Admit it. We human beings over-react to events on several occasions. And as the stockmarket puts together all the reactions, the compound effect is reflected in the prices as well-magnified, at times. This explains the wild swings.

The broad idea behind value investing, however, is that the intrinsic worth of a listed company-as a money-generating entity-is never quite so volatile. And that over time, a stock's price will move towards a level that's consistent with its true worth.

This means that you can make good money if you have a good fix on what a stock's actual value is. If the crowds are driving a stock's price crazily up, sell; if they're dumping a stock that's good, you buy. "It is like buying some thing worth Rs 100 for Rs 20," says Raamdeo Agrawal, Joint Managing Director, Motilal Oswal Securities.

What Value, Though?

The not-so-easy part is figuring out the intrinsic value of stocks. After all, the reality of a stock is the price quoted on the market. So what 'value' are we talking about here?

According to Agrawal, "You have to arrive at the value of a company based on its assets or earnings growth." The typical way to do this is to compare the market price with either of those figures. Now, the price-earnings-growth method has been explained in this magazine in the past (see BT dated December 21, 2003). The method detailed here is the one that uses assets as an indicator of value, and the relevant ratio is called the 'price to book value ratio' (P/B). The good news is that it's even easier to calculate and follow. This is because the so-called 'book value' of a company is more stable than its earnings growth rate.

The book value of a company can be easily calculated by deducting total external liabilities from total assets. Both these figures can be got from the balance sheet (just take share capital plus retained earnings as a proxy). Now, the book value per share is this figure divided by the outstanding number of shares. The market price divided by book value per share gives the 'p/b ratio'.

Workhorse Ratio

Though not as glamorous as other methods, book value investing is a workhorse that performs well under almost all economic cycles. Tested on historical data of Nifty stocks, for example, the results are astounding. To see the effect, we selected a portfolio of 20 stocks that had low P/B ratios, and, as can be seen on the other table, the one-year return generated from these 20 stocks was far superior to what a Nifty portfolio would have delivered. It beats the Nifty hollow.

The data, admittedly, is historical. Would it work in the future as well? This is a good question because the Sensex has already breached the 5,400-mark, and the recent return of value investing per se has meant that book value stocks have rallied strongly, of late. Assets, it seems, are back in the reckoning as an indicator of corporate worth.

In fact, just two Nifty companies (VSNL and MTNL) are quoting below book value now.

Use With Care

A book value rally having already occurred could possibly imply that the p/b ratio-used in isolation-has lost some force as a predictor of future prices. As Nandan Chakraborty, Head of Research at Enam Securities, puts it, "Value investing based on P/B alone works well in years of gross undervaluation, but that period is already over; and is in any case limited to those where tangible assets per share is a meaningful number, such as in commodity-manufacturing etcetera." What this also means is that the few stocks left that have seriously low P/B ratios might be companies with assets that investors are not enthused by for some good reason or the other. So how would you ensure that book value investing doesn't lead you up dud alley?

First, place the P/B ratio in the context of the company's specific industry. This means understanding just what those assets really are, and then making common sense judgments of their worth. Real estate, for example, is an asset that contributes to book value at the price at which it was originally acquired. The current market price of real estate bought 50 years back would be much higher than what's logged in the ledgers. So that would change your perspective. On the other hand, the actual value of computers bought five years back may be much less than the recorded book value. Then there are intangibles that go unrecorded. Companies selling FMCG products do not show the value of their brands in the books. So you should make special allowances for these.

Second, use the classic price earnings (P/E) ratio as a filter. "Even if the P/B is low, a company with a high P/E should also be avoided," says Chakravorthy. This way, you avoid firms that are unable to deliver earnings, despite their hefty assets.

Third, keep an eye on corporate news. Avoid companies that are reporting a huge fall in profits or increasing losses. Assets on the books could evaporate into thin air. At the end, a business must turn a profit. So you should look at the company's dividend records as well. A steadily increasing dividend record augurs well, and often reflects management confidence in the company's prospects.

And last but not least, concentrate only on big companies-say, with turnovers in excess of Rs 100 crore-that are easy to track. This will prevent any junk stocks entering your portfolio. Book value investing is not foolproof, but it works rather well when applied with a lot of common investing sense.

Signs of Rising
Are corporate fixed deposits ready for a big comeback? Depends on your appetite, dear investor.

