Apr 18, 2012|
Do rating agencies deserve such lofty valuations?
They are not the only blue eyed babies of stock investors in India. There are plenty in their class, when one compares pedigree, fundamentals and management. But these entities, unlike their peers in the West have managed to do what even the MNC parents haven't. They look the regulators in the eye while the likes of Standard & Poor's and Moody's face the fury of the SEC.
Steep valuations diminish returns
In fact India can be called a paradise for rating agencies. There are six of them, with the biggest of them all, CRISIL, having a market value in excess of US$ 1.3 bn. Each of these entities shares the same business model as that of their global counterparts, albeit with slight differences.
The issuer of debt pays for the credit rating resulting in conflict of interest on the part of the rating agency. That the likes of CRISIL and ICRA also offer ratings on IPOs and stocks and consulting services makes their business model slightly more resilient to volatility in bond markets.
But what really intrigues us is that fact that irrespective of market cycles, the rating agencies have managed to fetch valuations that very few blue chips can boast of. That too despite the fact that the Indian regulators too have frowned upon the loopholes in their business model.
Leave aside debt, many listed companies are happy to share 'sponsored' research reports on themselves citing attractive investment prospects by the rating agencies.
However, one cannot deny that it is lure of zero debt balance sheets, high return ratios and mouth watering dividend payouts that attracts investors to the stocks of rating agencies.
However, investors cannot lose sight of the fact that the high PE ratios have diminished the dividend yields despite the handsome payouts.
Hence unless they have been early investors in the stock, they are less likely to benefit from the extra returns. Also since the dividend yields now account for only a couple of percentage points of return, investors will have to rely on at least 15% to 20% profit growth to fetch good returns.
Data source: Ace Equity
||P/E ratio (x)
||Dividend yield (%)
At the same time, regulatory hurdles could sooner or later deal a blow to the conflict of interest in the business model of rating agencies.
The cases of micro finance and gold loan companies are there for us to see. Hence we believe that instead of getting blinded by the high return ratios and dividend payouts, investors should get more realistic about the valuations the companies deserve for sustainable growth rate.
||Tanushree Banerjee (Research Analyst), is the editor of ValuePro, The India Letter, and Stock Select, Equitymaster's oldest recommendation service. She is also the editor of Equitymaster's most popular newsletter read by over 200,000 subscribers, The 5 Minute WrapUp. Tanushree started her career at Equitymaster covering the banking and financial sector stocks along with scrutinizing the RBI policies. And over the last decade, developed our research processes that have helped us pick out various multibaggers, across all sectors. A firm believer of "safety first" when it comes to investing, Tanushree closely follows the investing philosophies of Warren Buffett, Jeremy Grantham and Joel Greenblatt.
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