The trick is not to lose sight of value stocks

Needless to say, investor confidence plummets when volatile markets experience historic cyclical lows like the one witnessed over the last one year. The major domestic markets were not an exception.

The Dubai Financial Market (DFM) lost around 70 per cent of its value in the last one year and the Abu Dhabi Securities Exchange (ADX) lost half of its value in the same period. But such periods provide good bargains for long-term investors, particularly if they are looking for picking value stocks that have simply hit historic lows in the momentum frenzy without much loss in their fundamental values.

Value investing is all about actively looking for stocks of companies that the market has undervalued. The strategy involves investing in companies that are trading significantly below their historic averages and below the market. Thus, it involves hunting for bargains on stocks trading for less than their intrinsic or true values.

The strategy relies more on fundamental information of the company as reflected in its financial reports. Thus, value companies stocks are characterised with low price earnings ratio (P/E), low Price/Book value (P/B) ratio, low EBITDA (Earnings before Interest, Taxes, Depreciation, and Amortization) multiple, a high level of asset backing and liquidity position and consistent returns to its shareholders.

Analysing some of the domestic stocks such as DP World, DFM, Aramex, etisalat, Air Arabia, Gulf Navigation, and Taqa that are trading near to their historic lows based on the value parameters, there is good evidence of their value to be unlocked in future.

The PE ratio of a company measures its current share price compared to its per-share earnings and is the most popular measure of value. It shows how much investors are willing to pay for each dollar of earnings. A stock with a low P/E ratio as compared to its peers suggests that investors are expecting lower earnings growth in the future compared to the overall market, as they are paying less for current earnings in anticipation of future earnings growth.

Simply put, investors seeking low P/E stocks have more modest expectations for its future growth compared to the market as a whole. Thus value stocks come ideally with lower P/E ratios as compared to their industry peers. In the current scenario, stocks of DP World, Aramex, etisalat, Gulf Navigation and Taqa are trading below their sectoral or peer P/E and making them attractive.

Another way to seek value stocks is to look for those that are trading below their book values or trading at a discount to their book values. Companies with Price/Book value less than one gives a significant 'margin of safety' to investors. Currently stocks of DP World, Air Arabia and Taqa are trading at a significant discount. At the same time DFM, Aramex and Gulf navigation have recorded a consistent fall in the value of P/B ratio in the last five years making them valuable.

The EBIDTA multiple also helps in determining the value inherent in a stock. It is a ratio of Enterprise Value/EBIDTA. Stocks with enterprise multiples below their historical average and market value provides a good entry point. This again makes stocks of DP World, Aramex, etisalat, Air Arabia, Gulf Navigation and Taqa quite attractive value picks.

At certain times, companies with a low debt or its shares trading below its book value may not have sufficient liquidity. The current ratio is an ideal tool to gauges the company's liquidity position. A current ratio value of more than 1 implies a comfortable liquidity position for the company. Looking at the current ratio of DP World, DFM, Aramex, Air Arabia, Gulf Navigation and Taqa provides significant evidence of their liquid strength.

A final look at the company's return on equity (ROE) also referred to as 'stockholder's return on investment' reveals the rate at which shareholders are earning income on their shares. Companies with consistent tract record of earnings always fits into the value stock league table.

To conclude, value investments strategy works best when the stock market as a whole is low and provides ample opportunities to investors to bottom fish. Like bargain hunters, value investors seek products that are beneficial and of high quality but underpriced.

In the last one year, DP World has lost 56.25 per cent of its stock value, Aramex lost 52.30 per cent, Etisalat lost 52.09 per cent, Air Arabia lost 51.26 per cent, Gulf Navigation lost 65 per cent and Taqa lost 50.28 per cent. Considering their business fundamentals, they do not fall under the penny stock category. It is very unlikely that they will further nosedive and some of these have already started rebounding thus making them more valued.

- The writer is professor of finance and accounting at S.P. Jain Centre of Management in Dubai and Singapore.