Understanding the P/B ratio

Understanding the P/B ratio

The P/B ratio is a classic tool to assess valuations, especially when the P/E ratio is not useful. Here is all that you need to know about it



Valuation metrics refer to the tools used to evaluate the financial strength of companies and are computed by making calculations using the data disclosed in the balance sheet, income statement and cash-flow statement. These ratios assess companies' profitability, liquidity, operational efficiency and stability, thereby providing investors with in-depth information on companies. By leveraging the power of ratio analysis, investors can make well-informed decisions.

The price-to-book ratio (P/B ratio) is a commonly used tool by value investors. Unlike the P/E ratio which mainly focuses on a company's earnings, the P/B ratio looks at how expensive a company is as compared to its assets (after paying off its liabilities). It is computed by dividing the price per share (or the company's market capitalisation) with the book value per share (or the company's net worth).

Let's illustrate this with the example of Reliance Industries, which is trading at around Rs 1995 per share and has a book value of Rs 736. So, its P/B ratio is 2.71. This means that investors are ready to pay Rs 2.71 for every rupee of net assets owned by Reliance Industries. If a company is trading at a P/B of less than one, this implies that investors can buy one rupee worth of assets for less than a rupee.

Advantages
Similar to the P/E ratio, the P/B ratio gives an easily understandable picture of the company's valuation in relation to its net worth. It is more stable (since asset prices are not as volatile as earnings) and can also be used to value companies which have not earned profits (start-ups and companies going through liquidation).

Disadvantages
However, this metric is based on the accounting recognition of assets and therefore, does not capture the true value of all the company's assets because the accounting system has not yet evolved to value intangible assets such as ideas, human capital, distribution networks and hard-to-value intellectual property. While book value might have been extremely relevant in the past when physical and tangible assets such as land, factory, equipment and buildings were the primary assets required for running a business, its relevance is decreasing in the modern era when the proportion of intangible assets is increasing(ex: e-commerce firms).

Therefore, the P/B ratio of companies having a greater proportion of intangible assets will seem optically higher than those having equal amounts of tangible assets.

Another drawback of this metric is that the value of assets is subject to management's discretion because entries like depreciation and goodwill can be manipulated to either increase or decrease the book value of assets.

Also, this metric cannot be applied to companies having negative net worth. For example, SpiceJet is currently having a negative net worth. And this could happen with startups as well as mature companies going through a difficult phase.

By Arul Selvan

Happy Investing

Source: Valueresearchonline.com

Bought a new house by selling a couple of old properties? You can still claim relief from capital gains tax

Bought a new house by selling a couple of old properties? You can still claim relief from capital gains tax 

The beneficiary must be an individual or a HUF and the residential properties being sold should have been held for more than two years


Can someone who sells two residential properties to buy a bigger house claim exemption from payment of capital gains tax? The Mumbai bench of the Income Tax Appellate Tribunal (ITAT) recently replied in the affirmative and that too while dismissing an appeal filed by the Revenue (Tax Department) in the ACIT-23(3) vs. Shri Sabir Mazhar Ali case. 

What does the judgement mean for taxpayers?

The issue

The main issue that came up for adjudication before the ITAT was if an assessee who sells two properties and invests the consideration into one residential house is entitled to exemption under Section 54 of the Income Tax Act, 1961 or not. Section 54 provides exemption to individuals and Hindu Undivided Families (HUFs) from capital gains tax on sale of a house provided the proceeds are invested in a new residential unit, within the stipulated time.

The essential conditions for availing the tax benefit under Section 54 are: the person claiming the benefit should be an individual or a HUF; and the residential property being sold should have been in possession of the seller for more than two years. The capital gains can be set off against the purchase of any residential property in the last one year before the sale of the house; or, the seller must buy a residential house from the sale proceeds within two years of the date of transfer of the old house or construct a new house within three years.

If an individual sells one house property to buy another residence, there are no issues. However, the law was unclear on whether a person can sell two houses and re-invest the amount in one residential house and still claim exemption from capital gains tax.

Initially, the Assessing Officer in the case mentioned above decided that the assessee was not entitled to the capital gains tax benefit under Section 54 of the income tax Act, as he had sold two properties and invested the proceeds in one property.

However, the Commission Income Tax (Appeals), on an appeal, decided the case in favour of the assessee. The decision of the CIT(A) was challenged by the Tax Department before the Mumbai bench of the ITAT.

ITAT's ruling

The appellate tribunal upheld the decision of the CIT(A), stressing that, "the Section nowhere restricts the claim of the assessee that he should have sold only one property and claimed exemption u/s.54 of the Act for one property...It nowhere prohibited the assessee to sell more than one residential house."

“Exemption under section 54 has always been a matter inducing litigation; however, the judiciary has time and again adjudged in favour of taxpayers, who were legitimately entitled to the benefit accorded to them by law. In this case too, relief has been granted to the taxpayer, to which she was lawfully entitled. 

Finance Act 2019

The Finance Act, 2019 amended Section 54 to extend the benefit of exemption in respect of investment made in two residential house properties with effect from Assessment Year 2020-21. In other words, Budget 2019 allowed home buyers to claim long-term capital gains tax exemption if they sold one house and reinvested the proceeds in two residential properties.

