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Crash Alert! Is There a Big Bubble in Nestle, HUL and Asian Paints?

Nov 7, 2019

Rahul Shah, Editor, Profit Hunter

No list of quality stocks in India is complete without names like Nestle, HUL, and Asian Paints.

Over the years, these bullet proof franchises have survived everything the competition has thrown at them. In fact, they have gone from strength to strength.

Little wonder, investors have gone gaga over them. They can't seem to get enough of these stocks.

What else could explain the meteoric rise in valuation multiples of these stocks in recent years?

PE Multiples: Up, Up and Away

PE Multiples: Up, Up and Away

All the three stocks have commanded significantly higher PE multiples in the last decade than in the previous decade.

Furthermore, their current PEs are unlike anything we have seen in the past.

In fact, so optimistic are investors about their future that all of them are trading 3x higher than the entire Indian stock market if we use the Sensex PE as a proxy.

But now doubts have begun to appear. Has this optimism reached dangerous levels?

What do you think?

Have the prices of these high-quality stocks been bid up so high that future gains will not be anything like in the past?

Have their multiples gone so out of whack that they may not even beat the 14%-15% long-term returns from the broader market?

My calculations seem to suggest this is indeed the case.

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These companies will have to grow their earnings at a massive rate to justify the current high multiples.

How massive?

Well, growth in the range of 40%-50% will be needed.

Put differently, the market has factored in an annual earnings growth rate of 40%-50% over the next 10 years in the current stock prices of these companies.

This is massive. None of these companies have managed these growth rates in the past. Historically, both HUL and Nestle have managed to grow earnings by than 10%-12%.

For Asian Paints, the historical earnings are slightly higher at 18%. But still well below the 50% that it is expected to grow at over the next 10 years if it is to justify the current high multiples.

Some of you might dismiss my assumptions as too conservative. And perhaps that is really the case.

However, in the case of these stocks, the gap between what is required and what they can realistically achieve is so huge, I believe they have a strong chance of underperforming the market.

Valuations for these stocks have gone up so high, there is no other option for them but to come down.

Besides, reversion to the mean is an iron law in finance. By that I mean, whatever goes up must come down and whatever is down must go up.

Just a decade ago, HUL was facing what is now famously called as 'a lost decade'. Its share price had gone nowhere for almost 10 years.

Does a similar fate await the company and the other two stocks?

Maybe my view is too extreme.

However, I won't be surprised if these stocks turn out to be underperformers over the next decade unless valuations come off and fall back to the long-term average.

Warm regards,

Rahul Shah
Rahul Shah
Editor and Research Analyst, Profit Hunter

PS: Equitymaster's small cap guru, Richa Agarwal, has found a tiny stock, currently trading at around Rs 300 per share, which has explosive profit potential. I believe it could be Richa's top pick for 2020 and beyond. Read more about this money-making opportunity here.

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1 Responses to "Crash Alert! Is There a Big Bubble in Nestle, HUL and Asian Paints?"

Ameet parekh

Nov 7, 2019

Rahul is right about the high price. Be aware Rahul It is very difficult for 99% of companies to replacate these companies success consistently over 50 years.If we sell these companies then what.Put money in a hot sector.My opinion do not sell these blue chips they will consistently deliver 10% returns over a long period of time.Why sell these iconic brands just because someone has bid them up to a fancy price.

Equitymaster requests your view! Post a comment on "Crash Alert! Is There a Big Bubble in Nestle, HUL and Asian Paints?". Click here!