Valuation Ratios Can’t Convey Undervalued Shares All the Time

Even most of the historical researches justify the statement that companies with low valuation ratios like price to earnings multiple and market price to book value ratios outperform the market in the long run, there are many exceptions to this statement in the current environment. In addition to checking valuation ratios of companies, every investor should check non-operating income, corporate governance, profit margins, ROE, ROA and cash from operations of companies for at least past three years. There are so many Indian companies which were trading at very low PE and gave investors negative returns. Check some of the low PE stocks which gave investors negative returns.

SEL Manufacturing Co. Limited:
The company is a Ludhiana-based manufacturer of yarns, terry towels, readymade garments and knitted fabrics.

Negative Cash Flows from Operations:
Even the company is showing good growth rate in EPS from the past five years, it generated negative operating cash flows, increased debt levels and does not have good dividend record. The general perception is that if a company generates more profit and shows less cash in its balance sheet, there might be a fraud in its books.

Sabero Organics Gujarat Limited:
The company is a manufacturer of organic compounds, including agrochemicals, and intermediates.

Corporate Governance Failure:
This company involved in fraudulent exports. Press reports alleged that Sabero Organics has been caught exporting large quantities of herbicide under the registered trade name of its competitor, Excel Crop Care.

Using PE ratio for banking stocks:
Even PE ratio is used to identify undervalued companies in all the industries, banking stocks should be analysed by certain industry specific ratios such as CAR (Capital Adequacy Ratio), NIM (Net Interest Margin), CASA ratio, restructured assets, exposure to commercial real estate sector, provision coverage ratio, and GNPA to check the quality of assets of a bank.

Conclusion: Even all the low PE stocks are not sharks, Investors should be very careful in analysing such stocks. Investors should closely monitor cash from operating activities, increasing inventory holding period, ROE, growth rate of the industries in which the low PE companies are operating, management views and profit margins.