Rajeev Thakkar Explains When It’s The Right Time To Buy A Stock
Are you among the investors who believe that quality stocks are always expensive, so why complain about higher valuations?
Rajeev Thakkar, chief investment officer at PPFAS Mutual Fund, cautions that investors need to “guard against these excesses”. Over a period of 10-15 years, even the best of the names go through valuation cycles, Thakkar told BloombergQuint in an interview. If the entry price is very expensive, he said, investors might run into time or price correction.
When buying a stock at high price-to-equity multiples, earnings growth from the company needs to be much higher than 12-15 percent to deliver a 12-15 percent equity return and make up for expensive price, according to Thakkar. “What an expensive entry price does is that there is no room for error. Your expectations need to click like clockwork.”
He cited that example of Wipro Ltd. in early 2000s to highlight how investors could run into a big correction because of a bad entry price. The IT major’s stock, which gained 5 times from start of 1998 until mid-2000s, gave negligible return for the next 13 years.
Thakkar used the price chart for Hindustan Unilever Ltd. between 2000 and 2010 to caution consumer goods permabulls. The argument of nothing going wrong in fast-moving consumer goods stocks is wrong because high price could lead to stocks hitting air pockets, leading to a long-time correction if not a price correction, he said.
Watch the full discussion here:
Here are the edited excerpts from the interview:
Hindustan Unilever Ltd. showed a time correction from around 2000 odd to 2005-06 or may be all the way until 2010, they (investors) hardly made any money. What does this experience teach you?
One of the good examples is HUL. The reason why the stock price went up steeply and why valuations rose is that they had a long period of merger- and pricing-led growth. In each company and industry, there is an element of cycle where you have short to medium period where everything goes right for the sector or company and then things start to turn. Typically, when you look at a rear view mirror, the past five-six years have been very good and people try to extrapolate that to the future. Then if, for some reason, there is stalling of momentum, then for 5-10 years the stock does nothing. This is a good chart for permabull in FMCG (sector) right now to consider. Today the argument is nothing can go wrong with the Indian consumption basket. All these FMCG companies are high quality names. India has lot of under penetration, but the valuations aren’t conducive. You could have these air pockets where you make five years of subdued earnings growth and for some reason disappointment comes and then you have time corrections coming in.
How do you figure out what you are entering into at a high PE multiple is not an HDFC Bank but an HUL? HUL had the time correction, but HDFC Bank didn’t.
Only time will tell what will the future look like for either of these names or others. What an expensive entry price does is that your thesis has to have no room for error. The estimate should come like clockwork.
In the financial sector, one could argue that public-sector banks are ceding market share on year-on-year basis. They are still 2/3rd of the financial sector space. With GDP growth and some amount of inflation, 12 percent deposit or balance sheet growth is almost a certainty for financial space. As long as they don’t do anything wrong on the lending side, most people should have a good run ahead of themselves. Paying high multiples brings forth that risk that if for some reason, growth does not come in or if something goes wrong on the lending side then there could be a severe drop in prices. People entering or holding these stocks should be doubly sure of what they are holding rather than relying on warm fuzzy feeling that these are high quality names.
Peter Lynch said once that more money could be lost waiting for a correction to happen than an actual correction itself. When we are seeing earnings for these companies looking like they are going to be trending. The managements are confident that numbers could stay a bit longer and you would trust these managements to know what they are talking about. Should one wait for a dip or should one take the risk and go and invest? How to identify whether this is the right time to take the risk? Because some amount of risk might pay because of better timing and not all amount of risk. How does one do it?
If we take D-Mart and Britannia, without getting into the prospects of these two companies, when something is at 75- and 60-times earnings, effectively on your purchase price, the company is making 1.5 percent profits. If earning is Re 1, you are paying Rs 75 as a purchase price, so 1/75x100 is less than 1.5. If you are going to earn 1-1.5 percent on your purchase price then the earnings growth has to be so high that somewhere down the road it reaches a sizeable number to start giving decent profits on your purchase price. There should be no room for error. These are very small bases where the growth has to be high for multiple years and decades. You also have some data point on Eicher Motors Ltd., Page Industries Ltd. There was disappointment and you saw a third or more of the stock price going away in short span of time.
If you were in 2001 and you where investing, then you don’t have to avoid the entire market and be 100 percent in cash. This was a period where people were talking about TMT, technology, media or ICE—information, communication, entertainment. Anything which was called old economy at this point of time was available at mouth-watering valuations. That was for avoiding the Pentamedia Graphics Ltd., Silverline Technologies Ltd., Wipro Ltd., Infosys Ltd. at this time and being in Hindustan Unilever Ltd., Nestle India Ltd. or Britannia Ltd.
