Many smallcap and midcap stocks have been trading near multiyear lows for a while. And they continue to remain so. However, when gauged on a price to earnings (P/E) basis, they may not seem attractive. This is because of the sharp drop in earnings witnessed by such companies leading to a rise in the P/E ratio. However, when compared to the net worth or book values of these companies, a different picture is painted altogether.
When the tides will turn for the better is anyone's guess. Stocks have gotten hammered on account of poor financial performances coupled with overall averseness to have the smaller companies as part of portfolios.
Amidst all this gloom, here is one thing that comes in as a sign that is reassuring that stocks indeed are cheap! As per an article in the Economic Times, promoters of many midcap and smallcap companies have been increasing stake in their companies through open market purchases. And as such one could take this as a sign of stocks having 'bottomed out'.
Why would any promoter increase stake in his own company? The obvious answer to this is because he feels his business is mispriced. And to take advantage of the low prices, he would buy more shares. In most cases, no one would know the value and outlook of a business more than the promoter; which is why investors take such developments as a positive sign.
But can one take this as a sign of stocks having bottomed out? We do not think so. And what is more important is for investors to not blindly purchase such companies just because the promoter is doing so. One has to realize that stocks - especially those trading at their lowest levels (of different periods being 52 week lows, three-year or five year lows) - would be seeming attractive due to certain reasons. One would need to understand and gauge those reasons, consider the risk-reward ratio, and identify stocks that would in fact be mispriced as compared to their underlying values.
Also, it must be kept in mind that as of now there are no clear signs of India's economic scenario improving. Nevertheless, the fact that promoters are increasing stakes can be taken as a cue that stocks are indeed cheap!