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Can P/E ratio and P/B ratio be used while selecting mutual funds?

- Ajit Pawar

The P/E ratio compares the current market value of the share of a company with the EPS i.e. earnings per share of the company. EPS is the profit earned by the company divided into the number of shares of the company. The P/B ratio compares the current market price of the share of a company to the value of the share as per the books of the company i.e. the value as shown in the balance-sheet of the company in the previous financial year. In the case of a mutual fund, a P/E ratio is the weighted average P/E ratio of all the stocks that it holds in its portfolio. Similarly, P/B ratio is the weighted average P/B ratio of all the stocks that it holds in its portfolio. So a fund that follows a growth style of investing will exhibit higher P/E and P/B ratio. Similarly, if a fund is following value or contrarian style of investing, it may have lower valuation ratios compared to growth-oriented funds.

This does not mean that value funds are better than growth funds. Therefore, these ratios can be used as one of the factors while selecting a scheme, but should not be the only factor as the P/E ratio of a stock and a mutual fund scheme do not denote the same thing. The P/E of a stock is applicable to an individual stock. Moreover, you need to compare the valuation ratios of a mutual fund scheme with its benchmark and peers in the category. Only after this you can come to any conclusion if the fund is undervalued or not. A lower valuation compared to its category and benchmark indicates better margin of safety and the scheme may fall less and will be relatively less volatile in a falling market. Nevertheless, we will reiterate once again that investors should not rely too much on these ratios to select funds. 

Is it the right time to exit pharmaceutical funds?

-Sumit Chawan

I n the past one and half years, the pharmaceutical sector has received a lot of attention from investors after the outbreak of the corona virus. Due to the increased demand of pharmaceutical products, shares of pharmaceutical companies have seen a significant growth in their value. This has come after a lull of almost four years in the sector. Hence, there is a question whether investors should wait for the stocks to yield more returns or should they realise the profit earned until now. As of now, i.e. June 2021, there is quite a bit of uncertainty in the markets. The overall market is thought to have been slightly overvalued as the Nifty 50, an index of the top 50 companies in India, zoomed from around 7,500 in the month of March 2020 to more than 15,000, doubling in value in just one and a half years. 

In the same period, Nifty Pharma index, which touched the lows of around 6,300 in March 2020, zoomed to almost 14,400. This shows that not only has it got more attention but has received more value than any other sector in the same period. In a recent development, new mutants of the virus have started appearing and therefore the revenues of the pharmaceutical companies might rise even more, which might lead to even better earnings for the stocks. Therefore, our advice to you would be to book partial profit from your pharmaceutical funds, ranging from 30-50 per cent. This would safeguard you from a larger loss if the pharmaceutical companies do not perform well from here on, but give exposure to the profits if the performance is very well.

The recent news referring to the possibility of a third wave of the virus in India will lead to higher demand for pharmaceutical products. Besides, if you look from the last five years’ perspective, the returns are not exceptional from pharmaceutical funds and a new cycle will help funds dedicated to pharmaceuticals to perform better.