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Olectra Greentech Zooms 250% in 5 Months. More Gains Coming?

Jul 17, 2023

Olectra Greentech Zooms 250% in 5 Months. More Gains Coming

Chances are you may not have heard of the famous German mathematician Carl Gustav Jacob Jacobi.

Famous for some work on elliptic functions, he is believed to have followed a simple strategy: "man muss immer umkehren". When translated into English, it means, "Invert, Always Invert."

Guess who picked up this simple strategy and has applied it to his personal life to some great results? Well, it is none other than Charlie Munger.

"Jacobi knew that it is in the nature of things that many hard problems are best solved when they are addressed backward," Munger advises.

And he is bang on. If you want to know the secret to losing weight, you can invert the question and ask yourself 'What will keep me fat?' You then avoid all the things that keeps you fat and voila, you have the answer.

Likewise, if you want to know how to become rich, inversion can again come to your rescue.

Invert the question and ask yourself 'What will keep me poor?'. Getting rid of all the bad habits like overspending, racking up credit card debts, investing in low yielding assets and many other things will set you up nicely for a wealthy life.

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So, that's the power of inversion, right there. Approaching a problem both in a straightforward as well as in an inverted way, lead to better insights. They help identify gaps in your knowledge as well as thinking and turn you into a better decision maker.

How is this theory of inversion useful in investing you may wonder?

You see, the conventional process of deciding whether to invest in a stock goes something like this: You choose your time horizon, you project the earnings growth of the company and arrive at its EPS over this time horizon, you assign an exit PE multiple to the stock and finally you arrive at the target price and then compute the CAGR between this target price and the stock's current price.

If the CAGR sounds reasonable, you invest in the stock and if it doesn't, you move on to the next stock.

This is a rather straightforward way of assessing whether to invest in a stock and nothing wrong with this in my view.

However, you can complement this approach with the theory of inversion, and you are likely to get a much broader perspective.

So, in the conventional method you are asking: 'What is the growth rate the company is capable of achieving and whether this growth rate will allow me to earn a good return on the stock from a 3-5 year perspective?"

But when you flip it, you ask: 'How much growth is embedded in the current stock price and whether it is really possible for the company to achieve this growth?'

I think an example will help make this point a lot clear.

You see, back in March 2020, I came across this small company which looked fundamentally very sound. It had consistently earned an EPS of Rs 4 to Rs 5 per share over the last many years and had a reasonably good balance sheet.

The fear and panic in the market on account of the Coronavirus pandemic led to the stock price crashing to Rs 20 per share. At this price, the stock was available at a mouthwatering PE of 5x, assuming an EPS of Rs 4 per share which it had consistently earned in the past. A PE of 5x means an earnings yield of 20% (inverse of PE). An earnings yield of 20% can be thought of as an FD that is paying you 20% interest every year.

Isn't that wonderful? Now, even if the company achieves no growth in the future, you are still earning a cool 20% return on your investment.

In fact, even if the EPS was to crash by 50%, the earnings yield would have come down from 20% to 10%, which is still good in my view.

So, the stock did look attractive even after assuming a 0% growth rate in earnings or at worst, a 50% hit in earnings.

Well, an investor in the stock back then would have pocketed a cool 1,100% return right now. The stock, Gulshan Polyols, is a 12-bagger from that price as its earnings did not crash by 50% but is currently 2x higher than what it was in FY20.

This is the power of inversion. Using this theory, you arrived at the conclusion that your downside seems well protected even after a 50% drop in EPS and you let the upside take care of itself.

Of course, you would have arrived at the same conclusion using a straightforward method of projecting the company's earnings 3 years out and assigning a proper PE multiple.

However, the theory of inversion led to a much better perspective in this case and allowed you to focus on the downside more than the upside, which is very important if you ask me.

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The same stock currently trades at a PE of 33x or an earnings yield of 3%. This means from becoming an FD with an interest rate of 20%, it is now an FD that's offering only 3% interest. Not a good proposition in my view.

Well, I have used the exact same logic for Olectra Greentech, one of the hottest stocks these days. Let's see what picture it paints.

Rather than figuring out the growth rate that the stock is capable of logging in over the next 3-5 years, I have tried using the theory of inversion.

The stock currently trades at a PE of a huge 171x. In other words it is an FD that's offering an interest rate of a paltry 0.6%. This is extremely low to be honest.

Now, I know that Olectra Greentech's EPS is not going to remain constant and it may grow at a very fast rate going forward. But what kind of growth rate will justify the current high PE of 171x?

Let's do some math. Let us assume that we want Olectra Greentech to become a '10% FD' stock again i.e. it should start trading at an earnings yield of 10%. The company's current share price of close to Rs 1,400 per share means that it will have to earn an EPS of Rs 140 per share in the near future in order to achieve this goal.

Considering the company's current EPS of Rs 8 per share, this implies a jump of almost 18x in the company's earnings over the next few years. Is this possible? Can Olectra Greentech grow its earnings by 18x over the next 3-4 years? Well, despite the company's great growth prospects, a growth of this magnitude looks very difficult indeed.

In fact, for the company to become a '5% FD' stock, the growth will have to be 9x and even this target looks quite audacious to say the least. Take the FD rate to 2.5% and the required EPS growth comes down to 4.5x over 3-4 years.

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While this is still achievable, would you want to earn a 2.5% interest rate from a relatively small company like Olectra, especially when the same interest rates are available in much larger and much stable companies.

The only thing that can help the company's investors, especially those that are investing at current levels, is superfast growth in earnings or investors continuing to accept a paltry FD rate of 1%-2% on the stock.

Even a small hiccup here and the stock can come tumbling down. So, you really need to think hard about this point before making any investment in the stock.

Happy Investing.

Warm regards,

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

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1 Responses to "Olectra Greentech Zooms 250% in 5 Months. More Gains Coming?"

Vikas goyanka

Jul 17, 2023

Very clearly n in a simple way you have given the feel where we are standing if we hold or buy a highly overbought stock. Today I learned a new thing a special thank you from my end ??

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Equitymaster requests your view! Post a comment on "Olectra Greentech Zooms 250% in 5 Months. More Gains Coming?". Click here!