Why I like reading stock charts

Stock Charts reflect trend in price movements. Prices are a reflection of market consensus of earnings, profitability and growth potential of the company. Over a period of say one year, charts give us fairly accurate estimates of a company’s growth and future.

I shall take the example of Larsen and Toubro. The market has historically given it a Price to Earnings ratio of 20. When L&T disappointed the market in January 2010 by lower than expected third quarter results, market punished the stock severely. But the stock found support at Rs 1400. 1400/20= 70. It indicates market had factored in an annual EPS of Rs 70 way back in Jan 10. The recent results have proved that it has actually delivered Rs 70 as EPS for the FY 09-10. Thus market knows in advance.

Now the future. The management has guided for 20% upward guidance.  70x1.2= Rs 84 EPS. Thus the target price for FY 10-11 ought to be 84x20=Rs 1680. If we look at Larsen chart, then we know that these price points are already existing. The strong resistance at Rs 1700 ( or Rs 1729), indicates 1700/20= Rs 85 EPS. See market knows it in advance. However if market decides to pay a premium and value it at 25 times earnings then the target price is 84x25=Rs 2100.

So what does one do with knowledge? We buy on all dips to 1600, 1500 down to 1400 if any. We may trade in the stock by selling partly at 1700 if desired. A fresh breakout above 1729 will however indicate a new range for the stock. Then trading should be avoided. Market is  perceiving some new developments. So go with it.

In a volatile market Larsen appears to be a safe stock which  needs to catch up on its performance.

Rgds

Vibhas