Should you buy 'recession proof' stocks? - The 5 Minute WrapUp by Equitymaster
Investing in India - 5 Minute WrapUp by Equitymaster
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Should you buy 'recession proof' stocks? 

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In this issue:
» The managements that are buying or selling their own shares
» China's ghost cities and extravagance
» Wisdom finally dawns upon Alan Greenspan
» 'Greece should default', former advisor to Argentina
» ...and more!

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00:00
 
What is common between stocks like Gillette India, 3M India, Nestle, P&G Hygiene and GSK Pharma? Well, they are excellent companies to begin with. Furthermore, these are the firms that have a steady demand for their products all through the year irrespective of the economic environment. It is not surprising then that investors flock to these companies when huge, dark clouds of uncertainty gather over the horizon. In view of the same, they have come to be called as defensives or recession proof stocks.

The current environment is one such environment we believe. And like on every such occasion in the past, investors of all stripes are recommending 'recession proof' stocks at the top of their voices. However, is their optimism justified? We do not think so. The companies mentioned above are extremely well managed companies no doubt but the prices they seem to be commanding in the market place are certainly on the higher side. Not just these firms but almost all the companies in this space are trading at a P/E multiples of more than 30 times their earnings for the last twelve months. In fact, some of them are valued as high as 50 times! This, at a time when the Sensex P/E is ruling at a lot lower levels of 18 times.

One could of course argue that these are high growth companies and hence, deserve high P/E multiples. But it would help to remember that a stock with a P/E of 50 times will have to at least grow 50% every year to justify those high multiples. Any lower growth than that and investors would start punishing the stock. And why is such a high growth impossible for a sustained period of time? Well, its impossibility could be gauged from the fact that even a small company with profits of Rs 1 bn growing at 50% per year will surpass the FY11 profits of Reliance Industries, India's largest private sector company in a short span of just 13 years! And where will it be after say 27 years? Well, its profits would be close to the total GDP of India! Need we add that we are dealing with things in the realms of impossibility?

It should be noted that we ourselves are big fans of well managed recession proof companies. But at current levels, the odds seem to be stacked firmly against them.

Do you think defensive or recession proof stocks are attractively valued from a long term perspective? Share your views or you can also comment on our our Facebook page.

01:20  Chart of the day
 
Ok, we've had a dismal growth in industrial production for the month of July. The index of industrial production, widely considered to be a gauge of industrial activity, grew a measly 3.3% during the month. However, as today's chart of the day shows, the widely fluctuating nature of the index means that it may not be a good indicator of India's economic growth. Furthermore, the high growth witnessed in July 2010 may have led to a high base effect thus making the picture look worse than it actually is. Thus, ringing the alarm bells on this one may prove to be a little premature.

Source: The Financial Express

01:50
 
Wisdom, however good, does not have the desired impact if it dawns upon somebody too late. No better example of this than the former US Federal Reserve chief Alan Greenspan. The veteran central banker who presided over the building up of subprime loan crisis in the US seems to have had a change of mind. Greenspan opines that the only way the regulators can fix the US economy is by inflicting pain. An overhaul of the tax code to solve the country's budget problem is one of the key solutions offered by the ex-central banker. What he seems to have missed is that the US could have done without the loose monetary policies that helped create asset bubbles during his tenure. Had that not been the case the global economy would have not been going through the pain that it has to bear today. Well, Mr Greenspan now seems to have loads of wisdom and shrewd advices for his successor Mr Bernanke. But the US Fed chiefs have for long hardly shown any inclination for conservative policy making. In such a scenario, we do not think Mr Greenspan's words are likely to have any impact on the US' monetary and fiscal policies.

02:28
 
If the management is buying its own shares, it is a clear indicator that the management is confident that valuations of the company would improve in the future. And if it is selling its own shares then it should indicate that something is wrong. Either the prices are too high to justify company fundamentals or something is wrong with the business itself. Recently, the managements of two major groups of India decided to deal in their own shares. On one hand, the holding company of the Tata Group, Tata Sons, decided to buy shares of Tata Steel and Tata Motors. Considering the fact that the prices of both the companies have taken a beating in recent times, this move may provide some support to the prices.

On the other hand, Mr Y C Deveshwar, Chairman of ITC, has been selling his holdings. The recent run up in the company's stock prices may have been one of the reasons for this. The important thing for investors to understand here is that the management of the company has better knowledge of the company's fundamentals as compared to the broader markets. And therefore, they are in the best position to evaluate if a stock is cheap/expensive in terms of valuations. Such moves (buying/selling) can be used as a good indicator of the company's valuations. And we all know the best way to maximize long term gains is by buying at cheaper valuations and selling the stock when it becomes expensive.

03:15
 
So indebted is Greece that it barely has sufficient cash to keep its head over water. European central banks in the meanwhile are scratching their heads in trying to come out with a solution to bail out Greece. Whatever stimulus packages the banks had doled out for Greece earlier do not appear to have bolstered the Greek economy. That is why former Bank of England advisor Mario Blejer is of the view that 'Greece should default, and default big' if it has to eventually emerge from this mess.

Blejer believes that rescue programs backed by the International Monetary Fund and European Central Bank are "recession creating" efforts that will leave Greece saddled with more debt relative to the size of its economy in coming years and stifle growth. What is more, a Greek default will also pressurize Portugal and Ireland to default and the pave the way for recovery however long and arduous that journey may be. For the Eurozone, this solution seems unthinkable as it is worried about the implications of a default on global markets. But we believe that Blejer has a major point here. It is more than evident that stimulus packages have not really done their bit in bolstering economies not only in Europe but also the US. Hence, defaulting on debt may just be the medicine that the developed world will need.

