Observing Broad Market Valuation And Buying Selective Stocks- Is It Prudent?
Observing Broad Market Valuation And Buying Selective Stocks- Is It Prudent?
(Study has been done mostly on Mcap weighted average-however the method of calculation has been consistent throughout)
When we say currently Sensex Forward PE (FY09E) is at 17x (Free Float weighted) and 20x (MCap weighted) and then compare it with last 12 months average forward PE and we deduce that market is cheaper and now we can buy GOOD STOCKS (within Sensex).
Stocks like Reliance Ind, ICICI Bank, HDFC twins, L&T and likes- Which have a consensus or Mostly Buy ratings from prominent research houses (domestic and international alike) are good buys. And we avoid stocks from cement, auto, IT (though INR depreciation has brought back interest-nevertheless could be short lived!)-these sectors have cautious (Hold/ Sell) view from the same prominent research houses. Then there are few stocks on which the views are mixed like Bharti, BHEL, SBI etc.
Then I thought market is looking cheap land lets look into stocks that fall into Consensus/ Mostly Buy category. I started looking into their valuations. I looked into their PE, PBV and earnings growth and ROE etc. On Forward PE, these stocks trade at around 16% premium to Sensex (MCap weighted Forward PE) with similar earnings growth expectation of around 13-14% Y-o-Y. On Forward P/BV, these stocks trade at 12% Discount to Sensex but expected to generate an ROE which is 16% inferior to MCap weighted Sensex ROE!
I did the same exercise on the stocks that are in cautious category (either Hold/ Sell). On forward PE, these stocks trade at a discount of 19% with FY09E EPS growth expectation of 11% against 13.5% of Sensex. On Forward P/BV, they trade at 13% premium to Sensex P/BV but with generate an ROE which is 20% better than Sensex.
Hence, if we say that broad market valuation is at 12-15 months lows and its time to buy stocks, should we buy selective stocks or should we buy market (typically an ETF)? We say that market is at 17x and we buy stocks with PE of 20-25x (that contains some stocks that were valued cheaply when market was more valued than today).
(There could be an argument that the BUY rated stocks continue to trade at premium, agreed but the stocks which are on consensus/ mostly BUY list changes-Ratings are not Static. And when Mr Market was at 20-25x earlier there were another set of stocks which were on Consensus Buy lists Like NTPC, Reliance Energy etc. and people were not so sanguine about Ranbaxy, ITC and DLF- I was considered as risky investor when I applied for DLF IPO for my company!)
(Study has been done mostly on Mcap weighted average-however the method of calculation has been consistent throughout)
When we say currently Sensex Forward PE (FY09E) is at 17x (Free Float weighted) and 20x (MCap weighted) and then compare it with last 12 months average forward PE and we deduce that market is cheaper and now we can buy GOOD STOCKS (within Sensex).
Stocks like Reliance Ind, ICICI Bank, HDFC twins, L&T and likes- Which have a consensus or Mostly Buy ratings from prominent research houses (domestic and international alike) are good buys. And we avoid stocks from cement, auto, IT (though INR depreciation has brought back interest-nevertheless could be short lived!)-these sectors have cautious (Hold/ Sell) view from the same prominent research houses. Then there are few stocks on which the views are mixed like Bharti, BHEL, SBI etc.
Then I thought market is looking cheap land lets look into stocks that fall into Consensus/ Mostly Buy category. I started looking into their valuations. I looked into their PE, PBV and earnings growth and ROE etc. On Forward PE, these stocks trade at around 16% premium to Sensex (MCap weighted Forward PE) with similar earnings growth expectation of around 13-14% Y-o-Y. On Forward P/BV, these stocks trade at 12% Discount to Sensex but expected to generate an ROE which is 16% inferior to MCap weighted Sensex ROE!
I did the same exercise on the stocks that are in cautious category (either Hold/ Sell). On forward PE, these stocks trade at a discount of 19% with FY09E EPS growth expectation of 11% against 13.5% of Sensex. On Forward P/BV, they trade at 13% premium to Sensex P/BV but with generate an ROE which is 20% better than Sensex.
Hence, if we say that broad market valuation is at 12-15 months lows and its time to buy stocks, should we buy selective stocks or should we buy market (typically an ETF)? We say that market is at 17x and we buy stocks with PE of 20-25x (that contains some stocks that were valued cheaply when market was more valued than today).
(There could be an argument that the BUY rated stocks continue to trade at premium, agreed but the stocks which are on consensus/ mostly BUY list changes-Ratings are not Static. And when Mr Market was at 20-25x earlier there were another set of stocks which were on Consensus Buy lists Like NTPC, Reliance Energy etc. and people were not so sanguine about Ranbaxy, ITC and DLF- I was considered as risky investor when I applied for DLF IPO for my company!)
posted by Vikas Maheshwari, CFA at 12:51 PM
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