What stocks to buy for profitable investing? Investor should try to “buy fundamentally strong stocks which are undervalued”. Undervalued stocks can fetch higher returns in long term. Not only returns, these stocks makes investment portfolio very robust.
When it comes to investing, people get confused about which stocks to buy. But focusing on fundamentally stocks will eliminate the confusion. We must kept our investment understanding as simple as these 5 words, “buy fundamentally strong, undervalued stocks”.
No matter how complicated is the decisions, one must keep buying undervalued stocks and selling overvalued ones.
The easiest time to find undervalued stocks is in falling market. But how to know if the market is falling or rising?
Tracking stock market index will give this answer. India has two main index, Sensex & Nifty. In United States people refer NASDAQ & DOW for such indications. Observing index is good, but it is not sufficient to see index movements alone.
To get a more meaningful idea, look at the index’s PE & PB ratios. SENSEX PE & PB ratio can be found by visiting BSE India Website.
It is interesting to observe index in terms of its PE, PB & Dividend Yield. As a rule of thumb, stocks having PE
But in addition to index, it is equally important to look at fundamentals of individual stocks.
No matter how undervalued are the stocks, but if their fundamentals are weak, it will not be a good buy. Many stocks trade at low PE & PB levels. But majority of them has weak fundamentals. One must buy only fundamentally strong, undervalued stocks.
Lets see what we can track in Index:
As on April’2015
|Sensex Levels||P/E||P/B||Dividend Yield|
As a rule of thumb, investors can use information of SENSEX to buy/sell stocks:
1) Buy stocks which has lower P/E Ratio than SENSEX
2) Sell stocks which has higher P/E Ratio than SENSEX
3) Buy stocks which has also has lower P/B Ratio than SENSEX
4) Sell stocks which has higher P/B Ratio than SENSEX
5) Buy Stocks which has Dividend Yield (Last 3Years Average) more than that of SENSEX
Sensex Vs. Individual Stocks
Price Earning (P/E) Ratio of Index represents average valuations of stocks listed in stock exchange. Presently P/E ratio of SENSEX is 19.71. Applying a rule of thumb, P/E above 15 hints at overvaluation.
In last 12 months, Sensex has risen by more than 8,000 points. This is the reason why P/E of Sensex is trading at 19.71 levels.
When Sensex is rising it means its P/E ratio is also increasing. It implies that stocks are getting overvalued.
In this uptrend of Index there are some good stocks that gets left-behind. Our intention is track those fundamentally strong stocks which are undervalued.
Let’s take an example of Tata Steel to see how we can compare stocks with Sensex:
The Values are Just for Example Only
This type of comparison of SENSEX with individual stocks gives insights about the market.
In last 12 months Sensex has really rocketed to all time high levels. First effect of soaring Sensex is seen in companies EPS & PE ratio.
Improving PE ratio also gets reflected in Dividend/share. Idea is to check if company is also doing well when sensex is rising.
Most important to see, in improving/depreciating index, how PE ratio is behaving.
Thumb rule says, a stocks with PE ratio of less than 14 is a good buy.
P/E Ratio of Undervalued Stocks
Investors must learn to take advantage of Market fluctuations.
PE ratio gives us a broad idea about market whether it is overvalued or undervalued. Let us see how effectively we can use PE ratio to buy stocks.
In years 1920, 1950, 2001 & 2008, stock market across the world saw its worst crisis. During these moments of turmoil the average PE ratio of stock market was at its rock bottom.
Investors who bought stocks during crisis, made handsome profits. But this is only one side of the story.
There were investors who bought stocks only when stock market got revived. Like in year 2010, PE ratio of stock market was at all time high levels.
Buying stocks when market has already peaked is bad. This happens because the price levels at which they bought shares are already overvalued.
Looking at PE ratio of Sensex will hint if market is really overvalued.
Today some might say that SENSEX is trading at all time high levels of 28,500 points. But does this mean that market is very overvalued?
Use our thumb rule. Present PE of sensex is 19.44 which is only 5.44 points higher than rule of PE14. Without doubt, market is overvalued but its not as overvalued as some might think.
PE ratio is a very helpful indicator to know valuation of market broadly.
In countries like like India, investors must also look into inflation.
PE ratio is effected by inflation rates. Controlled inflation is good for the economy. But erratic & high inflation is cause of worry. High inflation rates negatively effects PE ratio of Index.
In a market where inflation is dominant, the market tends to be volatile. Both Sensex and stock price fluctuate rapidly.This also decreases investors sentiments.
High inflation means low PE. This means investors money is getting devalued.
Markets where inflation is low and stable are ideal for investment. High inflation ultimately leads to slow growth of PE ratio of market.
High inflation levels may cause market to stay at low PE levels. This may look good initially but when reason is high-inflation, its can never be good for market in long run.
