Are Nestle Shares Finally Within Reach of Small Investors?

Seeing Nestle trend on the internet in the middle of a mania for power, rail and infrastructure stocks took me by surprise last Friday.

Closer inspection revealed that the Maggi-maker has undergone a 1:10 stocksplit and Friday was the first day it started trading ex-split.

Thus, the 6th most expensive stock in India was now 90% cheaper, bringing it well within reach of investors who had stayed away from the FMCG giant due to its high price.

To be honest though, a stock split should not be the reason to buy or sell a stock. Stock split increases the number of shares and makes the stock more liquid but it does nothing to alter the long term fundamentals of the business.

Stocks should be bought based on long term fundamentals and its intrinsic value and not whether it has undergone stock split or not.

Hence, those who are looking to buy Nestle post the stock-split only because it has become cheaper in terms of price, are not approaching investing the right way in my view.

Please remember price is what you pay, and value is what you get. Hence, the focus should be on value and not the price.

Speaking of value, what should be a good price to buy Nestle? Let's do a small exercise to figure out.

You see, another way of deciding whether a stock should be bought or not is by figuring out a price point below which a stock is an investment and above which it becomes a speculation.

I believe some of the most successful investors at experts at this.

Successful investors know how to differentiate between investment and speculation. In fact, they know this better than most other investors.

And this is not all. They build this huge wall between investment and speculation and rarely jump over and go to the speculative zone.

On most occasions, they stay well within the investment side and get heavily rewarded for it.

This is not the case for most of us.

First, our lines between investment and speculation are blurred at best.

And even where we know what investment is and what is speculation, we lack self-control.

We often turn greedy and end up speculating more than we should. Or we are so fearful that even when a stock becomes an attractive investment, we deem it to be speculative and stay away from it.

So, how exactly do we correct this mistake? How do we differentiate between an investment and a speculation? And once we do so, how do we ensure we always stay on the right side of investment?

Well, if you believe the late Walter Schloss, buying a stock below its book value is investment and everything else is speculation.

I am not sure whether you've heard of him. But Walter Schloss was perhaps one of the most anonymously successful investors of all time. He was also a very good friend of Warren Buffett.

Now, I have done some reading about Walter Schloss. I can say with confidence that Walter hated buying a stock above book value.

For him, a price to book value of 1 is what he was willing to pay for the stock. Nothing more. So, if a stock had a book value of Rs 100, he won't buy it if the price was significantly higher than 100.

Paying anything more than Rs 100 constituted speculation as per him.

So, if Walter Schloss had to buy the shares of Nestle, he will buy it only if Nestle was available at less than Rs 30 per share.

Nestle currently trades at Rs 2,666 per share.

It is a whopping 90x higher than its current book value. So, as per Schloss, Nestle is a highly speculative stock. He has a clear idea of what is investment and what is speculation for his own investment strategy.

It doesn't matter to him that a quality blue chip like Nestle will never become an investment as per his criterion.

This did not make him sad. He knew there were plenty of stocks that satisfied his criterion of investment and he was happy investing in those stocks.

In fact, he has put together one of the best track records and has beaten the smartest investors by putting up a big wall between investment and speculation and hardly every jumping over on to the speculative side.

What about his friend Warren Buffett? Will Warren Buffett buy Nestle at the current price?

Well, please read the book 'Inside the Investments of Warren Buffett: Twenty Cases' by Yefei Lu.

I have it on my Amazon kindle app but haven't read it yet.

What is the book about? Well, the single-most important takeaway is the valuation multiple that Warren Buffett paid in order to buy 20 of his best investments.

The answer is a PE multiple of between 7x to 18x. Yes, that's correct. If the book is to be believed, Buffett never paid more than 18x trailing twelve-month earnings even if it meant buying a high-quality stock.

What does this tell you about Buffett's definition of investment vs speculation.

Well, as per Buffett anything below 18x constitutes an investment and anything above that a speculation. Buffett has hardly ever strayed from this definition of investment. He has always stayed inside the investment zone the wall of which he himself has erected.

If Buffett had to buy Nestle, he would be willing to buy it at a price of Rs 554 or thereabouts.

How did we arrive at Rs 554? Considering Nestle TTM earnings per share of Rs 31, a PE multiple of 18x gives you a price of around Rs 554 per share.

Although Buffett is willing to pay a lot more than his dear friend Walter, it is still well below the current price of Nestle which is close to Rs 2,700 per share. Thus, even as per Buffett's valuation standards, Nestle stock price has a large speculative element.

Now, both the investors are super successful investors. They have earned fabulous returns for themselves and their investors based on their own definition of investment and speculation and by sticking to it at all costs. And yet, none of them find Nestle investment worthy.

We can consider the Indian stock market or Mr. Market as the third super investor. Across market cycles and going back all the way to 2005, Mr. Market has given Nestle an average PE multiple of around 50x.

Therefore, as per Mr. Market, you can buy Nestle at a price of Rs 1,600 or lower.

While this price is the highest of all the investors, it is still 40% lower than Nestle current market price.

So, what this study concludes is that Nestle looks highly overpriced even after taking into account a PE of close to 50x.

I am sure you are thinking what the harm is in having an investment limit of 80-90 PE if the stock is an gextremely high-quality stock like Nestle.

Well, you certainly can. But how will you justify paying such a high PE multiple?

Do you remember making market beating returns on stocks in your portfolio by paying a high multiple of 80x-90x on a consistent basis? I don't think so.

Do check out all the multi-baggers in your portfolio. I am sure almost all of them you'd have purchased at a low PE multiple.

So, why break your rule and buy a stock with such a high PE multiple even though it is as good quality as Nestle?

Define what is investment and what is speculation for you and stay on the investment side of it.

Of course, your idea of an investment should be based on logic and what kind of valuation multiple have worked in the past. It shouldn't be ad hoc like buying Nestle at a high PE multiple.

Please note that there is a difference between intelligent investing and intelligent speculation.

Nestle may be an intelligent speculation. You may not lose a lot of money by investing in the stock because it is such high quality.

But whether you will earn market beating returns over the next 3-5 years is not something I would strongly agree with.

For that, you must practice intelligent investing. Your wall has to be a lot to the left of the entire valuation topography.

Happy Investing

Warm regards,


Rahul Shah
Editor and Research Analyst, Profit Hunter
Equitymaster Agora Research Private Limited (Research Analyst)