Prof. Sanjay Bakshi, in his article “Pay Up, But Don’t Overpay” clears the misconception that several stock pickers and investors suffer from – that buying stocks quoting at high PE valuations should be avoided as they are “expensive” and there is no “margin of safety“. Such investors are making a huge mistake and losing out on super-duper multibaggers, he says.
To prove his point, Prof. Sanjay Bakshi cites three examples of stocks that have always quoted at high PE valuations. The first example is that of the venerable Nestle. In the heady days of Harshad Mehta, when the stock markets were at stratospheric heights, Nestle was quoting at an exorbitant PE of 68 times its TTM EPS and 9 times its book value. However, an investor who bought the stock and sat quietly on it would have made a CAGR return of 20% to date. An investor who bought the Nestle stock in 2004, when it was quoting at a PE of 22, would have taken home a CAGR return of 34%.
Prof. Sanjay Bakshi’s second example is that of the old war horse Asian Paints. In March 2002, Asian Paints was quoting at a PE of 20 times and had a market cap of $430 million. Five years later, by March 2007, the PE had swelled to 26 times and the market cap had soared $1.7 billion. Another five years later, by March 2012, the PE was at 31 times and the market cap had soared to $6.1 billion. Today, Asian Paints’ market cap is $8.3 billion, making it a 20-bagger in about a decade.
Prof. Sanjay Bakshi’s third example is that of Pidilite Industries which was quoting at a PE of 26 in March 2007 with a market cap of $656 million. In just 5 years, the market cap has trebled to $1.8 billion, giving its’ lucky shareholders a huge multibagger.
Prof. Sanjay Bakshi points out that the reason why these three companies have done so well for their investors despite their high PE values is because their business have grown disproportionately. These companies have used superb advertising and marketing strategies to create iconic brands out of products that are largely sold as commodities. The successful branding has given these companies strong competitive advantages, which has enabled them to produce exceptional fundamental and stock market performance.
The examples can be multiplied manifold. Titan Industries, for instance, has given a return of 8128% in 10 years while Sun Pharma has given a return of 3316% in the same period. ITC has given a return of 1345% and HDFC Bank has given a return of 1280% in 10 years. All of these are top quality companies with a strong management and a dominant market presence. They have never quoted at cheap valuations.
Prof. Sanjay Bakshi emphasizes that the best part is that the Indian market is growing at such a furious pace that none of these companies are anywhere near saturation point. On the other hand, the Indian consumer spending is at a tipping point and is expected to surge to about $3.5 trillion in the next seven years. There will be an “explosion” of spending, Prof. Sanjay Bakshi predicts and such companies will continue to do well in the future as well.
So, it is not be too late, even today, to board these top quality companies.
Some other stock pickers who share this approach of only buying top quality companies are Bharat Shah of ASK Investment and Basant Maheshwari of theequitydesk.com. Bharat Shah pointed out that though stocks like HDFC Bank, Asian Paints, Sun Pharma are quoting at high valuations, it makes sense to buy them because these stocks are seemingly immune to market cycles and downturns. Even Rajen Shah of Angel Broking is a proponent of the philosophy that you must not fuss too much about valuations if the quality is worth it.
At the same time, one must be careful not to indiscriminately buy every high PE stock in the expectation that it will continue to grow in the future as well. Instead, one should carefully and objectively evaluate the company’s business model and check whether the high growth rate will continue or there are any impediments in the path.