03:59
 
The human spirit often finds gratification in abandoning the bounds of reason and sanity. You look at the extravagances and excesses of the Chinese real estate and you would totally agree. Evidence is slowing growing strong against the Keynesian fallacy of growing for the sake of growth. This approach failed miserably in the US. And you could very well start counting the days of the real estate boom in China. Several lavishly built Chinese cities remain substantially unoccupied. But that doesn't seem to have deterred the builders. They continue to build more in the dreamy hope that if not now, if not in a few years, eventually someone will buy.

There's even more. The kind of opulence that some Chinese buildings show off would put the developed world to shame. Take the corporate headquarters of the state-owned Harbin Pharmaceutical. The palatial office boasts of gold-encrusted hallways, marble foyers and dazzling granite frontage. Though there is nothing wrong in splurging money that you own, this kind of lavishness will eventually hurt China going forward.

Source: Chinasmack.com


04:45
 
Meanwhile, indices in the Indian stock market got into acceleration mode after opening the day on a sedate note. The benchmark BSE Sensex was trading higher by more than 200 points at the time of writing. Tech heavyweights such as Infosys and TCS were seen adding most of the gains. Most indices in Asia however closed on a negative note. Europe on the other hand, is trading mixed currently.

04:55  Today's investing mantra
"If you can't find any companies that you think are attractive, put your money in the bank until you discover some." - Peter Lynch
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10 Responses to "Should you buy 'recession proof' stocks?"

S.K.Damani

Sep 15, 2011

Further adding to my previous comment, your last quote genrally sums up the entire article. The quote by Peter Lynch, provides the best answer to your question, whether we should buy recession proof co.s at present valuations? Just great.
Thanks Damani

Like 

S.K.Damani

Sep 15, 2011

Dear Sir,

Where there are thousands of Company, which can give faboulous return over every 5 yrs, it would be wrong to buy these recession proof cos., As I had written a few days back, one invests in the mkts to get good returns by way of Capital appericiation and life long dividends. The yields of these recession proof Co.,s would be less than 1 per cent per annum, if purchased at present prices. Secondly assuming that they would grow at 5opcent anuully, which you have very rightly termed it as absurd, is not going happen. Thus it would be much better to reasearch and buy "hidden Gems", future growth stories.
And please, there are many such Co.s available, one has to invest time, studies, regular monitoring to find such gems.

By the way if you invest 1 paise per day and promise to double it every day than after ONE MONTH that amount, which you have to double and invest would be Rs. 53 lakhs 68K.

AND even if you promise to invest at the rate of 50% increase every day, AFTER 30 DAYS THAT AMOUNT WOULD BE Rs. 1,29,000/-. Therefore growth at 50 per cent per year would definetly, as pointed out by you more that India's GDP.
Thanks Damani

Like 

amit

Sep 15, 2011

I believe that when equitymaster requests for comments on articles, it should also respond to them otherwise it pretty much loses the purpose of discussion and make it look like they dont have an answer :-)

Like 

Laxman Suvarna

Sep 14, 2011

The health of a company is reflected in the quality and commitment of its management, steady growth, ROCE, EPS etc. over a longer period (say 10 years)achieved with minimum debt. A shrewd investor remains invested in such companies for long term capital appreciation. In addition, if the company regularly declares bonus and handsome dividend then it becomes the darling of the investment community. Such companies need not grow at 50% every year for the investor to realize his targeted price appreciation!

Like 

sunilkumar tejwani

Sep 14, 2011

Well these are fancied companies, but surely their share prices will fall to realistic levels, to the P.E multiples of 20-25 or there about in a falling market conditions. That is the right time to pick up these stocks. At current valuations, market is fully discounting next three to five years earnings. And as such future is always uncertain. Within the next three years, competition or rising costs factor may take away some sheen off from these companies bottom lines.

Like 

lakshmanan

Sep 14, 2011

more or less your views are correct. but due to the uncertanity of the market & various economies worldwide investors preferred to stay with well managed companies even with higher valuations

Like 

shailesh

Sep 14, 2011



Like 

anupam garg

Sep 14, 2011

why is a pharma company's superfluousness targeted as pressuring the economy of a country?

Like 

Avinash

Sep 14, 2011

It's not about growing at 50% forever. But 50% growth for 4 years will increase the profit 5X and hence the P/E multiple would then be 10X from 50X - good investment if that is the growth expectation (and forecast) for 4 years, then it is a good investment, any good growth thereafter is a bonus!!

Like 

SVarghese

Sep 14, 2011

A company quoting at 50PE need not grow at 50% for very long time. Let us assume a growing company quoting at PE of 50 and growing at 40%. Let the share price be 500 and EPS=10. If the company grows 40% so that EPS becomes 14. Now the share price need not grow 40% to keep the PE at 50. Rather I will be happy if the share price grows 25% (which is more than the average growth in Sensex). If this happens for 3 years, the PE will moderate. So after 3 years the equation will be EPS = 27.44, Share price = 976.56. Therefore PE will be 35.55. Now all these companies which have a high PE have very large ROE/ROCE. These companies need only very little cash to grow in the long term. Hence the share price need not even grow by 25%, it need to grow by only 23% because the extra 2% will come from dividend payout. I still think a trailing PE of 50 is too much for any company, but a PE of 40 is acceptable for high growth, high ROE/ROCE, exceptional and honest management driven companies.

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