Value investing, one of the stock picking method, talks about picking stocks trading below their inherent worth. Basically this method is by its very nature a conservative approach to pick up stock wherein we focus more on the safety of the investment rather than exceptional gains on the investment.
There are various ways to identify bargain stocks in line with value investing principles: low P/E ratio, low P/BV ratio and low P/CF ratio among others.
For this discussion, we shall focus on the low P/BV ratio. Let us first understand what this ratio means. Book value is the total value available to shareholders on a particular balance sheet date.
We can calculate this by either of these methods: (Total Asset-Total Liabilities)/No of shares outstanding or total shareholders’ equity/No of shares outstanding. If a stock is trading at less than book value (P/BV<1), stock is considered cheap or undervalued or bargain buy.
The argument here is that the stock should at least trade at their book value, if not more, in near future. On the other hand, if a stock is trading at significantly higher than book value (P/BV>3), stock is considered overvalued or expensive.
Going with the above mentioned stock picking approach, we tried to find bargain buys (stocks trading below book value) in Indian stock market.
In our screening, we also added few more criteria such as minimum market capitalization of INR6 bln (to remove illiquid and small stocks), minimum last twelve month (LTM) return on equity of 10% (to keep quality stocks) and minimum 5 years LTM revenue compounded annual average growth rate (CAGR) of 10% (to keep quality stocks). The screening mentioned above resulted in following stocks:
Out of 17 stocks in the list, 11 are from banking sector, specifically public sector banks. This is not surprising given the fact that investors have been dumping public sector banks recently on account of various issues including increasing non-performing assets (NPA), low growth prospects because of slowing GDP growth rate and increasing capital requirement in view of proposed Basel 3 rules.
Not to mention, public sector banks have been more exposed to growth in NPA as compared to private sector banks.
To find out which stocks are relatively better bet among 17 stocks, we generated following charts. Stocks inside yellow circles in both charts are relatively better bet in terms of ROE and Revenue growth rate.
Investors should try to find out the reasons why these stocks are trading below book value. Sometimes stock may trade below book value just because a company is in deep trouble due to poor business and high debt among others. Investors should ignore those kinds of stocks to be on cautious side despite the fact that stock looks like a bargain buy.
Since increasing NPA is a big concern for public sector banks, let us compare how above mentioned banks stands against each other in terms of NPAs. Once again, stocks inside yellow circle appear to be a better bet as compared to other banks.
Should the tide turn in favor of banking stocks in near future, these banking stocks should yield good return to the investors. Evidence in case is the fact that when big bang reforms were announced by government recently, banking stocks jumped by as much as 20%. Moreover, many analysts feel that NPA concern and beating of public sector banks is overdone and hence these stocks should start moving up soon. Reiterating basic premise that the stock should trade at least at book value, these stocks should yield good return to the investors in coming time.
