If You Buy Quality Stocks Even At 100 PE, You Will Still Make Money: Saurabh Mukherjea Stays Defiant & Rubbishes Fears Of Bubble In Valuations

High-Quality stocks cannot be valued on P/E basis as they are immune from all ailments

There is presently a heated debate amongst the intellectuals of Dalal Street on whether investors should buy high-quality stocks quoting at nose-bleed valuations or opt for their undervalued counterparts.

According to one school of thought, it is frivolous to look at the P/E multiples of top-quality stocks.

This is because these stocks have an impregnable moat which allows them to earn high RoEs, keep the competition at bay and rake in massive profits for perpetuity.

It is also claimed that these stocks are immune from all ailments arising from an economic slowdown and are unaffected even by life-changing crisis such as the Dot-Com bust or the Lehman bankruptcy.

Saurabh Mukherjea explained this concept with his trademark clarity of thinking.

“Asian Paints, Nestle, Marico have track records of consistently growing revenues year after year, decade after decade, in double digits with ROCs consistently ahead of 15%. There are around 20-odd companies in our country which fall in this bracket where revenues are double digits year after year. It does not matter whether it is Lehman or the dot-com bust, these companies are able to grind out outstanding results,” he stated.

Saurabh also made it clear that it is futile to value these stocks on the traditional P/E basis.

“With franchises of this caliber – Asian Paints, Nestle, Marico, Kotak Bank, HDFC Bank – you really should not be using PE multiples and PB multiples to ascertain their fair value. It does not work. You have to look at their ability to generate outstanding results over long periods of time and therefore buy them even at current valuations,” he said.

Basant Maheshwari is also a staunch advocate of buying only top-quality stocks irrespective of their valuations.

He never tires of pointing out that investors who bought Infosys at the mind-boggling P/E multiple of 350 have still outperformed the Sensex over the past 12 years.

Quality of business prevails over valuations in the long run. Even at 350 PE (March 2000) #Infosys has beaten the #Sensex in the last 12yrs!

— Basant Maheshwari (@BMTheEquityDesk) April 15, 2012

What takes a month for the expensive stocks to lose the cheap ones are ready to do in a day ! Be careful if you are not with quality.#ThrThoughtfulInvestor

— Basant Maheshwari (@BMTheEquityDesk) May 21, 2018

Basant has cited examples to prove his point.

DMart, alias Avenues Supermart, which is promoted by Radhakishan Damani, the astute investor and 14x Billionaire, is one of his favourite examples.

He pointed out that experts who were advising against investing in DMart owing to its alleged exorbitant valuations are now cutting a sorry face because the stock has delivered multibagger gains since its IPO.

QUALITY helps you in bad times even as KACHRA sucks. The D-Mart stock is much like the D-Mart store. People who are in don't want to come out and the ones who are out can't get in. You can keep protesting but the stock is up 116% over listing price.

Disclaimer: We OWN it.

— Basant Maheshwari (@BMTheEquityDesk) February 23, 2018

Basant has also formulated the theory that the “expensive” stocks actually become “cheap” when they dilute their equity at high premiums.

He explained this theory in the context of Bajaj Finance, which is presently quoting at an eye-popping PBV of 13x (see How Top-Quality “Expensive” Stocks Become “Cheap”: Basant Maheshwari Explains With Real Life Example From Portfolio).

There is a valuation bubble in quality stocks and they will give Nil returns in future

The opposite side of the intellectual debate is led by Sunil Singhania, the distinguished former fund manager of Reliance Mutual Fund.

He has conducted a detailed study of 27 high P/E prominent companies and pointed out that a majority have not delivered performance that justifies current valuations, and there can be little return expectation from these investments.

He has also cited examples to prove his point that the stocks are overvalued.

He has claimed that a head-to-head comparison between Sherwin Williams (the Global paints giant) and Asian Paints shows that while the former has grown at a faster pace than the latter, Asian Paints is quoting at a 300% premium to Sherwin Williams.

Sunil Singhania has argued that a “herd mentality” amongst fund managers is leading to this paradoxical situation of them chasing the quality stocks and ignoring the broader market even though there is a big valuation gap.

