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Stock Investing: Are stocks really cheap?
June 19, 2012 12:09 PM |
There is a widespread propaganda that stocks have become undervalued. Think again
All professional money managers are parroting that stocks are undervalued currently. A pile of statistical data is produced everyday by a multitude of analysts working in broking companies that emphasises the undervaluation—using earnings forecast of not FY12-13 but FY13-14. This is called ‘forward’ earnings and is used to make a comparison with the past. They are all making the claim that the markets are at their cheapest in terms of many measures, including P/E ratios. I look at stocks prices, market indices and forecasts of companies, and find myself at odds with the masters of the markets. Good quality companies (where I can breathe easy and become a Rip Van Winkle) are at multiples of over 20-25. Nothing, except government-owned banks, is being valued at single-digit multiples of its earnings.
Well, if I believe that the stock markets are a reflection of the expectations of investors, then surely what remains expensive will continue to remain so, unless the expectations take a turn. If anything, they can take a turn for the worse. A lot of optimism is built into the forecasts of brokerage companies. After all, they have an interest in sounding optimistic. Let’s look at the problems facing some of the key sectors.
If you take the banking industry, we have the universe of government banks, none of which inspires trust. They change their basis of accounting and classification of loans like we change T-shirts in the Chennai summer. So, comparison of results from year to year is a thoroughly useless exercise. If I go by the news of industrial slowdown, the expanding basket of sticky loans to large borrowers in aviation, microfinance, textiles, real estate and infrastructure, how can I believe that a government bank has actually reduced its problems? More so, since it is these banks that had the size and malleability to have funded large (and dubious) borrowers (such as State Bank of India’s generous funding of the sinking Kingfisher Airlines). So, if we see stocks of a government bank trading at 3-4 times ‘reported’ earnings, there could still be a lot of downside. Sure, there is an upside possible too: when we see hordes of foreign investors coming back to buy Indian stocks as if they are limited edition copies of rare manuscripts.
Then we have oil company stocks which are neither expensive nor cheap. The excellent results of Bharat Petroleum and its bonus issue seem to be totally at odds with what is happening in the sector and disconnected from the politics that surround the industry. Does any one of us, even for a moment, believe that the chairmen and managing directors of oil companies actually decide the fuel prices? Is it not obvious that they are making these statements on the orders of their political bosses? How do you invest in such companies and not worry? Auto stocks are no bargain either.
If you go sector by sector, probably some metal stocks look undervalued by traditional yardsticks. But metal stocks, like Tata Steel or Hindalco, have become more global than Indian. Worries in Europe and America are ruining their bottom lines and they have become truly ‘cyclical’ stocks; so one cannot pay too much for these anyway and most long-term investors will keep away from them. Tata Motors is also headed this way; its fortunes are tied to global economy and markets. Our pharmaceutical company stocks are another ‘safe’ sector with reasonable growth prospects. However, none of them appears to be at bargain valuations.
That leaves us with the ‘technology’ sector that supplies labour to the world. The rupee’s weakness is surely a good thing for them. At the same time, their labour costs are going up; there is restlessness in the industry and there are doubts about their ability to go to the next level of growth and efficiency. Considering all the worries, the stocks are not at the bottom-end of their valuation band.
Inflation continues to be the friend of sectors that are engaged in direct consumer spending. With supply not improving (since there is a lack of confidence among businessmen to invest more money to expand), consumer demand is still driving prices higher. Consumer companies keep finding cleverer ways to increase prices at a rate higher than inflation and are enjoying a golden period. I have not even gone into a discussion on sectors like ‘infrastructure’ or ‘telecom’. These sectors have a great need to keep raising fresh rounds of equity and will remain out of my radar until they become mature companies.
We are all fretting because the indices seem to be kind of hanging in there, unable to break out of a range. Well, I wonder why we complain when we have got a 20% return in the first two months of the calendar year.
The real worry is the attitude of foreign investors to our markets. They are the pillars and the foundation of our markets today. So, we have to keep praying that their money will keep pouring in, to provide exit to temporary hands that hold them and the new supply that Indian promoters keep providing them with. Indian investors clearly overreached in the 2005-08 boom with most people who could not afford equity risks, putting money into mutual funds and direct equities. So, we have to wait for retail investors to come back.
Maybe the downside of this market is limited to around 10%-20% from these levels. However, there is no guarantee about the trigger that would attract money from foreign investors again. Until then, we can only hope that our politicians do not give us such a scare that our GDP growth rate expectations fall back to the Hindu rate of growth. As a strategy, if I do make a bet now, I would buy exchange traded fund of the Sensex for a one-year horizon, with a planned exit when the return nears or exceeds 20%.