Marcellus Study Belies A Traditional Value Investing Wisdom

The traditional value investor wisdom suggests buying shares of lenders with low price-to-book multiples increases chances of higher stock price returns. A study by Marcellus Investment Managers found it’s quite the opposite.

An analysis of historical data by the portfolio manager revealed that investments in Indian lenders with higher-than-median P/B multiple results in higher returns, according to a newsletter published on its website. Such investments rose at a 10% more annualised pace than money parked in stocks of lenders trading at lower-than-median P/B multiples.

In the broader markets, earnings growth determined returns over longer periods of time, and the entry-level price-to-earnings multiple had very little impact on the overall outcome, Pramod Gubbi, head of sales at Marcellus Investment Managers, told BloombergQuint's Niraj Shah in an interview. While the P/E multiple could make a difference for those investing for six months to a year, there’s no effect of the entry-level multiple when ploughing money for three to 10 years, he said.

P/B is a better indicator versus P/E for financials because an accurate picture of their balance sheet holds precedence over their earnings, he said. And the correlation between entry P/B multiple and eventual returns kept dropping as investment horizon increased.

The phenomenon is more prominent in financial companies because banks and non-bank lenders are capital consumptive—meaning, they generate a return on equity often and need external capital infusion to fund growth, according to Gubbi.

It is better to look at lenders with cleaner and stronger balance sheets, and prudent lending norms because all these factors, when recognised by the market, give them a higher P/B multiple, he said. Raising external capital becomes cheap for banks with higher P/B multiple because it’s required to issue fewer shares to raise the same amount of money, which improves book per share.

Banks with stronger balance sheets will be able to weather the crisis stemming from the Covid-19 lockdown and the moratorium since they wrote off bad loans and made heavy provisions. With the Supreme court now allowing recognition of non-performing assets, these banks will now see a huge earnings upside, according to Gubbi.

Watch the full interview here: