|»5 Minute Wrap Up by Equitymaster|
On This Day - 24 JULY 2015
Are you buying stocks at an auction?
In this issue:
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.
Data source: Equitymaster, Yahoo Finance, ycharts.com
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.
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.
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.
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