Despite many adverse international and national events in the recent past, domestic equities were not affected for too long. So, did you miss a buying opportunity or can you still find value in the market?
Brexit, US presidential elections, demonetization, none of these events-perceived as negative shocks-could keep the domestic equity markets down for a long time. After falling around 1,000 points (or roughly 11%) from a peak of 8950 in September 2016, the benchmark Nifty 50 is back up to 8650 or thereabouts-rallying nearly 10% in two months. If you didn't jump in to buy stocks at the near-term bottom levels, you may find prices too high once again. At a forward price earnings (P-E) multiple of around 19 times, the benchmark is trading at a value which is above the historical 16 times average. Mid- and small-cap stocks too have rallied. For those who didn't buy, have you missed the bus completely or are there pockets of value in this market where you can find stocks at good price?
Value in the market
It's rare that the same segments rally each time the broader market rallies. The year 2016 saw some of the under-performing sectors move up sharply. This includes metal and commodity stocks, energy stocks, oil marketing stocks and utilities. Some sector indices around these stocks have rallied anywhere between 15% and 40% in 2016. On the other hand, technology and health care stocks lagged. These segments could well present the value opportunity that investors seek.
According to Vikas Gupta, chief investment strategist, OmniScience Capital, "Technology companies have extremely strong balance sheets and there is earnings visibility. The concern is about near-term growth in earnings and where that could come from. As a result, stock prices have corrected sharply, presenting an opportunity to buy."
Similarly, the health care segment, too, is undergoing near-term earnings uncertainty as several probes from the US Food and Drug Administration (FDA) have resulted in negative impact on manufacturing facilities based in India. And the domestic market is undergoing some pricing changes. The NSE IT and the NSE Pharma indices corrected 9.3% and 11.1%, respectively, in 2016. Nevertheless, many of these companies have able and quality management and strong financials. Thus, experts are beginning to take the view that at current prices the value of existing business with a strong management looks attractive. Traditionally, pharma remains a growth sector, yet the events of the last one year have impacted valuations.
According to Ajay Tyagi, senior fund manager, UTI Asset Management Co. Ltd, "In the health care segment, despite the uncertainties and hardships, majority of the companies are generating cash flows. Recent events are getting extrapolated to long term and people are not able to visualise the growth in this sector."
A company can be a value pick despite high valuations. Experts often look beyond near-term quarterly earnings to find value. In the near-term market, prices can correct because of event-related factors, news and perceived impact of macro-economic changes, among other things.
However, long-term value of a business is more reliant on its ability to generate profits and cash flows year after year, over 10-15 years or more.
Some other segments where you may find value now are the consumption-linked segments like discretionary spend-linked automobiles, paints and consumer durables.
You need to be careful though as it's not always wise to apply a broad brush across an entire sector. Stock-specific investigations are important, specially in times of earnings uncertainty.
Rajeev Thakkar, chief investment officer, PPFAS Asset Management Co. Pvt Ltd, said, "This is a time to be cautious and look for individual stocks with value. Finding clear value across an entire sector could be difficult." In case of technology, for example, while multiples are cheaper compared to the past, the environment is changing and the companies are very large sized-one has to look at what each company is doing to get incremental growth from here on, he added.
How to identify value
The value approach to investing requires you to identify stocks that are trading at prices below their fair value. These could well be high-growth stocks. Fair value of a stock is what you are willing pay to own it based on the company's future cash flows or earnings. Compare this to the market-price valuation and you can determine whether the stock is overvalued or undervalued.
Fair value price below the market value indicates an expensive stocks and vice versa.
Thus, the stocks that offer good value are those where the market price of a stock is below the fair value and there is still room to gain more.
Another way to identify value stocks is to find companies where the share market price is below the book value of assets held.
While all value stocks will have a relatively lower market price (compared historically), all stocks with low market price may not have good value. For investors, it is not enough to just compare fair value with the market price, one has to consider other aspects as well to determine whether future earnings growth and cash flow generation is sustainable.
Tyagi said, "Companies with high return on capital employed, cash generation ability, low debt and ability to expand business will remain sought after despite fall in price and near-term uncertainties."
If other factors are not supportive, it could well mean that the fall in value is justified. These situations are referred to as value traps, which the investors should try to avoid. If you are going after value in the market now, keep in mind that many a times the stock where there is value is also the one that is either in a phase of correction or has just undergone correction.
Thus, these are not the stocks in favour or where there is investor demand: buying value stocks is therefore considered a contrarian strategy. You buy at a low price when others uninterested and have the discipline to remain invested for a relatively longer period.
In any market cycle, there will be some pockets of value. Gupta said, "Based on price-to-book value, the market is not expensive. Depressed earnings means that many companies with strong balance sheets are available at a good price. Gains can be extraordinary when the cycle turns."
At present you can find them in historically stable and some high P-E sectors such as technology, health care and telecom.
Also consider the consumer-discretionary goods segment like two-wheelers.
However, stay away from segments such as public sector banks, where the stocks are cheap but value may have eroded, thanks to the changing dynamics of the segment and the asset stress that these banks are currently undergoing.
The original article could be seen here.