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Buying value stocks
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trong>dividend plus the potential for share price appreciation. Equity is risky; hence the potential payoff must be significantly higher to make investing sense.
So for companies that grow their profits significantly, the stock price is higher, and dividend earnings lower. The latter is made up for in terms of greater appreciation in the stock price.
PEG Ratio
Another good guide is to identify fair valuation in equity. This is referred to as the PEG ratio. It’s the P/E divided by the growth potential of the company. If that number is 1 or less, the company is said to be fairly valued, and if it is more, it is said to be overvalued.
Let’s pick a company and check it out. Birla Corporation has a M-Cap of over Rs 1,296 crore. The latest sales and net profit figures (year ended March 2008) are Rs 1,996.78 crore and Rs 393.57 crore respectively, and have grown more than 11.27% and 20.64% over last year. EPS stands at Rs 51.1, and the estimate for FY09 is Rs 58.7, which represents 14.85% growth over the current EPS. The P/E for this company is 3.24. The PEG ratio is 3.24/14.85 or 0.22.
That means you pay Rs 167 (current market price) for a share in Birla Corp, and get an EPS of Rs 51.1. This is a return of 30.86%—much better than bank FD!(The actual dividend paid by the company was 40% or Rs4 per share)
And that’s not counting possible appreciation in the price of the stock or the bonus (the company has given bonus shares thrice so far)! Of course, the company is not going to pay out the entire profit as dividend. But the intrinsic value remains, which makes it a good stock to own.
Several reasons for low share prices
If the company is doing so well, why is the share price so low?
There could be many reasons. Perhaps the company is heading for slower growth in future. Perhaps it’s in an industry whose fortunes are cyclical. Competition could erode the margins or growth of the company.
Indeed, brokers agree in their estimate that the EPS will come down in FY2010 to Rs 52. Besides, the company has a troubled past. This is where patience and diligence count.
If one studies companies carefully, one can identify good value stock buys. Always look beyond the numbers and then decide.
Time Factor
That brings us to the next issue: time. Is this the right time to buy shares? What’s important is not timing, but time one remains invested in the stock market.
If you find a good company at a good valuation, the time is right. A time like this additionally presents an excellent opportunity to those who have the courage of conviction to buy now and hold on for later.
So now could be the right time to buy good value stocks. The value proposition is important.
If you’re convinced the company you’re buying is good, it should not bother you where the stock market is going.
For, once you’ve bought a good stock, its value does not diminish with the stock ticker’s oscillations.
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