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What Can Happen to the Stock of an Outstanding Company (You Might Find This Hard to Believe)

Oct 27, 2016

In this issue:
» Festive cheer for consumer durables industry
» FMCG companies confident of a better second half
» ...and more!
00:00
Rahul Shah, Co-Head of Research

We'll play a little game today. Here's what I'm going to do. I will show some key long-term profitability numbers of a certain company. And then I'll ask you a question you'll need to guess the answer to.

Here are the numbers:


  Net profit (US$ billion) Return on Equity
FY90 0.3 38%
FY91 0.5 41%
FY92 0.7 40%
FY93 1.0 35%
FY94 1.1 30%
FY95 1.5 31%
FY96 2.2 36%
FY97 3.5 42%
FY98 4.5 37%
FY99 7.8 36%
FY00 8.0 27%
FY01 9.0 16%
FY02 9.2 15%
FY03 6.5 13%
FY04 6.0 12%
FY05 12.3 21%
FY06 12.6 28%
FY07 14.1 39%
FY08 17.2 52%
FY09 15.5 40%
FY10 18.6 43%
FY11 22.9 45%
FY12 21.6 27%
FY13 21.8 30%
FY14 22.4 26%
FY15 18.6 14%
FY16 17.8 22%

Data Source: YCharts

Pretty cool numbers, eh?

Not even close to a loss in the last twenty-six years, and some amazing return on equity (ROE) numbers too. If you were co-owner in this company at the turn of the century in the year 2000, you could have barely hoped for a better performance from it over the next seventeen years.

Moreover, let me tell you, this is no small company. There are few people in the world who don't use its products.

So here's the question for you. How do you think this company's stock has performed over these last seventeen years? Good? Great? Fabulous?

Here's the answer:


Yup, that's right. The stock of this company has gone pretty much nowhere over the last seventeen long years. In fact, last Friday was a big moment in the life of this company. Its stock finally crossed the level it had touched way back in 1999. Phew!

I'm talking about none other than the third-largest company in the world by market cap - Microsoft Corporation.

So, what explains the strange saga of Microsoft stock?

The world's greatest investor, Warren Buffett, offers us a clue:

  • Investors making purchases in an overheated market need to recognize that it may often take an extended period for the value of even an outstanding company to catch up with the price they paid.

And yes indeed. In the overexcited markets of 1999, the stock of Microsoft was in seventh-heaven. It had touched a high price to earnings (PE) of almost 80 times.

The result is that it has taken the company seventeen long years to work out the hangover of that stock market party, despite a great performance in terms of sheer profitability.

What do we make of this? It is ironic, yes. But surprising? Not at all. Buffett is right. Time and again, over optimism about a company or sector takes stock prices to ludicrous levels. And in most cases, even if the company turns in a very respectable performance over the next many years, it could have a hard time living up to such hyped-up stock prices.

The only defense investors have to avoid getting stuck in such situations is to be intensely price-focused while buying stocks. Frugality is always the best policy.

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02:35 Chart of the day

If the sales for the first five months is anything to go by, looks like the consumer durables sector will have a bumper Diwali this year. As today's chart of the day highlights, volume sales for some of the key products have been very good so far this year, both on an absolute as well as a relative basis. And given that it is usually the second half of the year that rakes in big volumes for most products, the growth may look even better for the entire year.

Well, it is even showing in the performance of the BSE Consumer durables index as the same has gone up by some 13 odd percent over the last few months. In comparison, the benchmark index has nearly been flat. To be honest, with the way the economy and our demographics is placed, it won't be wrong to say that we in the midst of a multi-year boom in the consumer durables space and investors would do well to consider fundamentally strong companies from this space for their long term portfolio. However, caution needs to be exercised in terms of not going overboard with respect to valuations.

Consumer Durables is Riding a Strong Growth Wave


03:40

Consumer durables is not the only sector that's expecting a better second half of the current financial year. Even consumer goods firms are of a similar view. With all the major companies in the space reporting subdued second quarter performance, the revival becomes all the more important. Hindustan Unilever, ITC and Dabur have all come out with their second quarter results with topline growth almost flat save for ITC, which reported a more respectable 8% YoY growth. However, the companies are hopeful that the worst is behind them and are confident of putting up a much better show in the second half. And they have reasons to feel so.

The monsoons have been good and this means a revival in demand from the rural sector, a significant contributor to the sector's growth. Besides with money from the seventh pay commission and OROP also likely to come in, volume growth should certainly receive a boost. Does this mean investor should make a beeline for sector stocks? Absolutely not. Demand pick up alone should not be a reason for investing in firms from the sector as careful attention also needs to be paid to the valuations of these companies. If they are already trading at multi-year highs, then its better to give these stocks a miss.

04:45

After the Indian stock markets opening the day in the red, benchmark indices have moved upwards and were trading flat at the time of writing. BSE Mid and Small Cap indices however were trading weak. Amongst sectors, barring FMCG, most other sectors were trading weak.

04:56 Investment mantra of the day

"We simply attempt to be fearful when others are greedy and to be greedy only when others are fearful." - Warren Buffett

This edition of The 5 Minute WrapUp is authored by Rahul Shah (Research Analyst).

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1 Responses to "What Can Happen to the Stock of an Outstanding Company (You Might Find This Hard to Believe)"

Krishna Kumar

Oct 31, 2016

I wish you had put P/E, EPS, Dividend per share also in the table, along with RoE and Net Profit. Yes the way you had presented would have attracted readers and got them excited. But those who are looking for substance would feel cheated for giving conclusions from incomplete data.

Like (1)
  
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