The Indian equity market made a fresh new high last month and has continued to rally since then after nearly one-and-a-half years of consolidation and sideways movement. The benchmark indices such as BSE Sensex and Nifty 50 now make a fresh new high almost every day as foreign institutional investors (FIIs) continue to pump fresh capital into the Indian equity market. The rally has been largely driven by valuation re-rating.
The BSE Sensex trailing price-to-earnings (P/E) multiple has now shot up to nearly 26X from 23.7X at the end of December 2022. This is the highest valuation ratio for the Sensex in the last 18 months. Similarly, the index trailing price-to-book value (P/B) ratio has increased to 3.72X, the highest since October 2021.
Clearly, investors' optimism about future economic and earnings prospects is at its best in the post-pandemic period and they are willing to bet on new stocks and investment ideas.
The current Bull Run is however still in its infancy and stock prices could rally further. This provides the opportunity for new investors and fence-sitters to enter the market and make money by riding the wave. The best way to play this market is to buy high-quality stocks that still have the scope for a valuation rerating. These are stocks with still relatively low valuation ratios such as P/E multiple and P/B but have strong fundamentals and superior return ratios.
Here are five stocks that are still relatively cheap on P/E multiple and P/B basis but offer higher than market returns on equity (RoE). In other words, these stocks are trading at a discount to their intrinsic value.
In a normal course, a listed company's price-to-earnings multiple should be higher than its return on equity. Similarly, the price-to-book value of a growing company with double-digit RoE should be much higher than 1.0X.
In comparison, most of the stocks in our list are trading at a P/B ratio of less than 1X and their P/E multiple is in the low single digits which makes them a sure-shot bet in this bullish environment. As a bonus, most of these companies also offer very high dividend yields.
The analysis is based on the companies’ latest market capitalisation, their balance sheet for FY23 and their latest trailing 12 months’ net profit. All financial numbers are on a consolidated basis.
1. On the top of our list is the Great Eastern Shipping Company - India's biggest shipping company. The stock is trading at an unbelievably low P/E multiple of 4.4X and price to book value ratio of 1.1X. The company reported a return on equity of 24.4 percent in FY23, nearly 70 percent higher than the BSE500 Index’s average RoE of 14.3 percent. Besides, the stock offers a dividend yield of nearly 4 percent. In comparison, the BSE 500 index is trading at a P/E of 24.1X and a P/B ratio of 3.4X currently.
2. Public sector oil and gas producer Oil India is next on our list with an RoE of 22.7 percent in FY23. Against this, the stock is trading at a P/E of 3.2X and price to book value ratio of 0.7X, both a big discount to its intrinsic valuation as well as the BSE500 index average valuation.
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3. Public sector non-bank lender REC Ltd (formerly Rural Electrification Corporation) is next on our list with a P/E of 3.8X and P/B ratio of 0.7X respectively. In comparison, the company reported an RoE of 19.2 percent in FY24, nearly 500 basis points higher than the BSE500 Index’s average RoE. Besides, the stock is currently trading at a dividend yield of 5 percent.
4. Power Finance Corporation (PFC) is next on our list with a P/E multiple of 3.8X and price to book value ratio of 3.8X, a big discount to the valuation in the broader market. In comparison, the company reported a return on equity of 18.9 percent in FY23. The stock also offers a dividend yield of nearly 6 percent at its current stock price. Interestingly, PFC owns a 52.63 percent stake in REC Ltd.
5. Gold loan financier Manappuram Finance is next with a current P/E multiple of 7.1X and a price-to-book value ratio of 1.1X. In comparison, the company reported an RoE of 15.5 percent in FY23. The company has seen a decline in its RoE in FY22 and FY23 but the ratio is now once again rising.
(Disclaimer: This article is for information purpose only. Readers are advised to consult a certified financial advisor before making investment in any of the funds or securities mentioned above.)
(Karan Deo Sharma is a Mumbai-based finance and equity markets specialist).