The value of a stock is the future dividends discounted by the expected returns. Valuation, on the other hand, is just the price of a security expressed as a ratio.
India's most popular stocks are drawing sighs of despair from value investors at the moment, given their expensive valuations. However, Morgan Stanley is of the view that Indian equity markets still have a lot of value stocks to offer.
In a report authored by Ridham Desai and Sheela Rathi released earlier this week, the brokerage said the practice of value is loaded with subjectivity and judgment. The global investment bank attempts to identify value from their own coverage universe which includes Bajaj Auto, Mahindra & Mahindra (M&M), ITC, Yes Bank, M&M Financial Services, Shriram Transport Finance, Cipla, Tech Mahindra, Vedanta and GAIL India.
The value of a stock is the future dividends discounted by expected returns. If the price of an equity share is less than or even equal to its estimated value, it is called a value stock. Valuation is just the price of a security expressed as a ratio.
But, in practice, these are complicated calculations. Most investors are not sure what the expected rate of return is: Is it an absolute number, should it be relative to long-term inflation expectations, must it be a premium over the risk-free rate and if so, what is that premium, or is it the long-term return expected from all securities put together?
Morgan Stanley feels figuring the expected rate of return is considerably easier compared to figuring out future dividends. Estimating future dividends with a degree of confidence, let alone its terminal value, are, at best, heuristic decisions.
The common quip is that when a stock is cheap (on valuations), the downside is protected. However, the brokerage is of the view that such a statement can only be made with respect to value and not valuations.Does Sensex offer value at current levels?Morgan Stanley said it depends on how the index dividends grow in coming years. Its residual income model is projecting a 12 percent rupee return over the coming decade. If the return expectations are lower, the BSE Sensex offer 'value', it stated.