i.e. Rs. 1,00,000 on NABIL and Rs. 1,00,000 on CBL each.
3. The shares bought at 1881.45 have not been sold yet.
4. Cash dividends are not reinvested into the market and the bonus share dividends are not sold.
Analyzing price action of NABIL:
Total units of the NABIL scrip at NEPSE index 1881.45 with Rs. 1,00,000 = 40 units at Rs. 2466 per unit.
Then, we have added all the bonus share dividends distributed by the company since the 25th of July 2016.
Last Trading Price of NABIL as of the 30th December 2019 = Rs. 675
Present Value = (84 × Rs. 675) + 4,763 = Rs. 61,463
Analyzing price action of CBL:
Total units of the CBL scrip at NEPSE index 1881.45 with Rs. 1,00,000 = 357 units at Rs. 280 per unit.
Then, we have added all the bonus share dividends as well as the right shares distributed by the company since the 27th of July 2016.
Last Trading Price of CBL as of the 30th December 2019 = Rs. 136
Present Value = 569 × Rs. 136 = Rs. 77,384
However, when we subtract Rs. 14,600 for the 146 units of right shares issued by CBL, the new present value of CBL becomes Rs. 62,784.
Even though both NABIL, as well as CBL scrips, are in the negative balance from our principal amount, CBL has been showing a better balance than NABIL is. But will this result hold true in the long run?
However, to put the things in perspective, we should see that the investors are optimistic about the CBL scrip as the company hasn't been doing well and yet holds a Price to Earnings Ratio (PE Ratio) of 16.87 when its Earning Per Share (EPS) value is Rs. 8.06.
If we are to compare these companies fundamentally, NABIL holds a PE ratio of 13.39 when its EPS value is Rs. 50.41.
Would you own the stocks of a stable company with strong reserve, a reasonable EPS and a good PE ratio or gamble with the stocks of a company that's on the verge of bankruptcy? Which company do you believe will be able to give big amounts of dividends to its shareholders in the long run? That's where the investors need to decide on what to do with the money that they've worked so hard to earn.
But you might be telling me, "Suraj, our investments have reduced by 12.610% and by 11.089% on the NABIL scrip and on the CBL scrip respectively from our initial investment of Rs. 1,00,000 on each scrip. How do we make a profit while covering up our losses? Does this really need to be this way? Is there no way whatsoever to cover up our losses in this ongoing bearish market?"
I wish to repeat simple idea to book a good profit even when the market is still indicating the bearish trend. You can buy these scrips in less than what you had bought for and reduce the Weighted Average Cost of Capital (WACC) of the scrip. Then, you can hope for the bullish market to begin soon.
This is a moment to buy any scrip at a cheaper price and reduce your WACC as much as possible. As the volume of the stock in your portfolio increases, it will be easier for you to book a big profit when the market cycle turns bullish.
Disclaimer: Investing can be risky and it can turn out to be hazardous as we grab a wrong notion of investing. So, do not take this article as financial guidance. Always consult a licensed CFO or portfolio manager for your particular investment plans and financial goals.