WHAT TO BUY? OR “HOW” TO BUY?

about 6 months ago
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“Any stock worth buying?”

That seems to be the constant quip every time the market goes up. Indices are hitting historic highs and stocks too, making one wonder whether it is worth buying at such high valuations.

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 is good 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.

Today’s situation does explain this concept of value investing very well. Suddenly there is a long queue to buy stocks like Divi’s Labs, Ujjivan Financial, Axis Bank, NCC, IOC.  On the other hand, they are shunning automobile, power stocks as the clouds around them are not too bright currently.

Many feel that it is the PE which determines the value of a stock. Well, they couldn’t be more wrong. PE indicates investor fancy but it cannot be the true yardstick to measure its value. There are so many stocks today quoted at a PE of over 100 but there are people still buying into the stocks, where in majority of the cases, valuations have run ahead of its fundamentals.

On the other hand, there are illustrious and very sound companies in South India – the Lakshmi group, TVS, Murugappa, Shriram group and many more which are financially very sound, with excellent cash flows yet they command a very low, single digit PE. Now these are value stocks but the marketmen just do not seem to favour value.

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?

Despite the run-up in stock price, there are still many value stocks in the market, which will bounce back when economy improves. Look at the infra space and PSU banks. The story is good for cement and if you have the conviction that capital good stocks will fare once infra build spurs on, then they too will prove to be value buys.

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. Motherson Sumi, Crompton Consumer, Escorts, M&M Finance, Dabur India, Wabco, Voltas, Gabriel India, Karnataka Bank, Graphite India, HDFC, L&T, Asian Paints are some of the good value stocks which one can consider for investment.

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