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“Ask and it will be given to you; seek and you will find; knock and the door will be opened to you. For everyone who asks receives; the one who seeks finds; and to the one who knocks, the door will be opened. Matthew 7:7-8

11 Oct 2018

STOCK MARKET--When is a good time to buy stocks which are below book value?

A stock which is trading below its book value may not necessarily be undervalued. There could be valid reasons for the apparent “undervaluation”:
1.       Non-finance companies having high debt/equity ratio may trade below book value, for example, Aban Offshore. Market usually treats high D/E companies as risky because a slight bump in profitability sometimes results into an existential crisis.
2.      Finance companies having high NPAs can trade below book value just like India’s PSU banks.
3.      Commodity companies passing through the bottom of cycle. Examples are Nalco, Hindalco, Vedanta etc., almost a year back.
4.      It’s possible that while a company’s assets have a high book value, the return generated by those assets is very less. Berkshire Hathaway had to sell its textile division for the exact same reason; the business was too uncompetitive. Such businesses are not valued highly.
5.      A holding company’s stock can trade way below it book value because it’s expected to hold on to its investments indefinitely.
6.      Sometimes the real value of assets is lesser than their book value.
7.      Mr Market may be behaving irrationally.

There can be many other reasons for it. You can, of course, buy such stocks if you can determine with high probability that the underlying businesses will come out of troubles within a certain time period.

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