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 that lower-than-median P/B multiple.
In the broader markets, earnings growth determined returns over longer periods of time, and the entry-level price-to-earnings multiple had a very little impact on the overall outcome, Pramod Gubbi, head of sales at Marcellus Investment Managers. 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.