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Are you an enthusiastic investor? Meet your nemesis...

Nov 21, 2014

In this issue:
» Are all indices back to 2008 levels?
» Yawning gap in corporate governance shows in stock prices
» Are we back to crony capitalism?
» Roundup on markets
» ...and more!


00:00
 
Think, for a moment, about any business in your neighborhood that you know is doing very well. Any business that you have often seen in action. It could be your next door grocery store, or your child's favorite ice cream parlor. A restaurant round the corner perhaps?

You've seen the manager perennially on the phone trying to note down the incessant flow of take away orders. And the long waiting queues outside the restaurant. You even waited for your turn for 45 minutes once!

Now imagine also, that someone comes up to you and tells you that the owner is looking to sell his restaurant. And you have the money to buy it. Would you buy it then, irrespective of the asking price?

No, you say?

But why not? After all, you know that it is doing very well, and are highly confident that it will continue to do so.

You will correctly reckon that irrespective of how well it is doing, it surely cannot be worth an infinite price!

Yet, when average person steps out of the real world and steps into the world of the stock market, he often leaves behind such basic common sense. So when dealing with stocks, which are nothing but slices of ownership of a business, the questioning usually stops at "Is the company expected to do very well?"

And if the answer is yes, the automatic conclusion is often - BUY the stock!

They all so often forget to ask the second important question. What is that question?

Well, Benjamin Graham laid it down in 1972, in his book The Intelligent Investor:

'The habit of relating what is paid to what is being offered is an invaluable trait in investment. The really dreadful losses of the past few years (and on many similar occasions before) were realized in those common-stock issues where the buyer forgot to ask "How much?"'

This priceless advice has continued to ring true in the many decades since.

As it continues to do so today.

For even today, companies that are considered to be fundamentally sound and have good future prospects, often tend to see their valuations lose all semblance of gravity. As a thumb rule, anything at or above a PE ratio of say 50-60 times, and one should realize that he is playing in extremely dangerous territory as far as valuations are concerned. Yet, we see many stocks going far beyond even this level.

Let us present to you a few companies that trade these days at a valuation upwards of 60 times their latest earnings -

Fundamentally sound companies trading over 60 times PE Price to Earning Ratios
Page Industries 61
Alstom T&D India Ltd. 71
Info Edge (India) Ltd. 81
Jubilant FoodWorks Ltd. 82
Just Dial Ltd. 89
ABB India Ltd. 115
Blue Dart Express Ltd. 118
Siemens Ltd. 121
3M India Ltd. 130
Gillette India Ltd. 197
Source: Equitymaster
*PE ratios based on Trailing 12 months earnings, excluding extraordinary / exceptional items.

Investors at all times must be acutely aware of how much of earnings and asset values they are receiving for every rupee of price they are paying for a stock. Ignoring this most elementary of rules is fraught with peril.

How carefully do you consider valuations before buying a stock? Let us know your comments or share your views in the Equitymaster Club.

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02:00
 Chart of the day
 
With all the hoopla behind the stock markets these days, it is indeed interesting to see how the various segments of the markets have been performing. The BSE-Sensex has long past left behind its previous record high of 21,000 or so, first set 7 years back in the bubbly days of January, 2008. But the BSE Mid Cap and the BSE Small Cap indices were so far lagging behind.

With the recent rise in the markets, the BSE Midcap index finally broke through its previous high to a new record high the day before yesterday. Smallcaps however, have still been unable to do so, even after 7 long years. The BSE Smallcap index still trades about 20% lower than the highs touched in 2008. Considering that Smallcaps were trading at extremely lofty valuations during that time, it is again perhaps a grim reminder of the fact that pay too high a price for a stock, and it may take an extended time for even a the value of even an excellent company to catch up with the price you have paid.

