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Underdogs at a premium

Aug 2, 2000

If you thought only TMT (technology, media and telecom) stocks command logic defying valuations on the bourses, think again. equitymaster.com did a small study and found that the markets are also paying hefty premiums to relatively new entrants across different sectors. Take a look at the table below and you will understand what we mean. Henkel Spic (subsidiary of Henkel AG, Germany) was mired in losses until recently. It has shown signs of turning around only from the current year. Even then, its annualised estimated profits in the coming year are miniscule Rs 40 m as compared to a whopping Rs 13.9 bn (estimated) for FMCG major Hindustan Lever Limited (HLL). But ironically, it is Henkel which commands a P/E (price to earnings) multiple of 158 times (comparable or even higher than P/E multiples of Infosys and Satyam). HLL's P/E multiple you can see is far below Henkel Spic's.

Company Price
(Rs)
Net Profit*
(Rs m)
P/E ratio
(X)
Price to Book
value (X)
Henkel Spic 57 40 158.0 9.5
HLL 241 13,900 38.0 2.5
Whirlpool 29 100 37.3 2.6
BPL 139 936 4.1 0.9
Reliance Petro 48 13,000 16.0 1.5
BPCL 180 8,000 3.4 0.9
* Net Profit represents estimated earnings of companies in FY01

This is the story as far as consumer products sector is concerned. Even in the white goods sector, you find similar irony. Here the underdog Whirlpool India commands a hefty premium as compared to giant BPL Limited. By the way, Whirlpool was also mired in losses till its last financial year, only this year it has shown signs of turning around. The story is the same in the refining sector. Here too, the bourses have placed Reliance Petroleum on a premium compared to established player Bharat Petroleum Corporation Limited (BPCL). This is Reliance Petro's first year of operations.

Why is this so? The reasons are many. Firstly, all these so called underdogs are in a growth curve. They have turned around and their growth potential is estimated to be higher than established players. Secondly, if you look closely, all these underdogs are available at less than Rs 50 per share, which means investor's have to lock in lesser funds in these stocks.

In effect, the market is taking a higher risk in underdogs, simply because they expect higher growth rates as compared to established players. Higher risk, higher return (or losses). This is the same logic as applied for TMT stocks also.

These were just a few examples. Look deeper and you will find that the markets are flooded with such cases. Investors want to buy stocks with a potential to become future blue chips. Catch em young! That seems to be the motto.

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