Are you buying stocks at an auction?

Jul 24, 2015

In this issue:
» India Inc's pricey amongst the priciest
» Pharma majors' ambitious global foray
» How are companies using their 'crude' savings?
» ..and more!

Buy stocks like groceries and not like perfumes. This is possibly the simplest way to understand what value investing is all about. And coming from none other than the grandfather of value investing, Benjamin Graham, this is the most repeated sermon on the subject. However, for a lay investor, one look at the valuations today, will make him wonder what was Graham thinking when he said this! For there is so much money chasing so few good businesses that valuations have gone through the roof. And unless patience is one of your biggest virtues, you can forget about seeing the sought after stocks in your portfolio.

Over the years, investors have realized that amongst the thousands of listed companies, there is just a handful that has successfully multiplied investor wealth. And hence there is no reluctance in buying the most coveted 'trophy' stocks at auction-like prices.

Now, the rally in stock market valuations from 2003 till date has had three legs to it. The first one of course is growth in earnings as Indian companies displayed their ability to compete and acquire companies globally. The second was the huge influx in foreign capital with interest rates overseas heading to zero. And the third was valuation re-rating as emerging economies like India stood out for relatively higher growth rates. Barring the temporary correction in 2008 and 2009, the upward rise in valuations of the best businesses has been a one way ride. And even if the earnings growth takes a backseat, as long as the foreign funds keep trickling in, the most sought after business could enjoy their premium.

The current valuations of some of the best business seem to have no relevance to their past or future earnings growth. Rather they seem to be driven by the desire of investors to own the trophy stocks. And hence forget about groceries and perfumes, investors seem to be buying such stocks with an auction like mindset.

The assumption that the great businesses will always find takers at any price has driven their valuations to irrational levels. In fact some of the most consistent and fundamentally sound companies in India are currently valued at multiples that are amongst the highest globally. Kotak Mahindra Bank, one of the most expensive financial entities in India trades at 2.5 times the valuations of one of the world's best bank Wells Fargo. HUL too trades at almost 2.5 times parent Unilever's valuations. The multiple for Asian Paints is double that for global paint giant PPG. And in fact, if higher growth in the Asian region is the rationale for the valuations, India companies are leaving even the Chinese behemoths behind. The stocks of Eicher Motors and L&T seem to offering their Chinese auto and infrastructure counterparts stiff competition in valuations. This is even though the Chinese companies are much larger in size.

Priciest amongst the pricey?
 P/E or P/BV*
Kotak Bank 4.7
Wells Fargo 1.8
HUL 45.7
Unilever 18.7
Eicher Motors 103.1
Dongfeung Auto 108.4
Asian Paints 53.8
PPG 26.2
L&T 34.6
China Railway 12.5
*As on 24th July 2015
Data source: Equitymaster, Yahoo Finance,

So should you give in to the temptation of bidding for the trophy stocks at stock market auctions?

Well, buying stocks with auction like mindset may serve well in terms of helping you show off your portfolio to your friends and family. But it is rather unlikely that such a mindset will help you create real wealth over the long term.

And hence instead of fretting over the lost opportunity to bag such stocks when they were cheap, you would rather be on the lookout for the best businesses in the making. Even if just a few of your stocks bought with safety in valuations turn out to be winners, you could well be the owner of some trophy stocks several years down the line. That too without participating in the auction!

Do you approve of buying the most coveted stocks with auction like mindset? Let us know your comments or share your views in the Equitymaster Club.

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 Chart of the day
Talking about valuations, Indian pharma companies certainly deserve a mention. For they were amongst the biggest gainers in 2014. And it seems there is reason for some of the stocks to continue commanding their premium. The Indian pharma majors have been on an acquisition spree over the past few years. Lupin's latest buyout of Gavis Pharma is one of the biggest buyouts by an Indian company in the international market. The global generics market in recent times has become one that is characterized by intense competition, growing stringent regulations and price erosion. Hence, the companies are scrambling to acquire scale to have that 'edge' over their peers in terms of bargaining power and pricing.

