Companies which have a low P/E multiple compared to industry P/E have given exceptional returns of up to 280 percent.
There are a lot of methods which can help you pick the right kind of stocks for trading, but for investment, focus on few parameters which could help you to pick winning bets.
A small analysis run on BSE 500 companies on return on capital employed (RoCE) and Price-earnings (P/E) ratio threw many companies which have outperformed Sensex returns in the last one year. These companies have either more than doubled or nearly doubled in the last one year.
Companies which have a low P/E multiple compared to industry P/E have given exceptional returns of up to 280 percent in the last one year, which includes names like Escorts, Avanti Feeds, Caplin Point, REC, Hindalco, Jk Tyres, Gujarat Narmada, Sun TV, IOC, Navneet Education etc. among others, Capitaline data showed.
PE is one of the important and mostly used price multiples for valuation. A higher PE indicates better operating performance. It is the most common, and widely available indicator available to investors.
It is a very common and important valuation ratio used to measure the company. The standard rule is — the lesser the PE better the stock and vice versa. However, that might not apply to growth companies.
If PE of a stock is lesser than the industry PE or its peers then it gives a sense of confidence to buy the stock. However, when the company is in a growth phase, then a higher PE is justified for those stocks, which will not make that stock look overvalued, suggest experts.
“As market discounts in forward, companies which might have to add on benefits over its peers in terms of margin expansion, monopoly, less leverage etc., such stocks will quote higher PE and we might still see good returns,” Achin Goel, Head of Wealth Management and Financial Planning, Bonanza Portfolio told Moneycontrol.
“Companies Like India Cement, Navneet Education, Federal Bank, Dewan Housing etc. have very good fundamentals and are available at lower PE which makes the stock looks attractive,” he said.
Goel further added that stocks like Escorts, Sun TV also have very good fundamentals but are trading at exceptionally high PE where investors should book profit because markets have already discounted growth factor and might not rally at the same pace as it did in the past.
However, PE should not be the only parameter used for evaluating a stock. If you are not seasoned investor, chances are that you might make a mistake. Novice investor presumes when any company is trading around or below industry PE it is trading at a lower valuation.
“When it comes to investing, PE ratios aren’t everything and should not be looked isolated. One must also study growth potential, future profitability and superior corporate governance practice,” Jaikishan Parmar, Sr. Equity Research Analyst, Angel Broking Pvt Ltd told Moneycontrol.
“There are two types of valuation methods, relative and absolute. Relative valuation looks at the valuation methods such as P/E, EV/EBITDA, P/B, EV/Sales, etc. These relative methods compare the valuation multiples against that of the sector and comparable peers,” he said.
Parmar further added that the absolute valuation method, however, is independent in nature and methods like DCF take a long-term view on the future cash flows to value the company.
The general theory is companies which have strong fundamentals such as healthy balance sheet and good return ratios, should get premium PE valuation compared to the companies with poor future growth rate, or weak balance sheet, suggest experts.
ROCE is also important
Return on Capital Employed or RoCE is another ratio which investors can use when making their investment decisions. Usually, a figure over 12 percent is good for any company.
Almost 75 percent of the companies mentioned in the list have a ratio above 12%. The data is calculated based on March 2016 balance sheet numbers, Capitaline data showed.
“ROCE is a good indicator to check operating performance and balance sheet health. Therefore, any company with ROCE better than 12% is good. Navneet Education is one such quality name with better ROCE and comfortable P/E,” Tushar Pendharkar, Head of Research, Right Horizons Investment Advisory Services told Moneycontrol.
“In addition, there are few exceptions in this list where the ROCE is low; however, they have strong business outlook, such as – Hindalco Industries Ltd, and Indian Oil Corp Ltd,” he said.
Disclaimer: The views and investment tips expressed by investment experts on Moneycontrol are their own, and not that of the website or its management. Moneycontrol advises users to check with certified experts before taking any investment decisions.