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Introduction

Important indicators

  • Price Earnings Ratio

  • Price to Book value

  • Dividend Yield %

  • Compounded Annual Growth Rate (CAGR)

  • Standard deviation

  • Alpha

  • Beta

  • Volatility

  • Correlation

  • Sharpe Ratio

  • Sortino Ratio

Price Earnings Ratio

The P/E ratio is a measure to know how expensive the stock is when compared to scrips within the same industry or with the industry. It is an effective tool of fundamental analysis. Index PE can be used as an effective comparison benchmark.

Formula: Index Mcap / summation of cumulative rolling four quarters earnings adjusted for free-float

Cumulative Rolling four quarterly earnings:

The net profit as disclosed in the quarterly results (stand-alone basis) is cumulated for the rolling four quarters to arrive at the earnings of each scrip. The earnings (both positive and negative) of each scrip in the index are then cumulated to arrive at the index-wise earnings. In case the rolling four quarterly earnings are unavailable then the available earnings are annualized.

Index Mcap: Index Mcap of the Index constituents is sum total of the outstanding equity shares considered for index computation multiplied by the last traded price of each index constituent.

Price to Book value

Price to book value is considered as a better measure when compared to the price earnings ratio as the price to book value measures the enterprise value of the company and further the chances of book value being negative is very less. Further book value is considered to be more stable than PE ratio in a volatile market.

Formula: Index Mcap / summation of annual book value or networth adjusted for free-float

Gross book value of the index:

The equity capital and the reserves and surplus as reported by each company in the annual results (stand-alone) are cumulated to arrive at the book value of each company. The book value of the scrips in the index is cumulated to arrive at the gross book value of the index.

Dividend Yield %

Dividend yield measures the investment return and is an effective measure for both short term and long term investors.

Formula: Summation of gross dividend adjusted for free-float divided by Index Mcap * 100

Gross dividend of the index:

The total equity dividend of the company consisting of final, interim and any other special dividend is cumulated with respect to each company. Further, the equity dividend of each scrip in the index is cumulated to arrive at the gross dividend of the index.

Compounded Annual Growth Rate (CAGR)

CAGR measures the year-over-year growth rate of an investment over a specified period of time. The compound annual growth rate is calculated by taking the nth root of the total percentage growth rate, where n is the number of years in the period being considered.

CAGR= ((Ending Value/ Beginning Value) ^ (1/No. of years))-1

Standard deviation

Standard deviation is a measure of the dispersion of a set of data from its mean. The more spread apart the data, the higher the deviation. Standard deviation is calculated as the square root of variance. In finance, standard deviation is applied to the annual rate of return of an investment to measure the investment's volatility. Standard deviation is also known as historical volatility and is used by investors as a gauge for the amount of expected volatility.

Alpha

Alpha is a measure of performance on a risk-adjusted basis. Alpha takes the volatility (price risk) of a security or fund and compares its risk-adjusted performance to a benchmark index. The excess return of the fund relative to the return of the benchmark index is a fund's alpha.

A positive alpha of 1.0 means the security or fund has outperformed its benchmark index by 1%. Correspondingly, a similar negative alpha would indicate an underperformance of 1%.

Beta

Beta is a measure of the volatility, or systematic risk, of a security or a portfolio in comparison to the market (or market index) as a whole. Beta is used to calculate the expected return of an equity based on its beta and expected index returns.

A beta of 1 indicates that the security's price will move with the index. Beta of less than 1 means that the security will be less volatile than the market index. A beta of greater than 1 indicates that the security's price will be more volatile than the market index. For example, if a stock's beta is 1.2, it's theoretically 20% more volatile than the market. Beta is also known as "beta coefficient."

Volatility

Volatility refers to the amount of uncertainty or risk about the size of changes in a security's value. A higher volatility means that a security's value can potentially be spread out over a larger range of values. This means that the price of the security can change dramatically over a short time period in either direction. A lower volatility means that a security's value does not fluctuate dramatically, but changes in value at a steady pace over a period of time.

Correlation

Correlation is a statistical measure of how two securities move in relation to each other. Correlation is computed into what is known as the correlation coefficient, which ranges between -1 and +1. Positive correlation (a correlation co-efficient of +1) implies that as one security moves, either up or down, the other security will move in same manner, in the same direction. Alternatively, negative correlation means that if one security moves in either direction the security that is perfectly negatively correlated will move in the opposite direction. If the correlation is 0, the movements of the securities are said to have no correlation.

Sharpe Ratio

Sharpe ratio was developed by Nobel laureate William F. Sharpe to measure risk-adjusted performance. The Sharpe ratio is calculated by subtracting the risk-free rate - such as that of the 10-year government bond from the rate of return for a portfolio and dividing the result by the standard deviation of the portfolio returns.

The Sharpe ratio tells us whether a portfolio's returns are due to smart investment decisions or a result of excess risk. Although one portfolio or fund can reap higher returns than its peers, it is only a good investment if those higher returns do not come with too much additional risk. The greater a portfolio's Sharpe ratio, the better its risk-adjusted performance has been. A negative Sharpe ratio indicates that a risk-less asset would perform better than the security being analyzed.

Sortino Ratio

A modification of the Sharpe ratio that differentiates harmful volatility from general volatility by taking into account the standard deviation of negative asset returns, called downside deviation. The Sortino ratio subtracts the risk-free rate of return from the portfolio’s return, and then divides that by the downside deviation. A large Sortino ratio indicates there is a low probability of a large loss.

The formula does not penalize a portfolio manager for volatility, and instead focuses on whether returns are negative or below a certain threshold. The mean in the Sortino ratio formula represents the returns a portfolio manager is able to get above the return that an investor expects.

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