“Since these stocks have done relatively very well, funds that own them have done well over the last 2-3 years. Near term performance attracts more money and then the funds buy the same stocks again. Thus, it’s a self-fulfilling cycle of buying, performance, flows and more buying in the same stocks,” he has opined.

Indian equity markets have never seen as high a valuation in a few stocks for such a prolonged period. We attempt to unearth and understand the valuation bubble in perceived quality stocks in India.

The Big Call – Bubble In Quality? https://t.co/8jcBTqfuIW… via @AbakkusInvest

— Sunil Singhania (@SunilBSinghania) November 3, 2019

Sunil Singhania’s exposition is endorsed by Akash Prakash, the fund manager with Amansa Capital.

Akash Prakash has argued that the time is ripe for investors to bolt from overvalued expensive stocks and tuck into undervalued stocks.

The big call today comes fm Akash Prakash who takes inspiration fm @sunilbsinghania piece on a bubble in quality stocks. Akash, for the Business Standard today, argues that quality premium that largecaps enjoy will regress to the mean & that time to make that bet is now. pic.twitter.com/wy8h8cIoR2

— CNBC-TV18 News (@CNBCTV18News) November 5, 2019

Prashant Jain, the Fund Manager with HDFC Mutual Fund, expressed a similar view.

“I do not subscribe to this view that good businesses/good investment at any price and that is not borne out by my experience over the last three decades. Certainly we should buy a sustainable business but beyond that for a good business to become a good investment, the price must be good also,” the veteran said.

He gave the example of IT stocks in the late 90s to early 2000s where investors got no returns at all for 10-15 years.

Similarly, FMCG companies bought in 1995 gave zero returns for the next 10 years.

He also pointed out that consumer stocks are presently trading at life time high multiples.

“Never before in my experience have they traded so expensive and nowhere in the world do they trade at even probably half the valuations,” he stated.

I don't subscribe to the view that good business is good investment at any price: Prashant Jain, ED & CIO, @hdfcmf #ETMGS pic.twitter.com/KUEUqpMG8m

— ETMarkets (@ETMarkets) November 22, 2019

Don’t Buy “Glamour” Stocks. Buy “Bombed Out” stocks at cheap valuations if you want multibagger gains” Ramesh Damani

Ramesh Damani has sworn his allegiance to stocks with good corporate governance, good visibility and good earnings and which are quoting at cheap valuations.

He warned against investing in “glamour” stocks quoting at exorbitant valuations because these stocks can correct and stay in a correction zone for a year or sometimes decades after that.

“Starting point values matter as does stock selection. We are buying very expensive stocks at this point hoping alpha or momentum will take them higher. They may but they typically do not end very well,” he said.

“It is important for investors to find good valuations and I would suggest to them on a contrary basis to look at these midcap stocks which have bombed out completely,” he added.

He also cautioned that very few businesses, of any size or consequences, have a permanent moat.

I learnt that a great company is not necessarily a great stock: Ramesh Damani #MICIN @in_morningstar pic.twitter.com/z1Ke9RLXyT

— ETMarkets (@ETMarkets) September 18, 2019

There is an inverse relationship between PE ratio and subsequent long term performance: Ramesh Damani #MICIN @in_morningstar

— ETMarkets (@ETMarkets) September 18, 2019

Very few businesses, of any size or consequences, have a permanent moat: Ramesh Damani #MICIN @in_morningstar

— ETMarkets (@ETMarkets) September 18, 2019

High valuations lead to poor returns and vice versa: Ramesh Damani #MICIN @in_morningstar

— ETMarkets (@ETMarkets) September 18, 2019

Forget foreign stocks, India is a poor country and inefficient market

Saurabh Mukherjea has issued a rebuttal to Sunil Singhania’s analysis and made it clear that he is not much impressed with it.

Saurabh explained that in efficient markets like the UK, USA, Germany and Japan, it is very difficult to maintain return on capital at 40% or even 30% over an extended period of time.

Most glamorous well known American or Japanese firms will have return on capital of barely 15%.

In contrast, India is unique amongst the world’s 10 largest economies in that it is the only large economy which has around 20-25 companies whose ROC is a million miles above their cost to capital for decades on end.

