Is There a Price Bubble Building in Consumer Stocks?

All the time, I get the question consumer stocks are trading at such rich valuations and is there a bubble building up there? I did a post on same topic in 2011 here.

“Stay away” from these is the advice from some of the analysts. Graham worshippers and “Value investors” say these stocks are absolute no-no, and cannot be justified anyway you look at them.

There can be no two opinions about ultra-expensive valuations of consumer plays. At the same time, it can be intriguing to see every other investor taking shelter in these names despite such pricey tags. 

I, however, think it is important to appreciate the overall landscape in which consumer facing stocks are being evaluated by the markets:

1. Infra companies pack has been a disaster in their capital allocations and many of their acquisition and other decisions haven’t been financially prudent. Government alone cannot be blamed for policy paralysis and their sorry state.
2. Cash flows in power and capital goods companies are unreliable, or missing in some cases. Well established names of yesteryear are languishing at lows. A recent article on BHEL gave insight into the real situation, so much for a Navratna enterprise.
3. PSU stocks have not come out of overhang of OFS and dilutions, the woes of fundamentally strong companies like Coal India, NMDC and MOIL etc in mining sector are well known. Oil & Gas sector has some minor positive with reduction in diesel subsidy but it will take long before that makes any real impression on the stock prices.
4. Auto majors like Maruti have to stop production for a couple of days every now and then to cool off the supply mismatch. Entry of one Honda has changed the 2-Wheeler market dynamics for our Bajaj auto and Hero.
5. Pharma is a mixed bag. For an ace like Sun Pharma, we also have to live with a Ranbaxy that acts as dampener. Still, market is giving high multiples to well performing Pharma guys so long as they are performing.
6. Banks are somewhat of a divided house where many PSU banks are saddled with asset quality issues and trading well below book. Private peers are already priced in overvaluation zone in excess of 2-3 times book.
7. IT with some exceptions (HCL Tech, TCS, Mindtree) have failed to live upto promise of  volume growth. The stock uptick seem to be on account of currency moves rather than real operating performance.
8. No point discussing about real estate and the likes.

All the above tentativeness in market leaves us with consumer facing businesses in FMCG and Consumer durables. Yes, we are talking about the likes of Nestle, HUL, ITC, Colgate, Britannia, Bata, Asian Paints, Berger Paints, Pidilite, Dabur, Emami, Bajaj Corp, GSK Consumer, Tata Global, Godrej Consumer, Marico, TTK Prestige, Hawkins, P&G, Gillette and so on.

Now, question is what is distinguishing these from the rest:

a.  Consistent cash flows, debt free (most of them), incremental capex is funded internally, no dilution,  high capital return ratios and decent pay-outs.

b.     Market very well knows that Nestle cannot grow at 30%+ anytime in near future but still gives it PE of 40. Such companies are like oasis in desert where “Predictability of Earnings” is the real PE decider not just the earnings growth.

c.   Domestic consumption stories are here to stay. A large middle class and growing number of consumers add to it. They can reduce some discretionary spend in inflationary times, ultimately that has to be realized in the market. After all, Chinese folks may not succeed selling hair oil and toothpaste in India.

d. Established consumer companies have strong brand power, distribution network and geographical penetration. Most of this is irreplaceable moat.

e.   Gestures from the parent shareholders to hike their stakes even at current levels like in GSK Consumer and HUL boosts market sentiment for investors (why will promoters not raise their positions when they have business growth compared to home turf, they take away high royalty payments of 1-3% and of course the dividends).

f.     In this kind of scenario, where do you think an emerging market fund looking to put money to work in India will invest, if not in these consumer stories?

In short, these consumer stories may have their ups and down and occasional performance blips. Broadly, this theme will continue to deliver earnings and premium multiples accorded by the market may not significantly shrink going forward. These are uncertain times and the way macro-economic scene is panning out, there may be bouts of sustained selling. That will again make participants look for defensives. 

No wonder, consumer facing businesses will keep the markets interested!

Bottom fishing – Myth and Reality

In last couple of weeks, there has been too much talk from “experts” appearing on TV channels or print media or net about investing at bottom of the markets or whether bottom is formed or how far is that level and so on. In equity investing, Bottom fishing refers to buying the cheapest stocks in valuation terms at lowest levels. Let us look at some of the common myths in this regard followed by my views on each one of them. I am sure you are coming across lots of these advices and grand mythical statements now a days.

Myth # 1 – Investors can start buying at current levels and add on dips.

Views: This is such a cliché statement for whatever it means. We analyse it here in slightly more detail, as to what our beloved “expert” is saying.

-          If this is addressed to an investor who is new to equities, do you really think a novice will muster courage to step into such volatile equity markets. God forbid, if Johnie steps in and Sensex tanks 1000 points next day and there goes his stock, will Johnie be able to get sleep? Contrast it with bank FDs where Johnie is getting 10% assured return. So, this piece of advice makes no sense to our Johnie.

-          If this is addressed to an existing equity investor, Johnie is already invested and licking his wounds because his portfolio is in red by x%. In all probability, he might not be holding large cash balance to invest further. Even if Johnie is holding some cash, there is a second thought in his mind whether to put this as well in markets or deploy in safer options. This piece of advice makes no sense to this existing investor either.

-          If this is addressed to an experienced investor who can analyse stocks indepth, is this advice necessary? Either way, such an investor will assess the situation and decide the best course suiting the personal investment style.

Myth # 2 – We have strong support at 4,540.

Views: Again this and its like are some of the most rubbish statements one can come across in a bear market. When there is a concentrated bout of selling or basket selling by a large institution or FII there is no respite. Who cares for this mumbo jumbo levels of 4,540 or 4,440 or any other number given by some analyst. In some of the previous bear markets, I recall by the time analysts were giving a support level, it was getting broken such was the ferocity of the fall.

Myth # 3 – You cannot time the bottom.

Views: If our expert is referring to bottom level of Nifty or Sensex while making this statement, it should not unduly concern a discerning stock-picker investor. Please undertsand that different investors are interested in buying different stocks and all stocks do not bottom out at the same time in terms of price. To cite an example, if one is interested in a popular stock like HUL, it is making lifetime high when Nifty is at 2-year low.

Myth # 4 – Downside is limited to not more than 5%. There will be a V or U shaped recovery.

Views: Whether some astrologer or Santa Claus has given all these prophecies. And how can you decide the precise alphabet of recovery when range of growth in economy varies by the week, fiscal deficit is out of hand, more subsidy driven social programmes are on drafting table, currency fundamentals are out of place, Eurozone topshots themselves are not sure of resolution of debt crisis.

Myth # 5 – This time it’s different (This is not 2008).

Views: In markets, ticker is all. Buy-hold-sell decisions have to be made around that. So how can one market fall be more calibrated or more disciplined compared to another fall. But human being is such a rationalizing creature that any event or action can be justified with some reason when none is actually applicable in view of macro uncertainty factors I mentioned in Myth # 4.  

To conclude, don’t be misled by the noise around. Nobody knows how long this correction will continue price-wise or time-wise. Specific stock selection is what matters. As usual, keep grabbing the good opportunities provided you have the staying power and patience. It is times like these that separate the men from boys.

All the best!