How to spot deep value stocks
Often under-rated and out of radar, deep value stocks can do wonders to your equity portfolio. SundayET reports on what it takes to spot them. Investor options
They are believed to carry hidden treasure on Dalal Street. While investors call them the low-lying unpolished gems of the stock-market, brokers say there are big bucks to be made if you can identify these stocks early. No prizes for guessing this, we are talking about deep value stocks which can do wonders to one���s portfolio when market re-assesses them.
According to analysts, a deep value stock can be defined as something which is low priced in relation to the margin of safety the stock provides, to limit losses when a mistake is made. SundayET provides you an insight into how to identify these stocks, what should be your ideal portfolio allocation and reasons behind their low valuations in the market.
Sleeping giants
They are like any other stock traded on the exchange, but there is no hypothetical understanding of them. A section of traders on the Bombay Stock Exchange even call these stocks as ���sleeping giants���. Manish Sonthalia, vice-president, equity strategy, Motilal Oswal Securities, believes that there are two ways in which you can identify a deep value stock.
First, what Benjamin Graham recommends for the defensive investors in his 1949 classic, that the stock price should not be more than 15 times its average earnings per share over the past three years and the overall PE of the portfolio should not be more than 13. Or second, the stock should be trading below its 10-year median PE.
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���The other things to be kept in mind is to stick with companies that have a long history of consistent profit growth and steady dividend payouts and the fact that not every cheap stock would turn out to be a bargain,��� says Sonthalia. He believes that PSU banks like Oriental Bank of Commerce, which is trading at a PE of 5.6 with book value of Rs 240 for FY09, is a perfect example of a deep value stock. ���In a growing economy like India, banks should do well as the GDP expands,��� he reasons.
According to Ketan Karani, vice-president, research, Kotak Securities, these stocks generally remain neglected by the stock markets. ���The best (or you may call it worst) part is that people know it���s a great story but still they don���t want to touch it. If one saw the real estate boom in India five years back and bought into Unitech, his portfolio returns would have multiplied phenomenally,��� he sums up.
As far as portfolio allocations are concerned, analysts feel that an investor could invest 80% in growth stocks and 20% in value stocks (after keeping some cash balance or investments in fixed income instruments). In case of a pure deep value investor, Sonthalia says that typically 80% the investment of investible funds should be in these stocks and 20% of the funds should be kept aside for fixed income instruments or cash balance.
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���However, a hybrid investor should follow a strategy in between the two. The basic principle followed is the Pareto���s principle, the 80/20 rule,��� he points out. Sow to reap
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Though opinions differ on an ideal investment horizon, most analysts agree that it should not be less than a year and which could extend up to three to five years to reap big dividends. Karani says the first thing an investor needs to do is to ask himself whether he is a speculator or an investor. ���If he is a speculator, then there is no chance for him to stay in these stocks. If he is an investor, a time period of three to five years is what makes sense,��� he feels. However, if the stock does not give the required return even after holding for three years, there is something more than one���s own understanding about the stock.
���In such a scenario, you could sell the stock and move to something else. However, if there are compelling reasons, you could continue holding the stock,��� says Sonthalia. On why these stocks have ridiculously low valuations, Karani says that ���the market sometimes tends to overlook an industry. And usually these stocks are not popular with brokers.���
Apart from that, analysts explain that there could be reasons such as high transaction impact costs (small caps can have transaction impact costs as high as 30-50% ) and fear of uncertain events or adverse macro environment conditions such as rise in oil and interest rates, government policies, etc.
���You must also understand that fear always resides in the near term. And that���s why there is lower visibility of the future even though the broad picture remains intact in these cases,��� he says.
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