Thursday, March 28, 2024

Earnings uncertainty makes price-to-book value trendier than price-to-earnings

Wednesday, September 30, 2015, 21:57
This news item was posted in Business category and has 0 Comments so far.

Several fund managers and investors are now preferring price-to-book (P/B) ratio over priceto-earnings (P/E) for valuing stocks given the uncertainty over the earnings pick-up. Earnings of several companies have still not picked up as estimated by the analyst community and the confidence amongst the investors remains low. During periods of short-term uncertainty in profits, it makes more sense to look at a company’s book value, which is nothing but the net asset value of a company. “Whenever you have periods of cyclicality and the near-term earnings momentum deviates significantly from the long-term ability of the company or a project then price-to-book is handy,” explains Rajat Rajgariah, research head at Motilal Oswal Securities. Preferring price-to-book is the latest trend that we are seeing amongst our clients, he added. For this reason, it can be useful for finding value investments primarily in the companies which are composed of mostly liquid assets, such as power, engineering, metals and banks and finance. Price-to-book ratio is not as useful in valuing companies in pharma, IT and consumer industry. So this is how it works. If one assumes that a company has a cycle of three years, then he can look at the three-year trend of P/B of that company and once the share of that company comes close to the three-year low, he may consider buying. S Naren, CIO of ICICI Prudential AMC, who is known for his contrarian bets and value buys, too, is relying more on the P/B ratio now in these volatile markets. “P/E as an indicator is pro-cyclical and fluctuates with market conditions thereby making P/B a more stable indicator. We believe in equipping multiple indictors for these sectors as cost curves for commodities and competitive scenarios for energy and manufacturing companies can change,” said Naren. Naren added that for such sectors, the P/B value could increase to the historical mean value, a phenomenon called as mean reversion. Therefore, a fall in the P/B could give buying opportunities. According to analysis done by ETIG of the BSE200 companies, companies in the cyclical sectors including metals, energy, capital goods and banks have been the biggest underperformers since the beginning of the calendar year given their earnings fell short of their expectations. However, for value investors who are not looking at short-term gains, 80 out of 133 companies (BSE200 companies ex-IT, pharma and consumer) are trading below 3-year average P/B. In addition, 37 companies are trading at P/B below one. Top 5 companies where the discount of the current P/B to the 3-year average value is the highest include Tata Motors, Coal India, Suzlon Energy, Vedanta and Bank of Baroda.

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