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Low valuation of stocks leads to a market rally

Low valuation of stocks leads to a market rally
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First Published: Thu, Mar 19 2009. 11 39 PM IST

Updated: Thu, Mar 19 2009. 11 39 PM IST
Mumbai: The stock market is in the midst of a rally and analysts attribute it to the low valuation of Indian stocks, 50% of which are trading below one measure of their intrinsic worth.
On Thursday, the Indian equity market rallied for the second consecutive day as stable global markets and further steps by the US to stimulate its economy boosted investor sentiment and foreign investors rushed to buy stocks.
The Bombay Stock Exchange’s bellwether index, the Sensex, closed above the 9,000 level for the first time in almost a month. The index gained 0.28% on Thursday, following a 1.27% increase the previous day.
Also See Going Cheap (Graphic)
Almost all Asian markets recorded gains, led by China’s Shanghai Composite Index that rose 1.18% following the Dow Jones Index, which gained for the sixth time in seven days after the US central bank said it will inject at least $1 trillion (Rs50.8 trillion) to boost the housing market.
Foreign institutional investors pumped in around Rs353.7 crore on Wednesday, according to provisional data released by the market regulator. Analysts attribute this interest to valuations. One out of every two companies that constitute the BSE-500 index, which accounts for 93% of India’s total market capitalization, is now trading below its book value.
Price to book value ratio, or P/BV, is the ratio of a firm’s market value to its book value, which is the net worth—the sum of equity and free reserves—of a company. The P/BV is calculated by dividing the market capitalization of a firm by its net worth.
Overall, the BSE-500 stocks are collectively trading at 1.89 times their book value. However, the Sensex is still trading at a price to book value ratio of nearly 2.49. This is much higher than the 1.6 P/BV level when the market bottomed out during the bear phase in October 1998.
While the market capitalization is based on stock prices on Thursday, the 2008 fiscal year-end books of these companies were considered for this analysis. Ideally, the net worth of banks should be calculated taking into consideration their non-performing loans.
This analysis, however, has not followed this norm due to non-availability of such data.
Incidentally, the Sensex’s P/BV is among the highest among emerging markets in Asia, at least twice that of Hong Kong’s 1.21 and higher than Jakarta’s 1.48. Indeed some markets such as South Korea and Singapore are trading below their book value, as are several Indian stocks.
A Mint analysis shows 225 of the BSE-500 stocks are now trading at levels lower than their book value. The list of undervalued stocks includes 25 banking and 29 real estate industry companies—sectors whose books are viewed with suspicion by the market because of fears of rising non-performing assets and debt, respectively.
Analysts say these stocks are good buys given the current valuation, but in the same breath caution that in the short term, there is no way to predict which way the markets will move.
The book values used in these calculation are derived from balance sheets as on March 2008. If March 2009 numbers are used, the number of firms trading below their book value may further increase.
“There is no point in hurrying (to invest),” said Chetan Parikh, head of Jeetay Investments Pvt. Ltd, a wealth manager. “There are a lot of companies that are cheap, but that is not to say that they cannot become cheaper.”
Of the 30 Sensex stocks, four are trading below their book value. They are Hindalco Industries Ltd, Tata Steel Ltd, Tata Motors Ltd and ICICI Bank Ltd. While Hindalco is trading at 0.34 times its book value, Tata Motors is trading at 0.9 times its book value. Tata Steel is trading at 0.55 times, and ICICI Bank is trading at 0.95 times its book value.
Overall, 91 of the 225 stocks are trading below 50% of their book value and 82 of them between 50% and 75% of their book value. To be sure, one cannot make investment decisions solely based on market book values, which are just one of the indicators.
“The P/BV of any index depends upon the characteristics of the constituents of the index,” said an analyst from brokerage First Global, who wanted to remain unidentified. It depends on return on equity, growth expectations, inflation and inflation expectations, interest rates, cost of capital and so on, he said.
Some analysts see Indian stocks’ book value going down as more bad news trickles down to the market. “We believe this could be a temporary reprieve, if at all,” says Morgan Stanley India Co. Pvt Ltd analysts Ridham Desai and Sheela Rathi in a note circulated on Wednesday evening. “Our point is that if we knew the next piece of new bad news then the market would not be rising.”
Photo by Madhu Kapparath / Mint
Graphics by Ahmed Raza Khan / Mint
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First Published: Thu, Mar 19 2009. 11 39 PM IST