Careful of Low Valuation Stocks!!

Many stocks are trading at highly attractive valuations;  basically low price to earning (PE) multiple or high book value (BV) compared with market price.  It could be due to various reasons such as poor financial performance, operational difficulties, company specific problems, hostile business environment and contingencies and so on.  In such case, attractively valued PE stocks could be a fatal for less informed retail investors.  Investors should stay away from mysteriously attractive valuations unless they know the real reason behind this.

Quality stocks always come at a premium to peer groups.

Investors can easily spot companies that are loss making and trading at pathetically dismal valuation considering their turnover and asset.  Loss could be one reason for low valuation, but not everything.  However, one critical lesson for retail investors is that focus on management quality and corporate governance.  There are many ways to trace companies that are commanding low valuation due to corporate governance.  The following could few for low stock valuations:

·         Stocks posting excellent numbers but trading at at low valuations.  Why are investors not offering rich valuation if the numbers are so robust.  The reason could be dubious management.

·         Continuous underperformance of stock year after year.  This could be a pointer towards corporate governance issue. 

·         Look at institutional shareholding to understand whether the company is worth investing.  Declining institutional interest should be treated as an early warning by retail investors.

·         Companies reporting very high EPS but paying low dividends without any justifiable reason such as major capital expenditure plan.

·         Companies with promoters owning less than 26% and reporting robust earning, and thus, low PE multiple.  Promoters need 26% equity stake in a company to pass simple resolution and enjoy management control over a firm.  If companies are doing so well and simultaneously available at low valuation, why are such companies not subject to hostile takeover?  The simple reason is such companies have no value and competitors know this fact very well.  Therefore, carefully scan companies were promoters have little stake but have no excellent financial numbers to show.

·         Adverse comments made by the statutory auditors in recent past.  If the statutory auditors are not comfortable with the financial presented to them, why should shareholders trust those numbers??

·         Exodus of independent directors from the board of directors

Investors should make efforts to dig reasons for the alluring valuations.  Remember nothing comes cheap.