Sharp Correction Provides Good Value Buys For Investors With A Long Horizon. So how an investor can identify the good stocks to by for long term. In this article we discuss a method to do it.
THE stock market is known to over react on the way up as well as down. So, it should come as no surprise that the market price-to-book value of many fundamentally-sound companies has slid to its lowest level in many years as a result of the recent turmoil.
An analysis reveals that 181 companies (with strong fundamentals) are currently trading at a discount to BSE-500 index average price-to-book value (PBV) of around 4.75. And stock prices of 70 companies are trading at a PBV of less than 2. Such a sharp correction provides good value buys for investors with a long-term horizon.
To give a fair picture, only those companies whose revenues and net profit grew at a CAGR of 15% or more in the past three years have been included in the study. Companies with 3-year average return on capital employed of less than 15% and those with a market cap of less than Rs 50 crore have been excluded. Other than PE ratio, the book value is another parameter that is commonly used to value stocks. But what does P/BV means and how can investors use this parameter to value their investments?
P/BV is a valuation ratio and is arrived at by dividing the market price of a share with the respective company’s book value per share. Book value is equal to the shareholder’s equity (share capital plus reserves and surplus) and captures the intrinsic value of the company’s assets. Book value can also be arrived at by subtracting current liabilities and debt from total assets.
Besides relatively little-known stocks, the list includes some of fundamentally strong companies such as Clutch Auto, GIC Housing, Valecha Engineering, Ramsarup Industries, Indian Overseas Bank, Ansal Properties and City Union Bank, among others. Among the large-cap stocks, companies like Reliance Industries, Grasim Industries, Tata Motors, Bajaj Auto, Tata Motors, Maruti Suzuki, and Ashok Leyland are among the ones that are trading below the P/BV of BSE 500 companies.
P/BV is a good metric to value stocks of companies in the capital-intensive industries like engineering, automobiles and banks, which have large amount of tangible assets in their balance sheets. In contrast, companies in software and FMCG sectors have low amount of tangible assets (fixed assets etc) on their books and, as such, the P/BV may not be a correct indicator of valuation.
If a company is trading at a P/BV of less than 1, this indicates that investors believe that the company’s assets are overvalued or company is earning a poor return on its assets. Also, P/BV indicates the inherent value of a company and is a measure of the price that investors are ready to pay for a ‘nil’ growth of the company.
As such, since companies in the services sectors like software and FMCG have a high growth component attached to them, P/E and not P/BV is a right measure of their valuations.
