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Wild market corrections generally bring down all stocks, good or bad, in a fleet.
That often throws up opportunities to grab quality stocks at cheaper prices to reap handsome gains in the long run.
That is exactly what has happened in the domestic market in recent past: price-to-earnings (P/E) ratios of 57 per cent of BSE500 index stocks have fallen below their five-year averages as of November 19 following the relentless hammering.
P/E is a valuation measure that analysts use to know whether a stock is overvalued or undervalued with respect to its earnings growth.
The ratio is calculated by dividing the current market price with earnings per share.
It shows what the market or an investor is willing to pay for per rupee earnings that a stock delivers.
Multibaggers graphite electrode majors HEG and Graphite India, too, figure in the list, despite having given up to 75 per cent returns so far this calendar.
P/E values of IT players Tech Mahindra, Intellect Design Arena, Mindtree and pharma players such Pfizer, Ipca Laboratories have all slipped below their long-term average P/E ratios.
ICICIdirect is bullish on HEG and Graphite India with 12-month price targets of Rs 5,750 and Rs 1,400, respectively.
The brokerage projects Graphite India’s top line, Ebitda and PAT to expand at a CAGR of 57 per cent, 67 per cent and 63 per cent, respectively, during FY18-20E, while for HEG, the same components are projected to increase 53 per cent, 40 per cent and 46 per cent, respectively.
Market veterans, however, caution not to jump the gun as often taking investment decisions on the basis of P/E alone makes little sense.
“One shouldn’t invest just because a stock’s current P/E is below its five-year average.
It may be an opportunity if profits have risen more than the proportionate increase in stock price and the market has missed the opportunity,” says G Chokkalingam, Founder, Equinomics Research and Advisory said.
One has to ensure that there is no doubt on the company’s future growth potential.
“In some cases, a fall in price may be more than proportionate that the fall in profits, and there may be greater uncertainty on maintaining current profits.
In those cases, the market may be smart enough to value such stocks at PE valuations lower than their historical averages,” he said.
Analysts say before picking such stocks one has to have the confidence on continued future profit growth.
“If a stock is available at a significant discount to historical average valuation, it is also possible that the sector or theme as a whole may have lost the growth opportunity or positive perception of market participants.
The gap can happen in such cases too,” says Chokkalingam.
P/E ratios of stocks such as Reliance Communications, Dewan Housing Finance Corporation, PC Jeweller, Manpasand Beverages, 8K Miles and Kwality were all trading far below their 5-year averages after these stocks plunged between 60 per cent and 93 per cent on a year-to-date basis.
Among others, GAIL, Infosys, United Breweries, Avenue Supermarts, Suven Life Sciences, Sterlite Technologies, HCL Technologies, Linde India, Kotak Mahindra Bank, KPIT Technologies, Housing Development, Aditya Birla Fashion and Retail, Exide Industries and Bajaj Finserv are prominent names trading at discounts to their five-year averages.
That, despite the fact that these stocks are up between 10 per cent and 26 per cent so far in 2018.
ICICIdirect is positive on GAIL with a price target of Rs 450.
“There is no doubt that many midcaps and smallcaps have corrected badly in the recent past.
Second quarter earnings have also showed pressure on some of the midcap and smallcap names.
It will take time for confidence to revive in this segment.
Investors who have an investment horizon of at least 3-5 years should start nibbling at the quality names.
Looking at only five-year average P/E is not a good idea, as the market have gone up sharply over the past five years.
We are not out of the woods as far as the market is concerned,” said Hitesh Agrawal, EVP, and Head of Retail Research, Religare Securities.
From a valuation perspective, Agrawal recommends Godrej Agrovet, Reliance Nippon Life Asset Management, Maruti Suzuki and Cummins India.
Price-to-earnings ratios of these stocks were quoting below their long-term averages as of November 19.
Besides attractive valuations, investors also need to zero in on certain other things.
“Along with inexpensive valuation, investors must look at future growth prospect of a company, RoE and lower debt-to-equity ratios,” said Sanjeev Jain, AVP, Ashika Stock Broking.
Dividend policy is another thing to consider while investing in a company for a long-term perspective.
It is important that the company has strong fundamentals and a sound management.
“Stocks of good quality companies generally trade at higher valuations.
In that case, price/earnings to growth (PEG) ratio should be considered for investment ideas,” said Jain.
The depressed P/E problem is more prominent in the auto and auto ancillary space.
Stocks like Wabco India, Bosch, Jamna Auto, Endurance Technologies, Sundaram-Clayton, Minda Corporation, Motherson Sumi, Eicher Motors, Bajaj Auto, Hero MotoCorp, Mahindra Mahindra, Maruti Suzuki, Ashok Leyland, Force Motors and Tata Motors are among the stocks whose price-to-earnings ratio are quoting far below their long-term averages as of November 19.
According to Emkay Global Financial Services, the automobile sector has been facing near-term concerns due to increasing cost of ownership and selective financing by some of the NBFCs, which has led to the tapering of volume growth in recent months.
“These concerns are temporary and volume growth would gradually improve led by strong rural demand, new launches, and government’s persistent focus on infrastructure spend and rural economy.
In addition, pre-buying before the transition to BS6 emission norms would support volume performance in FY20,” the brokerage said.
The brokerage projects commercial vehicles, passenger vehicles and two-wheelers segments to witness double-digit volume growth over FY18-20E.
Its top auto picks included Maruti Suzuki, Ashok Leyland, Mahindra Mahindra and Motherson Sumi.
In the baking space, P/E ratios of Kotak Mahindra Bank, RBL Bank, IndusInd Bank, AU Small Finance Bank, The South Indian Bank, and YES Bank are now trading below their 5-year averages.
Global brokerage CLSA has ‘buy’ ratings on Kotak Mahindra Bank and IndusInd Bank with price targets of Rs 1,420 and Rs 1,910, respectively.
In the consumer food space, Jubilant Foodwork, Nestle India, Varun Beverages, GlaxoSmithKline Consumer Healthcare, Godrej Agrovet, Parag Milk Foods, KRBL, Manpasand Beverages and Kwality are showing the same aberration.
Within staples, Edelweiss Securities favours players with superior execution capabilities, disruptive innovations and distribution expansion and market leadership.
Nestle and Dabur are among its top picks.
