Selection based on BIB-ratio

 

A reliable way to gain insight in a stock's fundamentals is the NAIC method. It tells you whether you can consider a stock as cheap or expensive. Another and easier way to gain insight in a stock's fundamentals is offered by the BIB-ratio. It is also a good indicator for cheap and expensive stocks! Here you find a deeper explanation about the BIB-ratio.


 

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You will understand that a stock price by itself says nothing about the valuation of a share. Important is the stock price in relation to the company’s owners equity (assets minus liabilities), earnings per share and earnings yield. The BIB ratio puts together these parameters in a formula that calculates the value of a share.
Suppose a stock price of € 20 and the company’s owners equity amounts € 4,50 per share. This means that when you buy one share of this particular company you buy assets for € 4,50. The remaining € 15.50 that you pay can be considered as a premium which will be paid back later with the company’s future profits.
Suppose now that the company’s earning per share this year are € 1,25 and that analysts expect a future earnings increase of 15% each year. This means that it takes approximately 7,5 years before you have a full return on your investment.

The length of the return on investment period as a derivative of the stock price, the earnings per share and the expected average earnings increase is calculated as a ratio. The lower this ratio, the shorter your return on investment period and therefore the more valuable your share. A value under 0,5 indicates a buy signal, a value between 0,5 and 1 indicates a hold signal and a value above 1 indicates a sale signal.
The ratio is put together according to the following steps:

  • Determine the premium you pay by deducting the owner’s equity from the stock price.
  • Determine the return on investment period when the company’s profit level is concerned stable (earnings increase is zero). Do this by dividing the premium by the earnings per share. By doing this you calculated a corrected price earnings ratio.
  • Put this ratio against the annual earnings increase by dividing the first by the latter. A high earnings increase figure will lead to a shorter return on investment period and so justifies a higher stock price. The calculated ratio is in fact a corrected PEG-ratio.

The BIB ratio in our example will return a value of ((20 – 4,5) /1,25) /15 = 0,83. This means that the share is been valued neutral.