Kalyan Jewellers: A Tale of Fantastic Profits and a Crashing Stock

Two big reasons. First, the Prime Minister himself asked people to stop buying gold for a year. Second, the government raised the import duty on gold from 6% to 15% overnight. That is a double blow. It has shaken the entire jewellery sector.

But here is the strange part. If you look at the company's actual business performance, you would be forgiven to think that the stock has had a fantastic run in the last couple of years.

The numbers are genuinely good. The company has doubled its topline and grown its bottomline by more than 2.3x in the last 2 years. And yet, its stock price is down almost 10% during the same period. Yes, that is correct. Not up, not flat but down 10%.

So how can a company grow its profit so fast but still see its stock fall? Apart from the market apathy towards mid and small cap stocks, one big reason was the high PE multiple the stock was trading at 2 years back.

Two years ago, the market was in love with this stock. Everyone wanted to buy it. As a result, the market was valuing the company at an uncomfortably high PE multiple of close to 70. Just think about that. You were paying Rs 70 for every Re 1 of profit the company made. That is a very expensive price.

At this multiple, both the growth as well as the quality of the same has to be top notch. You need perfect execution. You need no mistakes. While the company did tick most of the boxes when it comes to growth, we have to be honest about the business.

The underlying nature of the business does not allow for a lot of capital efficiency. This is a jewellery business. Margins are wafer thin.

It makes a small profit on every gold bangle or chain sold. On top of that, working capital requirements are high. It needs to buy gold, keep it in a safe locker, and rent expensive showrooms. All of this makes a high return on capital a difficult job.

Owing to this, it was unlikely that the company could sustain such a high PE multiple for long. A 70 PE is for magical companies. Kalyan is a good company, but it is not magic. And this is precisely what happened.

While the bottomline grew strongly, the PE multiple shrank meaningfully. The air went out of the balloon. The profit growth was not enough to save the stock price, resulting in the stock price falling by 10% in the last 2 years.

At the current price, the stock trades at a far more respectable PE of almost 27. That is down from 70 but is this still high? Or do the valuations now make the risk-reward attractive from a medium-term perspective?

You have to be careful. Just because a stock's PE fell from 70 to 27 does not mean it is cheap.

Let me be clear about my style. I am a conservative value investor by nature. I do not like to gamble. I like my stocks to be tethered to factual data and to current earnings or book values. I do not buy hopes and dreams.

So let us do some simple math. Right now, bond yields in India are in the region of say 6% to 7%. A bond gives you a safe return with no risk. If you are buying a stock, which is risky, you need a higher return. So a fair PE multiple to pay to a stock should not exceed 15-16 for an average quality company. That is the baseline.

Of course, you can add premium over this for both growth as well as the underlying quality. If the company is growing fast, you pay a little extra. If the management is very honest and allocating capital well, you pay a little extra. And it is the judgement about these two parameters that makes investing both exciting as well as dangerous.

Exciting because if a good quality company with good growth prospects is available at these multiples, the upside could be quite decent over the long term in most cases. Dangerous because pay too much of a premium for quality and growth and you are entering the territory of speculation with a high risk of permanent capital loss.

So tread carefully. As far as possible, avoid paying too much of a premium for quality and growth. Kalyan is a good business. But a good business at a fair price is a good buy. A good business at a high price is a risky bet.

The next few months will tell us if that premium is worth it or if the fall has further to go.

Happy investing.

Warm regards,


Rahul Shah
Editor and Research Analyst, Profit Hunter
Quantum Information Services Private Limited (Research Analyst)