Want to pick stocks by fair value? Here are some ideas from Graham’s number

The Indian stock market has been slowly giving up some of the gains from the sharp bounce-back that followed the bloodbath a few weeks ago. While the bulls have managed to pull back share prices from what they believe was an oversold zone, the risk elements remain.

The benchmark indices are just 5% shy of their all-time peak but are slowly shedding small chunks. And even though many market pundits say the worst is behind us, few do consider this as a ‘dead cat bounce’ that has given a false comfort level for investors to pump in cash.

In a bull market, it’s easy to be swayed by a herd mentality to look for growth stocks but as concerns of valuations in the market grows investors start looking at alternative investment themes such as value investing.

On the flip side, when the markets are flush with liquidity, it is not a no brainer to identify value stocks, which refers to shares of firms that appear to trade at a price below what is suggested by its fundamentals, such as earnings, revenues and dividends.

One way to gauge a set of such companies is to scan them through the lens of the ‘Graham’s number’, which represents the fair valuation of a stock. It sets the upper price limit that a defensive investor can or should pay for a stock.

It is calculated from the Earnings Per Share (EPS) and Book Value Per Share (BVPS).

The measure was created by Benjamin Graham, a British-born American economist, professor and investor, widely considered as the father of value investing. Although there are limitations for the use of this number in asset-light technology enabled business, we set aside those conditions and try and identity stocks that could be considered as they are trading below their fair value.

If we look at the BSE 500 set of companies, we get a set of around a dozen names that are trading at a discount to the fair value.

At the top of the chart is Maharashtra Scooters followed by Power Finance Corp, Indiabulls Housing Finance and Tata Investment Corp.

Lower down the order we get names like REC, Indian Bank, PNB Housing Finance, Great Eastern Shipping, Uflex, Canara Bank, Bombay Burmah Trading, ONGC and Spandana Sphoorty.

Some other stocks that are not at a discount but close to their fair value and thereby could be buy candidates at dips includes names like Grasim, Cholamandalam Finance, HPCL, Cochin Shipyard, LIC Housing Finance, Oil India, Gujarat Alkalies and EID Parry.