There are two conditions: The amount of long-term capital gains must not exceed Rs 2 crore. And this benefit can only be availed once in our lifetime.

Going by the ruling of the ITAT and recent changes in the income tax Act, an individual or HUF will get the benefit of Section 54 if she sells more than one residential properties to buy a new house or sells one house to buy two residential properties. “The judgement shall prove to be beneficial to those taxpayers who wish to purchase/construct a bigger residential dwelling by selling one or more houses. The ruling further re-establishes the faith of the taxpayers in the Indian taxation system that a rightful benefit under law shall not be denied to those eligible for the same.”

Happy Investing

Source: Moneycontrol.com

Sensex at 44,000: Five wrong reasons to invest in equities now

A rising equity market often attracts a herd of investors. This is the time to be cautious and to avoid investing lump-sums


Sensex and Nifty are hitting record highs every other day and investors are flocking to the market. But it has often been seen that few people actually make good money. The market high doesn’t mean your portfolio value has also rallied. You need to avoid the following missteps, which could derail your wealth creation process.

Wrong interpretation of data

Do not get lured by the returns the stock market has given in the last 6-7 months, that is, after it crashed in the month of March. Don’t look at the returns a stock has generated from its low in March 2020. Let me give you an example, say a particular stock was trading at Rs 100 in the month of January, but declines to Rs 60 in March. Now, let’s say the same stock is currently trading at Rs 120, and you keep hearing on twitter or WhatsApp about how it has given 100 percent returns. But don’t get misled by this and look at the year-to-date returns, which is 20 percent and not 100 percent.

Similarly, look at the Infosys share, which was trading at Rs 736 on January 1 and fell to Rs 509 on March 19. But it is currently trading at Rs 1130. So, it has given around 50 percent year- to-date returns and not around 100 percent if you look at it from its March lows.

Data can be misleading and can backfire if misinterpreted, more so if it's a small or mid-cap stock.

Investing on the basis of past performance

Why are many retail investors buying shares of pharmaceutical companies or investing in gold, lately?

These two avenues have outperformed many other stocks and other asset classes. But what you need to know is the fact that before their recent bull run, they had a pretty long dull period of underperformance. Remember that most of the time, the sudden bull run in a particular sector may not sustain. Why? Not every pharmaceutical company is into making a COVID-19 vaccine or a drug that can cure the pandemic. So, there are no long-term gains to be made for many of these companies.

Similarly gold is always a safe-haven investment avenue, and whenever the overall economy gets back on track, the yellow metal may not outperform. So, never invest because of the past performance, especially after a sudden run, unless you are bullish about that sector and its future prospects and it is linked to your financial goals and risk profile.

Diversification is for the ignorant

The legendary investor Warren Buffett famously said that diversification is for the ignorant and for those who do not know what they are doing. In fact, you cannot create wealth by investing in multiple stocks; what you need is a concentrated stock portfolio. While this logic is true, it may not apply to you, unless you are an investor like Buffett or Rakesh Jhunjhunwala, whose main business is investing, isn’t it? You may have your other business or job to take care of, so while Buffett does not need to diversify, you need to, because you may not have an army of people monitoring your investments in terms of what and when to buy, and when to sell.

If you buy equity shares directly, then invest in 15-20 Nifty stocks. Holding five to six top sectors within the Nifty is good enough. Do SIPs in equity shares, just as you do in mutual funds, in companies such as Tata Consultancy Services (TCS), Infosys, HDFC Bank, ICICI Bank, Kotak Mahindra Bank, Hindustan Unilever, Dabur India, ITC, Reliance Industries, Bharti Airtel, HDFC Life Insurance Company, SBI Life Insurance and Bajaj Finance.

Investing in cheap/attractive stocks

People like to invest in companies whose shares are trading at low Price-Earnings ratio (P/E), as they look cheap and attractive. This is mostly done because of the lower investment amount and the greed for making quick money with the assumption that this would go up faster.

We have seen the same happen earlier with companies such as Kwality, Vakrangee or recently with Yes Bank. Retail investors assumed these companies be good buys, but what they didn’t realise was that these stocks are trading at lows for all the wrong reasons. Remember, what looks cheap and attractive today may remain cheap and become ugly, whereas there are companies with high PE such as HUL which have constantly given great returns.

How do you pick a good company then? Pick a good business with an eye on the company’s future prospects in terms of its earnings, cash flows, economic MOAT and so on.

Buy low and sell high

Buy low, sell high does not always work.

How many of you could take advantage of the market crash in March? People did not buy at that time because of fear, no cash availability or because they deployed smaller sums and so on. HDFC bank shares were available for almost Rs 1,030 just two months ago and the same is now trading at around Rs 1430, almost 40 percent higher. These shares were available for less than Rs 800 in March.

Instead, think of buying high and selling higher.

Remember: The S&P BSE Sensex was all time high when it was at 20,000 level. It will be at all time high when it touches 50,000 level also.

Do not waste time in finding out the bottoms or lows. Just stick to your asset allocation and rebalance your portfolio if needed. Always remember that as a retail investor, you do not need to do something every time the market goes up or down. Timing of the market is a futile exercise in achieving your long-term financial goals.


Happy Investing

Source: Moneycontrol.com