The Hindu Business Line : Indian markets among most expensive globally?

The Sensex PB ratio is now at a record high of 6.5, making the Indian benchmark the most richly valued among the global indices on this valuation parameter. The PB ratio is a measure of the value that the stock market is willing to assign to a company, based on the tangible assets on its books.

It is computed by dividing the market price by the book value per share. The PB ratio is the most widely used measure, after the PE multiple, to value stocks.

While the Sensex PB ratio rules at 6.5, data published in Forbes.com in mid-November, reveals that the developed markets in US and Europe trade at PB ratios of between 2.4 and 2.8.

Emerging markets such as Brazil (4.3) and Mexico (3.5) sport PB ratios that are a tad higher than developed markets, but they are still well below Indian levels.

Even the Shanghai Composite Index hovers pretty close to the Sensex, if you go by its PB ratio.

Rapid rise

The current PB ratio of the Sensex is 80 per cent above its eight-year average. What is more, it has climbed from 4.8 in August to the current value of 6.5, in less than three months. The rapid increase in the stock prices over the last three months could be partially responsible for the distortion in this gauge.

Another bit of disturbing news is that it is not just the 30-stock Sensex that is stretched on this parameter. The more broad-based BSE 500 index too is ruling at a PB ratio of 6.2.

This indicates that the widespread rally in recent months has expanded valuations across-the-board.

However, PB ratio for the BSE Small-cap index is at a relatively modest 3.4.

Understated values

However, there is a section of investors who believe that a high PB ratio isn’t particularly worrying for Indian stocks.

Explains Mr Shriram Iyer, Head of Research at Edelweiss Capital: “Price to Book Value, as a valuation measure, usually sets a floor for valuing a stock. It doesn’t capture future earnings potential.” He explains that while a company’s book value typically captures the cost incurred to build assets, it doesn’t reflect the earnings that can be generated by these assets over the next few years.

Mr Iyer also feels that “book value” in the Indian context tends to be understated in balance sheets due to several reasons. He cites the example of natural resource companies.

“The value of mining rights, gas reserves or other resources held by companies such as ONGC, Reliance Industries, Tata Steel, SAIL and so on has risen sharply in recent times, but these assets are captured at cost in the company’s books. To that extent, the price-to-book value may not reflect the earnings potential of such companies.”

“There could also be several intangibles that are not reflected in the books. The value of an insurance subsidiary for a financial service company or the earnings potential of land held by a realty company will not be reflected in book value; yet they may have high earnings potential.

However, it would be difficult to comment on whether a PB ratio of over 6 is expensive for the Indian market,” he adds.

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