Right time to invest in stocks

The recent carnage in the stock market has seen major indices losing more than half their peak values. By the first week of November ’08, the Sensex had fallen by 52.3% from its peak of 21,206.8 in early January ’08. The Nifty lost nearly 53% during the same period. While investors are concerned about the future performance of the stock market, they appear to be less familiar about an interesting fact. The market crash has resulted in stock prices falling below the book value of companies in most cases.

Book value represents the value of a company’s assets net of its liabilities. In other words, it tells what you will be left with, if the company were to shut down, its assets sold and liabilities paid off.

So, logically, a company that is a viable profit-making business will always be worth more than its book value due to its ability to generate earnings and growth. Hence, shares trading below their book value are a sure sign of gross under-valuation and indicate low risk for investors.

An analysis of BSE 500 stocks reveals that one out of every three stocks is currently trading below its book value. A sample of 479 companies with latest book value information was selected for the study from the 500 companies that comprise the BSE 500 index. The stock prices of these companies were then divided by their respective book values to arrive at the price-book value ratio (P/BV).

According to the study, as many as 170 companies reported stock prices lower than their book values. Interestingly, on January 21, ’08, the day when the market temporarily halted trading due to massive losses, only 26 companies out of the sample set were trading below their book values.

The study also revealed that as on November 3, ’08, nine out of 10 companies were trading at P/BV multiples which were lower than their value on January 21, ’08. Real estate companies dominated the list of companies that saw erosion in their book values during the said period. Among the top 10 such companies, five were from the realty sector.

There are two reasons for this erosion in P/BV. Not only have stock prices of companies fallen sharply, but in many cases, the book value has also increased. Every four out of five companies reported a jump in book value between January ’08 (BV in FY07) and November ’08 (BV in FY08). Investors can use the information on P/BV multiple as one of the decisive indicators while taking investment decisions in a falling market.

A P/BV multiple of less than one reflects lower risk for investors in case the company faces bankruptcy. Further, talking about stock recommendations by ETIG, some stocks have seen a considerable decline in their current P/BV compared to that on January 21, ’08.

Aban Offshore, Allied Digital Services, Bank of India, Adhunik Metaliks and Jain Irrigation are some of our recommendations that have seen a drop in their P/BV multiples, which are now between one and three. Moreover, India Glycols and Ratnamani Metals & Tubes are currently trading at P/BV of less than one.