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Are capital goods stocks a good buy? - Views on News from Equitymaster
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Are capital goods stocks a good buy?
Oct 14, 2009

The Index of Industrial Production (IIP) numbers for the month of August 2009 (a growth of 10.4% YoY) that came out last Monday lent some confidence to the market. The benchmark BSE Sensex closed the day higher by over 380 points and many capital goods stocks too ended on a jubilant note. Before we go any further, note that the growth in IIP number represents the growth in production of India's industrial sector. The IIP includes a representation for various use based categories, namely basic goods, capital goods, intermediate goods, consumer durables and consumer non-durables. For the month of August 2009, the capital goods sector within the index saw a growth of 8.3% YoY.

Many capital goods stocks are already enjoying some great valuations in the market currently. And some saw further upmoves post the announcement of the IIP number for August. But with the market's tendency to have a short term focus, it pays to have a longer term view of things. And a good place to start would be to not give so much emphasis on data that cover such a short period of time, which would be one month in this case.

From that persepective, let's have a look at the chart below. It represents the monthly growth figures for the capital goods sector's production from January 2005 ownwards. It should be more than evident from the chart that the good old days of stability and consistency of growth enjoyed by the capital goods sector between the period of January 2005 to December 2007 have not been the same post January 2008.

Data Source: Ministry of Statistics and Programme Implementation

In fact, growth rates have been highly volatile since January 2008, in line with the high amount of the uncertanity surrounding the general economic enviornment since then. Well, all we can say is that the enviornment continues to be uncertain and is surely not as stable as the good old days of 2005-2007.

Despite the smart recovery in the stock markets, India is still perched precariously and trouble may very well be just around the corner. A sudden spurt in inflation, higher interest rates, another reccessionary phase, and a high fiscal deficits are just some of the problems that could cuase another round of complexities in the real economy. And as we have seen, the capital goods sector, with its long gestation periods and capital intensive nature are very vulnerable and sensitive to macro economic shocks.

Data Source: CMIE Prowess

This is not to say that capital goods stocks are bad investments, but only that the high level of valuations the market is placing on many of the companies therein might turn out to be a problem (the BSE Capital Goods index currently trades at 28 times its trailing twelve months earnings). This is because they would need to rake in very good performances in the next 2-3 years to justify these valuations, which may or may not turn out to be the case taking into cosideration the uncertainities surrounding the economic enviornment.

The question is - are you willing to take the risk?

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