Stocks with low price-earnings ratio lead the rally

BSE 500 stocks with P/E of less than 10 deliver 50% returns.

Vidya Bala

Which category of stocks has made the biggest gains in the recent market rally? Believe it or not, it was the really beaten-down stocks, trading at a single digit price-earnings (P/E) multiple.

An analysis of stock price returns since March 9 shows that investors cherry-picked low P/E stocks from the Sensex and BSE 500 baskets; making them the top performers in this uptrend. Price-earnings ratio is a measure of how expensive or cheap a company's stock is, relative to its earnings.

In the Sensex basket, low P/E stocks such as Tata Steel and Tata Motors delivered over 60 per cent returns.

Lower the better

BSE 500 stocks with a P/E of less than 10 (as on March 9) averaged a stellar 50 per cent return till date, compared with the index returns of 35 per cent. The lower the P/E, better the returns, suggests the data. Stocks with a rock-bottom P/E of less than 5, delivered even higher returns of 56 per cent on an average. This analysis has used the trailing standalone earnings of companies, for four quarters. Only stocks with a meaningful P/E were considered.

The majority of stocks with 50 per cent-plus returns belonged to the low P/E club. About 170 stocks in the BSE 500 surged by over 50 per cent in this period. Eight out of every 10 of these stocks had a price earning multiple of less than 10 as on March 9.

In stock markets, price earnings multiple is often used as a measure to judge how expensive a stock is, in relation to the market or the sector in which the company operates.

Attracting retail investors

In this context, investors perhaps saw value in stocks such as Gitanjali Gems, Rolta India, Tanla Solutions, Prime Focus and CMC, whose prices discounted their trailing four quarter earnings by just 2-4 times when the Sensex was at its three-year low in March. These stocks have more than doubled since then.

One key aspect of this rally is that investors bought cheap stocks, without paying much heed to the uncertainties surrounding the company's prospects. Beaten down stocks from sectors such as realty, that are yet to witness a clear recovery in their fundamentals, too were sought after for their low P/Es as well as low absolute prices.

Unitech, HDIL, Phoenix Mills and IVR Prime Urban Developers were some of the stocks with P/E of less than 5 that have surged over 80 per cent.

Interestingly, the shareholding pattern as of March 2009 reveals that some of these low P/E stocks were offloaded by foreign institutional investors in the January-March period and were lapped up by retail investors. Stocks such as Rolta India, Aban Offshore, Balaji Telefilms, Suzlon Energy, Bharati Shipyard witnessed increased retail holding in the quarter ended March compared with December, even as FIIs sold.

On the other hand, many quality stocks also lost out on the rally, probably as a result of high valuations. Stocks such as Dabur India, Hindustan Unilever, Marico, Power Grid Corporation and NTPC, sporting PEs of over 20, had to settle for modest returns of 5-20 per cent.

High P/E stocks (valued over 20 times their per share earnings) that were laggards belonged to sectors such as consumer goods, pharmaceuticals and power.