1. How to spot cheap stocks using P/E ratio; 5 wealth creating ideas

How to spot cheap stocks using P/E ratio; 5 wealth creating ideas

Buying quality stocks at lower valuations could be a good idea to generate lucrative return in the long run.

By: | Updated: May 12, 2016 12:19 PM
attractive stocks to buy In the BSE 500 index, PVR, Apollo Hospitals, Credit Analysis and Research, Cox & Kings, Colgate Palmolive, Bajaj Corp, Radico Khaitan, Kaveri Seed Company and Kwality Ltd are some of the stocks whose P/E ratio is lower than the industry average.

 

Buying quality stocks at lower valuations could be a good idea to generate lucrative return in the long run. There are over 200 stocks whose price-to-earnings (P/E) ratio are lower than the industry average in the BSE 500 index. A P/E ratio lower than industry average reveals stock may be undervalued.

In the BSE 500 index, PVR, Apollo Hospitals, Credit Analysis and Research, Cox & Kings, Colgate Palmolive, Bajaj Corp, Radico Khaitan, Kaveri Seed Company and Kwality Ltd are some of the stocks whose P/E ratio is lower than the industry average.

For a layman, P/E ratio is a valuation measure, which can be used to know whether the stock is overvalued or undervalued with respect to its earnings growth. The ratio can be calculated by dividing the current market price with earnings per share. Basically, price-to-earnings ratio shows what the market or an investor is willing to pay for a stock based on its current earnings. An industry PE ratio can be calculated dividing its market capitalisation by its total net profit.

For example, if the P/E ratio of a company is 10x (10 times) it means that an investor has to pay Rs 10 to earn Rs 1 hence lower the ratio, cheaper is the valuation and vice versa.

Akhil Rathi, AVP retail research, Asit C. Mehta Investment Interrmediates, said, “P/E gives investors an idea if the stock has sufficient growth potential. Stocks with low P/E but with high earnings growth can be considered good bargains since their growth potential is high. If PE is high, it indicates over-pricing of the stock. It means the stock price is much higher than its actual growth potential.”

Sanjeev Zarbade, vice-president, private client group research, Kotak Securities, said, “During bear markets, stocks generally trade at lower PE multiples and during bull markets at higher levels in relation to historical/median values. Put simplistically, it is prudent for the investor to avoid shares that are trading at a significant premium to their historical PE trading range.”

On the other hand, companies such as Apollo Tyres, Tata Sponge, Bank of Maharashtra, State Bank of India, Gujarat Gas, Coal India and SRF are some of the companies whose P/E are higher than their industry average. On asking how feasible is it to invest in companies which trade higher than their industry average, Siddharth Oberoi, founder Prudent Equity, said, “Companies which have competitive advantages, brands, predictable earnings, pricing power have higher price-to-earnings ratio. It makes sense to invest in these companies. Companies trading at high P/E’s too can be undervalued. However, the growth rate needs to be both significantly higher and assured to justify a lofty P/E.”

As an investor, one needs to objectively assess whether the PE ratios are justified in light of their profit growth potential. In case the potential profit growth rate of a company is strong enough to justify a high PE, then one may consider investing in such stocks.

Vaibhav Agrawal, VP and head of research, Angel Broking, said, “Mainly high-growth companies have higher P/E ratios. Investors usually are willing to pay a higher P/E for companies they believe will be growing faster than the norm even though they do not pay those earnings out in dividends but retain them to fund future growth. If that growth is realised, the price of the company’s stock usually grows faster than the price of a company with a slower growth or even a higher dividend-paying company.”

With the help of market experts we collate some stocks which are trading below their price-to-earnings ratio and can give you lucrative returns in next few quarters.

Siyaram Silk Mills (SSML)
Recommended By: Angel Broking
Target Price: Rs 1354
Why Buy: SSML has strong brands which cater to premium as well as mass segments. In the past five years, the company has demonstrated a steady 10-15 per cent sales growth. The stock is trading at price-to-earnings ratio of 11.50 against industry average of 23.36.
According to Angel Broking, the company would be able to leverage its brand equity and continue to post strong performance. The company has a nationwide network of about 1,600 dealers and business partners while it’s in the process of adding another 300- 350 stores going forward. The brokerage house expect the company to report a net sales CAGR of around 10 per cent to Rs 1,815cr and net profit CAGR of around 11 per cent to Rs 98 crore over FY2015-17E on back of market leadership in blended fabrics, strong brand building, wide distribution channel, and strong presence in tier II and tier III cities.

Mindtree
Asit C. Mehta Investment Interrmediates
Target Price: Rs 800
Why Buy: Operating margins are likely to improve in the coming quarter underpinned by levers such as improvement in utilisation, growth leverage, productivity gains and investment in organic and inorganic growth. On May 11, price-to-earnings of Mindtree was at 18.10 against industry average of 19.07.

Century Ply board Ltd
Recommended By: SBICAP Securities
Target Price: Rs 186
Why Buy: Century Ply, maker of plywood and laminates, is one of the largest player (25 per cent market share) in the organised plywood space. It has strong backward integration, pan-India presence, robust distribution network and upcoming new peeling plants. SBICAP Securities expects consolidated net sales and profit CAGR of 14 per cent and 20 per cent during the period of FY15-18e led by EBITDA margin expansion of 200 basis points to 18 per cent by FY18E. Return ratios of over 35 per cent (RoCE) and 20 per cent (RoE) with P/E at 13.8x on FY18E makes it attractive.

Inox Wind
Recommended By: SAMCO Securities
Why Buy: Inox Wind is available at 12 P/E growing at 50 per cent CAGR since last 3 years with high ROE of 26 per cent. The industry is growing at 15 per cent plus and three players control 80 per cent of the market share which makes a solid case for long term investments.

YES Bank
Recommended By: SAMCO Securities
Why Buy: Yes bank trades at 16 P/E growing at 20 per cent plus rate having high ROE of 21 per cent and low non-performing assets of 0.29 per cent. The bank is in the process of raising capital for meeting growth capital requirements which is positive for the stock. The stock is trading at reasonable valuation considering the growth potential and sustainability thereof. This is one of the fastest growing private sector bank having reasonable valuation.

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