Growing M&A activity in the pharma space

The large ticket acquisition provides the much needed scale to survive the tough conditions in the generics market. But one also needs to keep in mind the aftermath of these acquisitions. The companies that embark their ambitious expansion plans at the cost of high leverage could cause disarray in its financials. Other than this, are the integration issues that companies face. Ranbaxy's acquisition by Sun Pharma is the case in point here.

Further, these global acquisitions certainly bring in the country risks. The classic example here is of Dr Reddy's acquisition of Betapharm. Betapharm at the time of acquisition was the fourth largest generics company in Germany. The subsequent changes in the German generics market had an adverse impact on Betapharm. Dr Reddy is still struggling to grow in this market. At the end of the day, what matters is how the company is able to derive value from the acquisition. And augment the overall performance despite the slew of challenges in the medium term.

Meanwhile, low crude prices continue to be a windfall for India Inc. Perhaps the government was the biggest beneficiary of the steep fall in international crude prices as it helped contain the current account deficit (CAD) as well as cap the subsidy burden. However, there are many sectors which seem to be taking advantage from this plummeting crude price. The FMCG sector is the case in point here.

The input costs of various FMCG companies that have crude as input for manufacturing soaps etc, have come down. Some of these companies have been utilizing these incremental savings for R&D purposes. The trend is already visible for various leading players viz; Britannia, GlaxoSmithKline Consumer, Marico, ITC and others. ITC has already increased its expenditure as much as 48% in the year gone by. While the current fall in crude is giving these companies an extra cushion in margins, the R&D spend is likely to strengthen their product pipeline. But given the volatility in the crude prices one cannot expect this trend to last long. Hence, companies that can stand relatively resilient when the cycle reverses should be the preferred bets.

After opening on a weak note, the Indian stock markets have continued to decline. At the time of writing, the BSE-Sensex was trading lower by around 177 points. Selling pressure was largely seen in realty and auto stocks. Stocks from the consumer durables space were, however, trading strong. Both the midcap and smallcap indices also were marginally down, with the S&P BSE Midcap and S&P BSE Smallcap indices down by about 0.15% each.

 Today's investing mantra
"The highest stock market prices relative to intrinsic business value are given to companies whose managers have demonstrated their unwillingness to issue shares at any time on terms unfavorable to the owners of the business" - Warren Buffett.

This edition of The 5 Minute WrapUp is authored by Tanushree Banerjee (Research Analyst).

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4 Responses to "Are you buying stocks at an auction?"

G S Apte

Jul 25, 2015

This is indeed a very good article, which clearly indicates why value buying is important to achieve handsome returns from the equity. If an investor look at buying a stock as auction, then more than he often s/he has to pay high price without any margin of safety, leading to short term losses and sub optimal long term returns.

In all areas of life, one has to always look for price bargains, and the same applies to real estate and stocks. I often find it hard to understand when people buy stock/real estate at unrealistic prices and expect high returns on that. "Margin of safety" should be applied by all investors in real estate and also in stocks.

This article has managed to explain this in more simple language.


kamal jain

Jul 24, 2015

you have added new facet to think about value investing.often my friends do like this.i will be more wiser.


Dara Kalyaniwala

Jul 24, 2015

Good article which in a few words communicates the thought so well. Fully agree with the thoughts shared by Mrs Banerjee. In this market, patience is the key. It's pointless buying "trophy" stocks at these prices. If bought at these prices, the portfolio will become "poorer".

I like the term "trophy" stocks. It describes the category of stocks listed out in the article very well.


ameet parekh

Jul 24, 2015

great good business are very few .so if someone is willing a pay a fancy price should an investor sell???.my take on the matter "if you have found an equally good business to invest in at the right price then sell otherwise sit tight and do not sell."

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Definitions of Terms Used:
  1. Buy recommendation: This means that the investor could consider buying the concerned stock at current market price keeping in mind the tenure and objective of the recommendation service.
  2. Hold recommendation: This means that the investor could consider holding on to the shares of the company until further update and not buy more of the stock at current market price.
  3. Buy at lower price: This means that the investor should wait for some correction in the market price so that the stock can be bought at more attractive valuations keeping in mind the tenure and the objective of the service.
  4. Sell recommendation: This means that the investor could consider selling the stock at current market price keeping in mind the objective of the recommendation service.
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