‘Low-cost Blue Chips may be a Value Trap’

Investing in select stocks may be a better strategy than value hunting, suggest analysts     The economy may be facing uncertain times. But even such period of uncertainty throws up a few opportunities for investors: some of the blue chips, for instance, are going at mouth-watering prices.  Large cap stocks such as Tata Steel, Sterlite Industries (India), Punjab National Bank, JSW Steel, Reliance Infrastructure, Reliance Communications and HPCL are trading cheap on the bourses based on a comparison between their market capitalisation and net assets as local and foreign investors remain extremely skeptical in a highly volatile domestic equity market.  With rising uncertainty over economic growth and lack of policy initiatives, market capitalisation of some of the blue-chip stocks has fallen below their net asset values. One out of every five companies in the BSE 200 index currently trades below its total equity, which includes paid-up capital and retained earnings, shows an analysis by the ET Intelligence Group.  There are over 1,100 companies in our sample from across sectors that met the criteria based on the latest market cap and FY12 total equity. The number is astoundingly large given that only 27 of these companies were trading below their net assets five years ago when market was in the middle of a bull phase.  While this reflects how cheap some stocks have actually become, analysts warn against rushing into bargain hunting. Instead, they recommend a much more selective approach to enhance portfolio. This is because the higher net assets compared to the market cap may be the result of increased amount of intangible assets such as goodwill, which lacks economic value. Also, lack of future prospects may be another reason for some of the stocks to go cheap.  In a well informed securities market, market capitalisation of companies, which is the stock's worth in the equity market, tends to either equal or exceed the net assets (total assets less total liabilities), represented by equity capital and retained earnings. When this no more holds true, there's an opportunity to earn profits by investing in stocks which have net assets in excess of their market cap.  Ambit Capital's equities head Saurabh Mukherjea wants to avoid what's considered as a "value trap," while acting on inferences drawn from such value parameters. "In cases, where net assets tend to exceed market capitalisation, one must inquire about the extent of intangible assets reported on the balance sheet." When assets are inflated by net intangibles, the valuation parameters would give skewed results," he feels.  Mukherjea draws attention to Tata Steel which has been reporting a significant amount of goodwill following its overseas acquisitions of Corus and Jaguar Land Rover. Regarding acquisitions, goodwill reflects the excess of purchase price over the fair market value of acquired assets.  In FY11, Tata Steel had recognised . 15,298 crore in goodwill, which was more than one-third of its total equity of . 35,563.9 crore. While its FY12 annual report is awaited, the company has reported . 52,621.4 crore in shareholders' funds or total equity. Though this is lower than its current market cap of around . 40,659 crore, the difference can be largely attributed to the presence of goodwill.  Apart from Tata Steel, other metal players in our list include Sterlite Industries (India), SAIL and JSW Steel. A relatively lower valuation of these players compared to their net assets is indicative of market's cautious approach towards commodity players. "Of late, valuations of commodity-driven stocks have taken a beating due to an expectation of slower global economic growth and increased volatility in prices of major commodities," says Sonam Udasi, head of research, IDBI Capital. Another reason for metal companies and players from other capital-intensive sectors to have lower valuations is the discount given to their capital work in progress, says Dhananjay Sinha, co-head of institutional research at Emkay Global Financial Services. "You need to consider a gestation period of around five years for new capacity to come on stream, which creates uncertainty about these assets and, hence, requires some discounting while arriving at the final valuation." On the flip side, this also means that investors should have a longer investment horizon and the ability to wait until the next uptick in the business cycle to take advantage of the current lower valuations. Udasi of IDBI Capital thinks that long-term investors can consider investment in select counters. "Many public sector banks are trading below their net asset values. We do not expect the valuation of these banks to surpass their book values till the global economic environment remains gloomy," he says.  There are as many as 15 banks in the list of BSE 200 companies that have higher net assets compared to market caps. "For banks, the main concern now is rising non-performing assets (NPAs). Markets have factored that in valuation of banks," reasons Sinha of Emkay Global. He points out that for State Bank of India, the country's largest lender, NPAs are 20% of net assets, thereby reducing the amount of worthy assets by that much. SBI is not featured in our list.  ranjit.shinde@timesgroup.com