Bull Market & Overvalued Stocks
Bull market is not new for investors. We have seen such phases during the great depression of 1927. We also saw it during dot com bubble in 2000 & in 2008 US debt crisis.
During these times stocks market first got bull and then crashed.
In the bull phases PE ratio rose to exorbitant levels. After the market crashed, PE ratio hit all times lows. After this the market recovered to justifiable levels.
When market is bull, it is difficult to find fundamentally strong stocks which are undervalued.
Generally, fundamentally strong stocks first becomes overvalued during bull runs. This happens because almost every one is buying these handful stocks.
For investors the problem is how to find undervalued stocks during bull runs?
In such times relying only on PE ratio is not sufficient. We shall use PEG ratio to unearth undervalued stocks.
Inflation Rate & Bear Market
Inflation plays a big role in bear market.
Market hates high inflation and unstable market. Market like to trade when price of goods and services are stable.
It helps investors to take calculated risks.
But when inflation is high, people prefer to invest in risk free investment options.
In such cases there will be gradual decline in the PE ratio of stocks. So one should start buying low PE stocks during such times?
Low PE ratio is not always reliable. A stocks which has low PE ratio does not necessarily mean it is undervalued. A more reliable tool for investors to use is PEG ratio.
Fundamentally Strong, Undervalued Stocks
Using the concept of PEG ratio we have tried to list down fundamentally strong Indian stocks which are undervalued. The stocks are called fundamentally strong because they have shown the following behaviors:
1) Zero Debt Company
2) High Operating Margin
After doing the fundamental analysis, price valuation was done. Market price of stocks was done on the concept of PEG ratio. The result that came out is like this:
(Updated as on December’2016)
|SL||Company name||Market Price (Rs.)||Market Cap||ROE (5Y) (%)||Div Yield (%)||P/E||PEG||RoCE (5Y) (%)|
|1||Tata Consultancy Services Limited||2223.9||4.39T||40.6||2.01||17.33||0.80||39.74|
|3||Hexaware Technologies Limited||201.05||60.93B||28.55||3.34||15.45||0.53||27.6|
|4||Torrent Pharmaceuticals Ltd||1347.85||228.26B||41.7||2.52||22.3||0.50||25.16|
|5||Avanti Feeds Ltd||487||21.99B||45.08||1.4||14.2||0.13||41.53|
|6||Interglobe Aviation Ltd||847.05||307.72B||166.25||1.79||15.83||0.55||18.15|
|8||Kaveri Seed Company Ltd||411.5||28.30B||36.13||1.84||16.46||0.51||35.66|
|9||R Systems International Limited||55.55||7.04B||25.11||4.42||12.08||0.29||23.9|
|10||Jagran Prakashan Limited||173||56.67B||28.69||1.97||12.65||0.80||20.71|
|11||Coal India Ltd||306.1||1.89T||36.72||8.95||14.24||2.53||19.48|
|12||Sasken Communication Technologies Ltd.||392.05||6.93B||21.55||1.65||4.18||0.13||21.24|
|13||Welspun India Limited||69.9||69.93B||28.31||1.84||16.27||0.07||12.04|
|14||Tech Mahindra Ltd||472.85||460.00B||27.76||1.26||12.45||1.15||21.44|
|15||KPIT Technologies Ltd||132.2||25.99B||20.91||1.66||9.68||0.47||18.72|
|16||Redington India Ltd||94.95||38.72B||18.63||2.2||8.68||0.66||17.28|
|17||JK Tyre & Industries Ltd.||118.2||26.79B||22.47||2.11||6.27||0.14||8.02|
|18||Ashok Alco-Chem Ltd||96.25||440.07M||43.84||1.02||6.01||0.14||41.39|
|19||Alembic Pharmaceuticals Ltd||632.25||120.44B||45.66||0.62||20.44||0.38||39.64|
|20||SQS India BFSI Ltd||684.75||7.41B||25.77||3.4||22.25||0.28||24.23|
|22||VST Industries Limited||2193.05||33.87B||45.65||3.16||20.24||2.02||45.22|
|23||Indiabulls Ventures Ltd||21.8||6.41B||29.02||13.33||10.28||1.12||19.32|
|24||Chembond Chemicals Ltd||203.7||2.73B||41.1||2.24||20.42||0.34||38.29|
Under effect of high & erratic inflation rates, finding fundamentally strong stocks which are undervalued get easy. High inflation rates forces market to down perform. As a result PE ratio will see a downward trend. When investors invests in stocks market they want at least inflation to be predictable. Market in itself is volatile. If inflation also becomes fluctuating it makes it decreases investors confidence. A stable inflation is ideal for investing, Lower inflation levels will lead to gradual PE growth. Investors must keep a close look at the inflation trends.
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