He pointed out if a company can earn 40% ROC for a very extended period of time, it enjoys a mountain of free cash flow and if the same is reinvested in the business, the earnings growth are kept around 20%-25% mark.

He also cited examples to prove his point.

He pointed out that even 20 years ago, Asian Paints and Nestle were quoting at the same high P/E as they are quoting presently even though both companies have given investors returns of over 100x.

“In a poor country like ours, the growth potential is immense. Even in a downturn, you are seeing these companies — Asian Paints, Dr Lal Path Labs and even Page Industries, give you volume growth between 9% and 19%. That gives you a sense of how far we have to go in terms of development to our country,” he stated.

“If you invest even at 100 times PE in companies which have high RoE and earnings growth, you still make very healthy returns,” Saurabh declared with a flourish.

Find out why Saurabh Mukherjea of @MarcellusInvest is bullish on building materials, select mid & smallcaps while staying away from realty, power & metals pic.twitter.com/vw2Yj5d0RZ

— ET NOW (@ETNOWlive) November 20, 2019

Valuation is irrelevant in India: Shankar Sharma

Shankar Sharma has played arbitrator between the rival views and chipped in with his take on the controversial topic.

Shankar has opined that the concept of “valuation” is irrelevant in India because investors are starved of companies with honest and quality managements and robust cash flow.

Such companies will always be in demand despite their tepid growth, he pronounced.

Despite my good friend @SunilBSinghania 's view that "quality" will lag in future,I'm not convinced: India's a country&market starved of honesty, quality, cashflow.Companies with these, are near-always in demand. Even with tepid growth. In fact,valuation is irrelevant in India.

— Shankar Sharma (@1shankarsharma) November 22, 2019

Actually, having watched these" quality" names for a very long time ( and wrong for long, because of aversion to crazy valuations), these stocks have done well irrespective of cycles. Am convinced valuation is an irrelevant metric in India when it comes to quality

— Shankar Sharma (@1shankarsharma) November 22, 2019

Have seen valuation be " irrelevant" since the 90s. Not just today. And quality never" topped out", as a basket

— Shankar Sharma (@1shankarsharma) November 22, 2019

Don't Point to the outlier ( ie HUL). We all know that. Look at the aggregate of the" quality" space, across decades. Answer is clear

— Shankar Sharma (@1shankarsharma) November 22, 2019

There is no bubble. Quality stocks are expensive because they are stable (low-beta) and high RoE

According to Ravi Dharamshi, it is not correct to condemn quality stocks as being in a “bubble” because while they may under-perform in the short-term, they are unlikely to cause permanent destruction of wealth.

He also suggested that the ideal compromise is for investors to come a notch down the quality chain in the quest for higher returns.

Mostly agree with the “Bubble in Quality” generalisation. 2 points of disagreement 1. Quality is not a fixed set of stocks – Eicher,Page etc were quality now down 50%+ 2. Bubble is very strong word (underperformance is likely not wealth destruction). #markets #bubbleinquality 1/2

— Ravi Dharamshi (@ravidharamshi77) November 12, 2019

Better way to describe “Bubble in Quality” would be “Premium for certainty and growth”. Odds are better if you are willing to take a little bit of uncertainty without compromising on quality. #markets #bubbleinquality

— Ravi Dharamshi (@ravidharamshi77) November 12, 2019

By the way now it’s getting bubblish in calling a bubble in quality #markets #bubbleinquality 2/2

— Ravi Dharamshi (@ravidharamshi77) November 12, 2019

Veteran investor Sunil Singhania feels there is a bubble in 27 quality stocks. Yer, Scores of quality stocks have been multibaggers for value investors.There is a reason quality (stocks) is expensive. It is stable (low-beta) and high RoE.@lonelycrowd has this deep dive. Read it! pic.twitter.com/hQeYjFhE6q

— ET Prime (@ETPrime_com) November 15, 2019

Conclusion

So far, we have burnt our fingers very badly by investing in so-called “cheap” and undervalued stocks run by chor managements. We should now try our hand at investing in high-quality stocks to see whether it changes our luck and makes a material difference to the outcome!