Indian Markets: Hidden Pitfalls to Playing by the Book

That stocks on Dalal Street have been beaten and hammered out of shape is probably old news. But allow us to put some numbers to it.

As per an analysis on most actively traded stocks (1,600 to be precise) published in a leading business daily, around 55% of the stocks are currently being valued by the stock market below their book value! What this essentially means is that if one buys into the complete equity of these companies and sells the assets in the open market, one could take home a pretty handsome profit.

The study further reveals that the discount to book value increases as the market cap decreases. In other words, there are quite a few mid-cap and small-cap firms that are trading at a steep discount to their book value.

While the current opportunity to buy into stocks with attractive growth prospects is indeed once in a lifetime, we would like to add that book value could be a misrepresentation of the true value of the company in quite a few cases. For example in companies with technologically obsolete plants, actual book value could turn out to be a lot less than what the balance sheet might imply. In other cases where companies have a lot of real estate bought many years ago, book value could turn out to be a lot more understated. Similar study needs to be conducted on other assets like inventory and receivables. Thus, while investing in a company based on book value, don't just go by the book.