Which is the one formula the Big Bull held sacred?

Rakesh Jhunjhunwala earned his first big hit in 1986 when he bought 5,000 shares of Tata Tea at Rs 43 which rose to Rs 143 within three months earning him profit.

Rakesh Jhunjhunwala, the Big Bull of Indian stock markets, had fallen back on one mathematical formula time and again.

It captured the importance of both the company’s ability to generate profits and the market’s perception of its ability to generate profits.

“I was introduced to a simple mathematical equation. Earnings per share (EPS) x price earnings ratio (PER) = price. It was apparent that when both the variables determining price, that is EPS and PER gain, the stock prices explode,” he said in an interview with N Mahalakshmi, formerly editor of Outlook Business.

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Jhunjhunwala was introduced to the stock market when he was very young, at the age of 15, when he used to listen to his father talking about it. It captured his curiosity and he studied stock price movements through newspaper articles and by quizzing his father. He read every annual report he could lay his hands on, he said in the interview. After his graduation and clearing his chartered accountancy examination, he decided to accept the “challenge of making a career by investing and trading in stocks”, and since then he has held this formula close.

Going by what he said in the interview, predicting the EPS can largely be done using numbers–it is “mainly science and partly art”--but predicting the second part of the formula or PER was more than that. About predicting PER he said, “ Like cooking and sex, it cannot be taught, but it has to be learnt. I learnt that understanding/predicting PEs is the most difficult of all and the most critical factor to successful investing.”

Jhunjhunwala said that the EPS was specific to each company, but the PER was dependent on the company and its externalities. “The internal conditions that determine PER include the reward records of the company, predictability of earnings, risk model, perceived growth opportunity, and the perceived integrity of the management,” he said.

When looking at the EPS, it’s not just the absolute value we need to consider, according to him. We need to look at the quality of EPS, he said. “In my analysis, rather than trying to project absolute profitability, I try to understand the reasons and circumstances that give rise to these profits,” he said.

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While trying to predict the company’s profit, he considers the demand or the market for the product/service; the ability of the company to deliver it at the “lowest price to the widest customer base”; its strength in operating leverage; its scalability and integrity of the company.