‘Don’t bank only on price-to-earning ratio’

Mumbai: Reviews have been the big buzzword on Dalal Street for a while, but it’s suddenly gaining momentum. Today, every conversation starts with the price-to-earnings ratio (price-to-earnings ratio that compares the stock’s current price to earnings per share) and ends with a vociferous declaration that valuations look “a bit stretched.”

However, many experts believe that looking at a rate in isolation will not help investors understand the realities of the market and that higher valuation may not be the only crucial factor driving the market.

“Reviews are important in the long term, but they don’t have to have an impact in the short term. This is because there is never a right valuation for a stock as it is a highly individual decision,” said Mukesh Dedhia, Director, Ghalla & Bhansali Securities.

“For example, a stock with a higher P/E ratio may move further because there is greater demand for the stock due to its higher earnings potential. So there’s always a bit of confusion about the right rating,” he adds.

“When you look at the broader market, it’s difficult to find a value pick. But if you use a bottom-up approach, you would still find many stocks in the market with the right valuation,” says Rajiv Thakkar, CEO of Parag Parikh Financial Advisory Services. While he’s a firm believer in value investing, he says looking at a metric alone isn’t the right way to invest in a stock.

“There are many things to consider. For example, you need to figure out if the growth rate is sustainable or how much capital is needed to sustain growth. Sometimes there has been volume growth, but margins could come under pressure. There are a variety of aspects to consider, it’s not enough just to look at a ratio,” he adds.

Some experts also believe the higher valuations could be justified if foreign investors continue to pour money into the stock markets in hopes of better performance from Indian companies.

“Current valuations do not justify India’s long-term growth potential. The market is trading at 17x earnings potential in 2011 and about 13.8x 2012 earnings forecast. It even offers around a 50% premium to other emerging markets and around a 25% premium to other global markets,” said Devendra Nevgi, Founder and Principal Partner, Delta Global Partners. He believes the premium may be justified if foreign investors continue to bet on Indian stocks. ‘Don’t bank only on price-to-earning ratio’

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