By Supriya Shrinate

If you're the sort who buys anything financial that stirs to life after a long slumber, you might already have put money into these. Otherwise, welcome to the ranks of those asking if corporate bonds should be back on their investment radar. For now, it looks like a lot of people have already made their decision. According to Bajaj Capital's estimates, volumes of corporate fixed deposits (FDs) have shown a 30-40 per cent jump over the past six months. Current bait-danglers include Escorts, East India Hotels, Jindal Stainless, Surya Roshni, Camlin, HDFC and HUDCO. If interest rates in the economy show any further signs of hardening (after all, the category had tanked when rates crashed), more might come looking for your cash.

Choice Of Debt

For the past few years, fans of debt have stuck to return-based debt mutual funds that do active debt trading (quite well, till awhile ago), and high-safety fixed interest schemes such as bank FDs, RBI bonds, Post Office deposits, National Saving Certificates (NSC) and so on. Debt mutual funds ran into trouble after interest rates bottomed out, their returns collapsing. Super-safe bonds are still a good bet, but they have low liquidity. RBI Saving Bonds offer 8 per cent, but have a lock-in of six years; Post Office Schemes like MIS also offer 8 per cent, but it's a six-year lock-in; NSS and NSC are also at 8 per cent, with your money captive for five years.

That leaves corporate FDs. Their attraction? As Rajiv Bajaj, Managing Director, Bajaj Capital, spells it out, "If funds are available for short periods, fixed returns desired and time is an issue, company fixed deposits are the best bet to get maximum returns."

Now, don't look for the heady double-digit rates of the earlier era. Those were the days when banks lent money at about 16-18 per cent to companies, and companies issued debt to the public at over 10 per cent (of course, some high-rate offers ended up defaulting too). As interest rates have declined and the rating scene tightened up, the business has sobered up quite a bit. These days, it's unrealistic to expect double-digit rates on the safer instruments rated highly by independent rating agencies such as CRISIL and ICRA (see Everyman's Guide To Fixed Deposits). Debt in the 'A string' rating category is going at interest rates that are barely higher (or even lower) than RBI bonds and the like; their bait is simply the liquidity. If you need the cash, you can liquidate your holding quite easily.

Why are corporates issuing debt? For companies with solid repayment records, it's cheap and convenient. Moreover, the central bank regulation prohibiting the use of external commercial borrowings (ECBs) for the purpose of working capital has raised corporate demand for such funds from people at large.

Should You Go For It?

Go ahead, say investment advisors, so long as you're comfortable with the safety. If return of capital is more crucial to you than return on capital, advises Bajaj, don't be too greedy with interest rates; go for government bonds and triple-A-rated corporate debt. Rohit Sarin, partner, Client Associates, also advises caution. "It is difficult for small investors to judge credit quality," he says, "and recent track record being no guarantee of a company's future only makes matters difficult."

Check out the company's prospects, too, adds Gautam Nayaka, a ca. "The future of the industry and the company's position is a judicious approach to gauge investment," he says. For instance, Lupin's offer of 11 per cent had not found too many takers, but the pharma boom helped the investment come good for those who went for it. The company's investor relations could shape your choice, too. In fact, according to N. Radhakrishnan, Deputy General Manager (Deposits), HDFC, "Safety, return, service and liquidity are primary concerns, and any investment should be weighed for all these."

Minimum deposit levels vary, and the trend of higher minimums is helping cut transaction costs. Still, ensure you read the fine print; if you want to exit early, you should know the penalty and ease of liquidation. By RBI guidelines, no money can be encashed before three months from the date of deposit, and money is made available after six months by deducting 1 per cent from the rate of interest. However, a company may have its own exit penalty as well.

On the whole, a good way for a debt investor to cut risk is to diversify holdings; if the interest from a single company is under Rs 5,000 a year, you escape tax deducted at source (TDS) as well.

As for debt tenure, says Bajaj, "Investments should be made for only a year, unless the company is tried and tested, for which the lock in could be even up to five years to get maximum return."

But Then Again...

Just how attractive company FDs are is still not clear to everybody, which is why the prospect of a big revival is still iffy. According to Nayaka, "An FD should be the last thing to put your money in; instead, RBI bonds at 8 per cent are a safer option, barring the premature encashment." Balaji Swaminathan, CFO, ICICI Bank, echoes the same: "Why should one look at any other risk when there is a Government of India risk to be taken?"

Rated well the debt might be, but to whet investor appetite in larger numbers, the offered rates would have to be higher. After all, inflation corrodes fixed returns, and that has been a story playing on people's minds. Moreover, a boom can only happen if the market acquires depth. That happens if variety grows, and even riskier bonds start finding takers at commensurately higher rates. Right now, there are few signs of that.