Investment Shastra

MRP – the simplest way of communicating ‘fair value’ says the Editor of Outlook Profit

You must be aware about our ‘MRP’ concept for stocks and the benchmark indices Sensex and Nifty (Sensex@MRP and most recently Nifty@MRP). MRP gives you the fair value of the stock based on the long term earnings ability of the stock. One of the key individuals responsible for encouraging us to do a much rigorous analysis of the entire MRP concept was the Editor of the Outlook Profit magazine N. Mahalakshmi. She gave us extremely valuable insights and guidance when we were backtesting our method and validating its results. The concept also featured as a Profit Special story titled ‘The Right Price’ a few months back. Click here to read the Story

Recently, we got a chance to have a tete-a-tete with N. Mahalakshmi and got to know her views about the current rally and her thoughts on the concept of MRP. Mahalakshmi feels that, MRP is the simplest way of communicating the meaning of fair value to a common man. Though in the short term, prices are affected by sentiments over a period of time, prices tend to align with the fair price or MRP based on earnings. She also said that, as individual investors we should be focusing more on the MRP of the individual stocks.  Here is the detailed interview.

Q: What were your initial thoughts when you got to know the concept of MRP?
Mahalakshmi: Very interesting. Simplest way of communicating what “fair value” means to a common investor.

Q: What do you think are the biggest benefits of this concept for the retail investors?
Mahalakshmi: You get a sense of value in the market. Is it cheap or expensive compared to its real worth? But investors have to exercise caution – because this real worth as captured in the MRP is not sacrosanct; it is subjective and based on the earnings growth assumptions made by the analyst.

Q: Do you think it will be helpful to extend this concept to sectoral indices?
Mahalakshmi: Sure, why not. It can be indicator of how a sector is poised relative to other sectors.

Q: Sensex has crossed the Sensex@MRP. What are your thoughts on this rally? Can we expect a correction?
Mahalakshmi: As the analysis of historic Sensex@MRP shows that the markets at most times do not move in the trajectory predicted/dictated by the MRP. But over a period of time, prices do tend to align with the fair price (MRP) based on earnings.

This disconnect is because of the transient nature of the stock market itself. While earnings play a vital role in predicting stocks prices over long periods, other factors best captured by the word “sentiment” dominates stock prices in the short term. The limitation of the MRP methodology is that it does not capture variables other than earnings that determine prices in the short/medium term.

Q: Any areas in which we can improve the MRP concept?
Mahalakshmi: Can be, but really it depends on the objective and operating time frame of the targeted investor and conviction in a certain style. Every methodology has its times in the sun and nothing works all the time. A strong earnings based approach has stood the test of time, so any methodology – even the Sensex@MRP – which follows an earnings based approach will work provided the assumptions are right.

So the emphasis has to be on analytical rigour to crack the growth predictions.

There is no one formula to achieving success in stocks. All the great investors we know have had different styles of investing.

Q: Can it prove to be useful even for professionals and fund managers?
Mahalakshmi: My understanding is, this is what analysts are supposed to do – gauging MRP — and are doing albeit with little success.

Q: We have recently also come out with Nifty@MRP report. Personally, do you follow the Sensex or Nifty?
Mahalakshmi: They serve a limited purpose — of capturing the market action in one number. So for investors, it is of little significance. After all we invest in stocks, and not in indices. My vote is thus for Stocks@MRP, with assumptions stated upfront.

So, in a nutshell MRP can prove to be very useful to investors to find the fair value of a stock. The MRP needs to be supported by rigorous analysis of the growth prospects of the company.  So, this is what N. Mahalakshmi – Editor of Outlook Profit magazine thinks about the MRP concept.

What are your thoughts on this? How helpful have you found, knowing the MRP of the stocks you invest in? Do share your thoughts!

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