All about the intrinsic value of a real estate stock

Representational image.

Ramneek Sethi, an IT professional, wanted to invest in the stock market. He was keen on real estate shares, keeping in mind the sector’s growth potential and India’s increasing urbanisation.

However, he changed his mind after meeting a financial planner, who asked him to stay away from volatile real estate stocks and instead get into the power play through proxies in cement, steel, and other ancillary businesses.

Reason: Real estate stocks are not only volatile, but more often than not, they even defy the principles of fundamental analysis and technical analysis.

The financial analyst was not without sound logic. No one has been able to decode what drives a real estate stock. Although it’s always been debatable what determines the market price of a stock in any business, in real estate, logic goes for a toss when one finds two identical companies with similar financials but different fortunes on the bourses.

There’s no denying that real estate stocks have always been in high demand. After all, in a housing-deficient country like India it has to constantly grow.

However, what is often intriguing is that some real estate stocks have much higher price points than their peers with similar fundamentals, including the EPS and PE ratios. This raises a fundamental question about what determines the price of the real estate stocks.

Why are certain real estate stocks undervalued? Is there any rationale behind overvalued real estate stocks? Every overvalued stock has a moral high ground that investors believe in. In contrast, every undervalued stock has an alibi that the market has failed to assess its intrinsic value.

The intrinsic value of a realty stock is yet to be defined. Is it EPS, PE, market price, land bank, or the company’s future earnings?

Market perception can play a greater role than fundamentals when it comes to stock performance. Take the case of Godrej Properties. The stock touched a peak of Rs 2,502.75 on October 14, 2021, and it fell to Rs 1,871.80 by December 31, 2021. Since then, it has been on a downward curve. What changed the fortunes of Godrej Properties in less than three months?

Godrej Properties had been growing. Its balance sheet and sales had increased and launches exceeded industry average. Still, the company’s stock declined.

The reason was negative market sentiment over a planned alliance with DB Realty, which was eventually scrapped. But the stock still did not recover.

A section of analysts said the very nature of real estate is not meant for getting listed because there is hardly any price movement and/or sales momentum quarter on quarter. The new accounting norms, IND AS 115, also prohibit recognition of sales realisation in the books until a project is completed.

Other analysts said the earnings of a real estate enterprise depend on the quantum of delivery and those with a diversified portfolio such as residential, commercial and contractual projects have an edge over financially sound and well-earning companies. So, these experts say PE is not the right way to evaluate realty stocks.

The profile of investors and their holdings in a company is also an indicator of the market’s perception. If institutions with better access to information and sound analysis own a higher percentage of a company’s shares, it is an indicator of institutional trust in the company.

A comparison of PEs of developers shows that Puravankara is at 13.29, Prestige is at 13.34, Sobha is at 45, Godrej is at 114.15, and Brigade Enterprises is at 123.44 (all figures at the time of filing this analysis). Does this mean that the fundamentals and portfolios of Puravankara and Prestige are at par? Does Brigade have that much of an edge over the others?

According to Abhishek Kapoor, CEO of Puravankara, the healthy way of evaluating the performance of a company is to look at the sales figures, the cashflows, the money being burned in projects, and the launch pipeline.

“A couple of years ago we were selling ready-to-move inventory where we were collecting 100 percent in a span of three months. So, our cashflows were strong,” Kapoor said. “What happened last year is that our cashflows were strong and our ready-to-move was down by 67 percent. So, how do you interpret it?”

Kapoor said this meant sales were definitely good, Puravankara was burning a lot more money on operations and they were delivering. Therefore, collection milestones were achieved from old sales.

“So, it is more about the perception issue where people have to understand and identify the actual numbers,” said Kapoor.

Perception might be a logical answer to the complex behaviour of real estate stocks, but then what defines perception is also a subject of debate. Many real estate companies with heavy debt and standing inventory twist the narrative by saying that gross debt may sound high but net debt is low because they have saleable inventory.

However, this narrative is flawed because it is subject to the interpretation that there are ready buyers in the market and that developers don’t have inventory holding costs.

Does it affect the general public? Well, for a common homebuyer, the only equity is property – it doesn’t matter whether the builder is a listed entity.

But for stock-savvy Indians, real estate stocks are definitely a subject of interest, given the volatile but high probability of handsome returns.