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Bargain Hunting: Stocks cheaper than their Book Value

, November 5, 2012, 5 Comments

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.

Chart 1: P/BV Vs ROE

 

Chart 2: P/BV Vs 5Y Revenue CAGR

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.






About author
Rajesh Ranjan is a Chartered Accountant with Post Graduate Diploma in Investment Analysis and MBA(finance) from Asian Institute of Management (AIM), Manila. He has around nine years of experience in the field of investment research (equity and fixed income) with leading financial services firm such UBS and Guggenheim Transparent Value. ...more
  • T.P.A. Narayanan

    Dear Mr.Ranjan,

    Your article made an interesting reading and gave a new perspective to think about. However, I feel that there are very strong reasons why these companies are quoting below the book value. For these purposes, I will classify the stocks that you have mentioned in to banking stocks(meaning public sector) and others and would like to provide my perspectives:
     Banking stocks:
    1) Tangible assets:
    As we are all aware, banks do not have any/have very few tangible assets in their Balance Sheets because of which their being quoted at below the book value is not surprising. In the business of banking, as you are aware, one instance of a debt gone bad erases all the income earned from that account for the past many years. Further, in case of liquidation of banks, the investors do not have tangible assets to fall back on which does not give any fallback option to investors.

    2) Government interference
    The public sector banks will always trail their private sector cousins in this aspect because by the very nature of their ownership, they are expected to follow the Govt. policies and dictat which we all know many a time are not commercial and are downright populist

    Other stocks:
    1) Management quality:
    I feel that the important issue you have missed out which the stock market places a high value on is the management quality. Most of the other companies in the list are owner driven companies with opaque quality of management and in the past have proved themselves to be not worth the investor’s trust. No wonder that the market does not trust them anymore.

    Pure financial analysis many a times does not give a correct picture and there are many other factors at play in the market some of which have been highlighted above. Lastly, I would like to believe that market is highly intelligent and if we go deeper in to the histories of each of these companies, we may know the exact reason why these shares appear cheap.

    Regards,
    TPA Narayanan

    • Rajesh Ranjan

      Dear Mr. Narayanan,

      Thanks a lot for sharing
      your views. I broadly agree with your point but would like to point out
      following:

      1)    
      This article does not talk about complete fundamental analysis of
      the company but just a stock picking approach or screening method. If I were to
      invest in these stocks, I would certainly do detailed fundamental analysis
      (which will include business & industry analysis, financial analysis and management
      analysis) of all the shortlisted stocks before making final cut. Most of the
      points mentioned by you will be part of complete fundamental analysis. This is
      the reason one of the paragraph in the article says: “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”.

      2)    
      Lack of tangible assets is certainly an issue but not the main
      driver of cheap valuation. If that were the case banking stocks should almost
      always trade below book value. Case in point may also be software industry
      wherein there are hardly any significant tangible assets on the balance sheet
      but still most of the software firms do not trade below book value. In my view,
      one of the main drivers of cheap valuation is increasing NPA. One should also
      note that absence of tangible asset on the balance sheet is permanent issue
      whereas increase in NPA might be a temporary issue. And it is the temporary
      increase in the NPA that is pulling down the valuation temporarily. Not to
      mention that private banks have been more prudent in managing their NPA (apart
      from other efficiencies) and hence getting relatively better valuation.

      3)    
      Government interference was always there with public sector
      banks (even when these public sector banks were trading above book value) and
      it’s not a new issue. In my view market has discounted this since long and
      hence not a main driver of cheap valuation these days.

      Hope
      this helps. Thanks again!

      Regards,

      Rajesh Ranjan 

      • T.P.A. Narayanan

        Dear Mr.Ranjan,

        Thanks for your reply. Enjoyed reading your rejoinder as much as the original post. All the best.

        Regards,
        TPA Narayanan

  • arup

    not clear about author’s qualifications. either you are a mba finance studen or a graduate student. which?

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