Midcaps back to 2008 high, Smallcaps not yet

02:45
 
If you were an investor in Indian stocks a decade back, you would know that valuations of companies then largely depended on their recent fundamentals. Companies sporting higher growth, better margins, clean balance sheet were the ones to fetch a premium. Quality of corporate governance was not really a factor that created a yawning gap between companies in the same sector. However, over the years, companies like Satyam, DLF, Kingfisher Airlines changed all that. The fact that management quality plays a vital aspect in creating or destroying shareholder wealth got increasingly higher weightage in risk assessment of stocks. And every time a company proves its quality of corporate governance or lack of it, we find ample evidence in stock price.

Right from Satyam's near liquidation in 2009 to Kingfisher Airlines' and DLF's more recent debacle in stock markets, we have been witness to more than one such stock get hammered. However, the stock price movement of Infosys in recent days is an example of impact of corporate governance on stock price of a different sort. Despite the company's BPO division firing top managers on account of fraudulent billing, the company's stock price showed no unusual movement! Had this been any other company with lesser track record of corporate governance, the price would have touched lower circuits for several sessions by now. However, the case of Infosys proved that a track record of good corporate governance can help a company retain premium valuations even in difficult times.

03:25
 
Now, since we are on the topic of corporate governance, it would not be out of place to talk about our PSU banks. Even the largest bank in the country, SBI, does not enjoy valuations at par with its private sector peers. And the prime reason being lack of management autonomy and corporate governance.

Take the recent case of SBI signing a MOU with Adani group for offering a loan of Rs 62 bn (US$ 1 bn) for its mining project in Australia. Now, investments in mining projects overseas by companies like Tata Power have not yielded very profitable results in the past. Also such projects are typically subject to environmental sanctions etc. Besides SBI has admitted to not having completed due diligence of the project yet. Therefore the hurry to sign the MOU with the corporate group smells foul. And one cannot help but wonder if crony capitalism is once again at play with the help of political backing!

04:30
 
The Indian stock markets had a strong close today. The BSE-Sensex ended higher by around 267 points, while the NSE-Nifty was higher by 75 points. Banking stocks were amongst the top gainers. Most Asian stock markets were trading higher. European markets too have opened the day on a positive note.

04:50
 Today's investing mantra
"Bull markets go to people's heads. If you're a duck on a pond, and it's rising due to a downpour, you start going up in the world. But you think it's you, not the pond.". - Charlie Munger

This edition of The 5 Minute WrapUp is authored by Tanushree Banerjee and Taha Merchant.

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4 Responses to "Are you an enthusiastic investor? Meet your nemesis..."

Kekin

Nov 24, 2014

Well, like most of the equitymaster members I constantly look for stocks offering Value for the Money. I request you to keep a watch and if possible a weekly report of what the Big Funds or FIIs are buying or selling....like last week One big Fund bought some lacs shares of Shakti Pumps or another bought Camson Bio Technologies....It will be a another feather in your

Like 

c.s.suresh

Nov 22, 2014

Definitely I am enthusiatic investor. Always looking for value for money . Patiencely waiting for beaten down frontline counters. Wealth creators who add value over a long term . As an example I have been holding half a dozen stocks since 2003 value of these cos are mindboggling they are hdfc hdfcbank asianpaints Infosys tcs larsentoubro sbi M&M to name a few . I do spend a time to select lists to all friends who are satisfied. I have been a fan of all those gurus who have also gained their thoughts like Warren Buffet.Your organisation have been doing good job in this respect.

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Sandeep Sahajpal

Nov 21, 2014

I could not agree more with you. Your list of high price to earning companies is a proven track for long period of time. But in the present bull market, one of the prime responsibility is also to save your clients from making wrong decisions. Just because some "top executive of Amazon says that logistics companies will gain value", (as the story goes on the street, does not mean that Gati should run from Rs 179 to Rs 342 in less than one month!? Mostly weaker hands take the worst hit in such cases. Is there a school to teach them not to chase quick money?

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Bhagwanji

Nov 21, 2014

Before buying any Long Term stock, always consider PE, EPS, BV, Dividend yield and more importantly Management.

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