“Any stock worth buying?”
That seems to be the constant quip every time the market goes up and nowadays more so, when markets are down. With valuations soaring, many times surpassing the fundamentals too, it makes one wonder whether there is anything worth buying?
In fact many brokerages and fund houses have raised red flags on equity valuations, especially given the poor expected earnings for Q1FY20. The BSE Sensex is today trading at a valuation of over 28 times its underlying earnings in the trailing 12 months. If that does not give a resounding knock on valuations, what will?
And when asked, “Are you looking for growth stock or value stock?” most are stumped and just shrug their shoulders and say that any stock as long as it makes them money.
Making money alone cannot be the criteria for investing – it is the driving force but it you do not look at growth or value as two decisive factors of investing, buying shares could always remains a losing proposition.
But therein lay the flaw – growth and value are like Siamese twins joined at the hip and where growth is a component of calculating value. So what this means that every investment that we are making is essentially about getting the value for your money.
Thus if the ultimate purpose of investing is to get value for your money, then it definitely means that one has to buy stocks when quoted at lower rates and then wait for the value to get recognized by others. On the other hand, growth stocks are those which are already on the rise, have caught the investor fancy and the underlying assumption here is that growth of the company and stock price are directly linked and this is based on overall profitability estimates of the company and lesser of the sector.
Some of the common characteristics of a value stock is high dividend yields, lower price to book value multiple, lower price to earnings ratio making it look more attractively priced compared to its peers. These fundamentals give an opportunity to value investors for huge gains.
A mature company having a stable dividend history and currently experiencing negative sentiment due to some outcomes is mostly considered a value stock. Also some companies having been listed recently on the exchange and investors not having much knowledge about it can also be considered as a value stock.
However, value stocks are considered to be more risky than the growth stocks for whatever potential upside because of the sceptical attitude towards value stock. Once the sentiment in the market for the stock changes only then a value stock will be able to grow to its utmost potential and turn profitable for the investor. This is why most value investors have a higher long term return as compared to a growth stock due to the risk involved. The duration of investment must be observed to allow the stock to emerge from its undervalued position and also involves a risk that the investment would never materialize due to prolonged negative sentiment or lack of triggers for unfolding of the specific events.
So then how exactly does one identify a value stock? Warren Buffett rightly puts it – “ Value investing connotes purchase of stocks having attributes such as a low ratio of price to book, a low price-earnings ratio, or a high dividend yield. Unfortunately, such characteristics, even if they appear in combination, are far from determinative as to whether an investor is indeed buying something for what it is worth. Correspondingly, opposite characteristics -- a high ratio of price to book value, a high price-earnings ratio, and a low dividend yield -- are in no way inconsistent with a “value” purchase. Similarly, business growth, per se, tells us little about value.” He succinctly explains, “ investors will benefit only when each dollar used to finance the growth creates over a dollar of long-term market value. In the case of a low-return business requiring incremental funds, growth hurts investors.”
Thus PE and dividend yields could be some of the components for measuring growth but if we want our money to earn more, we need to assess the cash flow of the company over the next few years – whether it will be positive or negative and then the macro factors governing the sector, which may or may not warrant future plans for expansion. Thus growth needs to be looked at from a free flowing cash perspective and how well it can be used for future growth enhancement. What is the point of a company giving high dividends and having good profits, if all its cash is to be eaten up by paying interest on the high debt it has taken?
Remember, value stocks are like pickle – they will taste better over time; so patience is integral to realize profits. Such stocks will give you a steady earning, are low risk and thus high on safety. Lakshmi Machine Works, Century Textiles, CG Power, NCC, Jain Irrigation, Force Motors, GSK Consumer, RBL Bank, Shriram Transport, SKF India, HCL Tech are some of the good value stocks which one can consider for investment.