The general rule is that when a stock is trading below its 5-year PE, it usually indicates sluggish movement in price, which is further linked to earnings potential
The Indian market rebounded in November after having corrected significantly in September and October. The bounceback helped Sensex reclaim 36,000 and pushed Nifty over 10,900, but there is still plenty of action that one can expect from individual stocks.
Half the stocks in the Nifty are trading below their 5-year average price/earnings multiple, which suggests there is still some value left in them.
Stocks that are trading below their 5-year average PE include Bajaj Finserv, HPCL, Eicher Motors, JSW Steel, Indiabulls Housing Finance, HCL Technologies, GAIL India, Infosys, Hero MotoCorp, Bajaj Auto, Cipla, and NTPC, among others.
PE ratio or PE multiple is a widely-used valuation tool that helps in screening a stock on a relative basis.
The stock market has remained volatile for most of 2018, despite Nifty climbing to a record high of 11,760 earlier this year. The rise in the index was supported by a handful of stocks, as others lacked momentum.
Both Sensex and Nifty slipped after hitting record highs, but the pain was much worse in small and mid-cap indices, which saw double-digit falls from their respective highs.
The BSE Midcap index has slipped 17 percent this year, while the BSE Smallcap index has fallen 28 percent. In comparison, the Sensex is down just 7 percent from its 2018 high.
The Nifty recovered a bit in November, but only a few names were responsible for it. But it is a known truth that consolidation offers an opportunity to buy quality names that are currently trading below their 5-year average PE.
Generally, when a company is trading below its 5-year average PE, it is perceived to be undervalued. But to qualify as a stock worth buying, it should be backed by superiority in business fundamentals, experts suggest.
But, is the valuation methodology enough for investors to hit the buy button? Well, maybe not, suggest experts. The general rule is that when a stock is trading below its 5-year PE, it usually indicates sluggish movement in price, which is further linked to earnings potential.
“The PE multiple is a derivation of factors like earnings growth, operating margin, the fundamental outlook of the company prevailing in the market that decides a future prospectus,” Dinesh Rohira, Founder & CEO, 5nance.com told Moneycontrol.
“In general, it indicates the stock is not able to garner earnings potential or company is at bad phase on fundamentally. When there is no earnings visibility, investors will be unwilling to pay price or premium for such a company that in turn halts the stock price,” he said.
Rohira further added that to get a clear understanding, an investor should compare PE of a company with its peers. One should not take PE at its face value.
To make an investment call, it requires a holistic approach and disciplined study from investors which usually boils down to fundamental aspects of a company. Although, most of the stocks which are trading below their 5-year average have also corrected in double digits from their highs but investors should do their own research before pressing the buy button.
We believe PE should not be looked in isolation, Atish Matlawala, Sr Analyst, SSJ Finance & Securities said. A company with higher growth potential could see increase buying from investors which could in turn boost PE multiple of the stock, but the trouble is many of these companies may not grow at the same pace as they grew in the last five years, he explained.
“Sector like NBFC and auto may see their growth taper down as the cost of funds increases. Having said that there are few companies which we believe can give better returns in the medium to long-term perspective. These companies are HCL Technologies, Infosys, HDFC, Tata Steel and Vedanta,” Matlawala said.
He added that average PE will decline with declining growth prospects. It is therefore important to look at PEG ratio to make investment decisions. For the metal sector, one must look at EV/EBITDA ratio to select companies.Disclaimer: The views and investment tips expressed by investment experts on Moneycontrol.com are their own and not that of the website or its management. Moneycontrol.com advises users to check with certified experts before taking any investment decisions.