In 2007, overall valuations were high but no one wanted information technology. The hero of the last bull market was actually available at reasonable multiples. No one wanted IT, pharma, FMCG. Everyone wanted infrastructure, commodities and real estate. So, the heroes of this market were DLF Ltd., Unitech Ltd., GMR Infrastructure Ltd., GVK Power & Infrastructure Ltd., iron ore, steel companies. It really is about figuring which space there is euphoria and where there is pessimism and be more into companies/sectors which are available at reasonable valuations rather than staying outside of market or liquidating and being 100 percent in cash.
At this time, everybody wants consumption and lot of people want financials despite the IL&FS issue crimping non-banking financial companies. Are you saying that a prudent approach might be don’t bet all your eggs on it but try to look at something which is shunned by market right now? Also, how to identify what is it that is being shunned which might go up? Not everything which is shunned is good quality at reasonable price.
I have been something like a broken clock over last two years saying small and midcaps were overvalued, consumptions and financials were overvalued. So, small and midcaps corrected very significantly last year. Financials have had that one scare where some of the companies sold off. Some names like Bajaj Finance Ltd. are still holding on very strong. But you had a sell off in financials after IL&FS. But consumption names barring a few had held on to their high multiples. There is risk over there in terms of some disappointments coming down the road, broadly as a sector rather than specific names.
We can’t time the risk which can come in. How do you balance in a scenario like this? Do you reduce exposure; do you take part exposure to pockets which the market doesn’t like right now?
Taking some money off the table in businesses which are extremely overvalued and buying something which is against the overall consensus may make sense.
What do you do in companies that are down from their peak?
This can happen if there’s a disappointment. When you are projecting continuous earnings growth and based on that projected earnings growth, if you are even jacking up the earnings multiple, you will have a double whammy when the scenario reverses. Arguably you will see a scenario where earnings dip and valuations dip even further in which case the fall could be steep. All of these are otherwise high-quality names. But the implied valuations were such that there was no room for error. There was no room for disappointment.
How do you figure out that this is the right time to take a cautionary call? Let’s use Eicher Motors as an example.
The ten-year average which is showing close to 39 would be coloured by the recent high valuations. Comparing this with its own history when it traded at the lower end of the band, the yellow multiple is around 19, so when it goes up to 60-80 times then you know that it has also traded at 19 and one cannot assume that 60-80 times is the normal for the company.
This hits at the argument that such high-quality names are always expensive which is wrong. Each company goes through a cycle where sometimes they're available cheap, sometimes they're available very expensive. It's not necessary that you should own a stock compulsorily. If you can’t figure it out that this makes compelling investment opportunity, then there are other stocks which you could invest in.
Let’s assume that at some point of time we were at 58-59 times of multiples. And I look back at this chart and see that this stock has traded 19 times as well. But my argument is that when it traded 19 times, Royal Enfield as a machine and juggernaut wasn’t there and now the time is different. How do I figure out that it is not the case?
The best investments are when you buy here at a low multiple, the profit grows and not only your stock price grows with profits but the multiple also expands and you get benefit of profit growth and multiple expansion. The worst time to invest is when profit degrows and where the multiple also comes down. In between you have a combination where profit could grow, multiple could come down or profit could come down and multiple could go up. Those are tricky questions. If you are at this band then chances of multiple expansions are ruled out. Then you are only dependent on one lever which is profit growth and if you get that wrong then you have severe trouble.
Page Industries at Rs 36,000. It traded at substantially higher bands and then profits started showing some chinks in armour. Was that the signal?
Yes. If you have a very strong entry price then you can afford to go wrong in your earnings growth projections by some small amount but if you are paying near perfect valuations for multi-decadal growth then any small estimation error can result in severe losses. In Page Industries, best time to buy is when the valuations are low, and base is low. If base is very high and if that growth could taper off and if the multiples are also very high, then chances of losing 25-30 percent start to creep in.
How do you figure out what is a good valuation to buy these stocks? How do you figure out what is good time to buy in such names?
Wipro which had a long time correction and in shorter time span there was a steep time correction, from the lows which we saw in 2008-09, it tripled in a short span of time. Cash flows on your purchase price was giving you close to 10 percent. Given that your entry purchase price is so low and even if the price increase was not so steep in short span of time you will have decent returns even holding it for 5-7 years.
So, what do you look for?
You look for a reasonable entry price. We looked at the band for Eicher at the low and high end. We looked at Page. One could argue Eicher is now at below average multiple and one should wait for a good entry multiple which is reasonable. Two-wheelers, typically, have been 15-20 times earnings and that has been entry price for well-run two-wheeler companies and 50-60 times is not a great entry price provided the earning is not artificially suppressed. After a steep price correction and where earnings growth trajectory isn’t damaged, it would make sense to look at some of these for purchases.