“Don’t just bet on price/earnings ratio”

Mumbai: Appraisals are the big buzzword Dalal Street for a while, but it suddenly picked up speed. These days every conversation starts with P/E ratio (a price-to-earnings ratio that compares a stock’s current price to its earnings per share) and ends with a loud proclamation that valuations look “a bit stretched.”

However, many experts believe that looking at the ratio in isolation will not help investors understand the realities of market and the higher valuation may not be the only decisive factor driving the market.

“Grades matter in the long term, but they don’t need to have an impact in the short term. This is because there is never a right valuation for a stock as it is a highly individual decision,” says Mukesh Dedhia, Director, Ghalla & Bhansali Securities.

“For example, a stock with a higher P/E may move forward because there is more demand for the stock due to the possibility of higher earnings. So there is always a bit of confusion about the correct assessment,” he adds.

“If you look at the broader market, it’s hard to make a value pick. But if you use a bottom-up method, you will still find many stocks in the market with the right valuation,” says Rajiv Thakkar, CEO, Parag Parikh Financial Advisory Services. Although he is a staunch proponent of value investing, he says that looking only at a ratio will not be the right way to invest in stocks.

”There are many things to consider. For example, you need to understand whether the growth rate is sustainable or how much capital is needed to sustain growth. There will be volume growth at times, but margins may be under pressure. There are multiple issues to consider, just looking at the ratio is not enough,” he adds.

Some experts also believe that higher valuations may be justified if foreign investors continue to pour money into the stock market in the hope of better performance by Indian companies.

“Current valuations do not justify India’s long-term growth potential. The market trades at 17 times 2011 earnings potential and about 13.8 times 2012 earnings estimates. It even carries a premium of about 50% to other emerging markets and about a 25% premium to other global markets,’ ‘ says Devendra Nevgi. Founder and General Partner, Delta Global Partners. He believes the premium can be justified if foreign investors continue to bet on Indian stocks.

Related Posts

Leave a Reply

Your email address will not be published.