Tuesday, May 15, 2012

Are stock market valuations attractive now?

After hitting a year to date high in February 2012, the BSE-Sensex has lost more than 12% value since. There are many reasons behind it. Global worries and weak macroeconomic indicators are some of them. Unfortunately, the signs on these indicators further down the road do not seem very encouraging either. As a result, investors have a big question in their minds. Is this the bottom of the markets can things get worse? Of course the reason they ask this question is to understand if they should invest in the markets now or not.

Morgan Stanley has tried to answer this question. As per a study of theirs that was also reported in a leading daily, the markets seem attractively valued at present. In their study, they have conducted a historic analysis of the price to book value (P/BV) of the Sensex and tried to correlate it to its returns.

As per the results, each time the P/BV of the Sensex dips below 3, the markets have delivered healthy returns in the next 12 months. They have cited 3 such incidents in the past.  And they feel that this time too, the Sensex would deliver over 30% returns if the P/BV dips down. The ratio currently stands at 2.98. But Morgan Stanley has stated that the returns would be even better if P/BV were to fall further.

The P/BV is a good valuation multiple to look at while investing. However, there are other things that are equally important to look at while investing. Like any other multiple, P/BV is just an indicator of whether the stock or the market in this case is cheap or not. The bigger question is will the stock deliver returns in the long term or not? The underlying fundamentals answer this question. If fundamentals are strong, then earnings would expand. Such a stock purchased at cheap valuations would help increase shareholders returns. But if fundamentals are poor then no matter what the valuations, things would continue downhill for the stock.

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