Vivek Sharma
What decides share price of a company? This is one of the toughest questions which remain unanswered till date inspite of numerous theories and models available to value the stock price of a company. The main challenge in deciding share price of a company is understanding linkage between various factors that decide share price. With ceteris paribus assumption, one can look at some of the important factors that should ideally decide share price. For instance, how well a company is doing in terms of its sales growth, which industry it is operating in, what are the prospects of the industry, what are the corporate governance practices followed by a company etc, the overall macroeconomic condition etc .
While there are innumerable factors that may influence share price of a company, one factor which gets noticed is the relationship between share price and the profit made by a company. After all, profit is a key factor that is often tracked by market experts to find out in which a company is moving. Rise in profit on a consistent basis may potentially enhance the ROE of a company unless it has been diluted by issuing additional capital which has not been productively used. So what role profit has to play in deciding the share price? Are both of them linked, even if not linearly? Answer to this question requires extensive research and analysis. However, sample of some of the good companies can also give a fair idea about linkage between share price and profit.
Let us look at two stocks to answer this question. First stock is State Bank of India which has been in news for some wrong reasons recently while the other is ICICI Bank which has been favourite of market players for long time. Banking is thriving business in India and these two stocks are part of both Sensex as well as Nifty. Banking and financial services dominate the stock market landscape in India.
Both the banks have seen phenomenal rise in profit over a period of last five years. Barring last one year and half years in which SBI performance as a bank has shown erratic behaviour, SBI has not seen any major change in the profit pattern. SBI’s net profit in 2008-09 on standalone basis was 9121 crores which went up to 9166 crores in 2009-10. This profit in FY11 was 11707 crores which went up significantly to 14105 crores in 2012-13. Now let us look at share price. In 2009, the share price of SBI went up all time high of Rs.3515 per share which is now hovering around at Rs. 1500. While the profit has gone up substantially, share price has gone down just opposite of it. There is no doubt that recent fall in share price has been primarily because of the negative sentiments about PSU banking stocks. Please note that dividend has not been added in case of SBI which is close to Rs. 170 approximately over a period of last 5 years.
The same story is there in case of ICICI Bank. In spite of surge in profits continuously over a period of last five years, the share price has remained where it was five year back. Though in 2009, ICICI Bank share price had touched as low as Rs.259 because of the crisis that the bank had faced post global economic crisis is not true manifestation of the share price. The same year the share price of the bank recovered and reached Rs. 875 at year end. In case of ICICI Bank profit of the bank has doubled during this period but the share price has remained more or less ignoring the dividend given by the company during all these years. Even if share price of ICICI Bank has shown better upward movement than SBI, it cannot be directly linked to the increase in profit.
So what is the answer to the question raised in the first paragraph? The answer again is difficult to give but to draw a relationship between share price and profit is unfair in many scenarios. However, one critical aspect that investors can ill afford to ignore i.e. share price is not just impact by profit but also by the prospects of the profits and its sustainability in the future. Market may not always reward high profitability by upping the share price but it definitely pulls the share price down when profit is not good.
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