A nightmare for a value investor?

Here is the list of Sensex non-commodity stocks with their P/E ratios. Ben Graham would not touch a company with P/E of more than 18 and with P/E of last 7 years' EPS of more than 25. The criteria for commodity is different. Can you find even one with P/E less than 18?

Company	TTM P/E	P/E of 7 year EPS
BHEL	34	62
Hero Honda	22	37
HUL	30	30
HDFC	30	50
ITC	27	40
Infosys	19	40
L&T	22	55
Maruti	30	38
NTPC	21	30
Tata Power	23	38
TCS	19	33
Wipro	18	32

This really is a nightmare for a value investor. Stocks are overvalued doesn't mean they would come down soon. The famous British economist John Maynard Keynes has said

"Markets can remain irrational longer than you can remain solvent".

The only thing a value investor can do is to sell some of his holdings. Mr. Market is very enthusiastic right now and nobody can fight his enthusiasm.

Thumb-sucking s**ks

I wrote an article in March about investing in IT stocks. But I myself didn't take the plunge since I am a software engineer by profession and I cannot invest in the sector I am employed in. The reason? If there is a big slowdown in IT and I get laid off, I will lose my job as well as investments. Now most of the recommended stocks are up by 2-3 times. Geometric is up from INR 10 to INR 36, CMC is up from INR 280 to INR 800, Polaris is up from INR 35 to INR 110, KPIT is up from INR 25 to INR 53. The one that I missed during my analysis, Patni is up from INR 110 to INR 320 and still moving up. So much for the rules!!!!!!

IT company profits boosted by USD-INR rate?

Looking at the cheer in stock markets about good earnings reports from IT services companies, I thought of looking at the results and found that IT companies benefited to some extent by USD - INR exchange fluctuations. INR has depreciated by almost 16.2% between June 2008 and June 2009. The average exchange rate was 42 INR for USD in June 2008 quarter which has gone down to 48.82 INR for USD as per Infosys consolidated results. The consolidated net profit of Infosys, Wipro and TCS is up by 17.28%, 12.65% and 18.85% YOY, i.e. most of the gain has come from exchange rate differences. Looking at the USD-INR 2 year chart, we can say that this boost can last for one more quarter since exchange rate was average 43 INR for USD in July - September 2008 quarter and may remain between 48-49 in July - Sept 2009. But after October 2008 onwards exchange rate has remained around 48 so the results may not get any boost from exchange rate differences. Add to that the addition of new employees to the tune of 20K for all the firms before January 2010.

IT is a business which caters to other businesses and mostly in developed nations like the US, Europe and Japan. The sector has remained unaffected from this downturn so far due to the fact that businesses cut spending on IT after their own business slows down. Thus IT has a lagging impact from the real economy.

All three areas, the US, Europe and Japan, are under severe recession and capacity utilization of manufacturing plants are at historic low of 65%. Before manufacturing businesses expand, there is not going to be demand recovery for IT. Microsoft results already show this fact.

Does buying a safe heaven help?

I am talking about companies/sectors which are considered safe heavens, i.e. fast moving consumer goods (FMCG) and Pharmaceutical. In a previous article, I already mentioned about the raw deal an investor got when he invested in HUL in 1999. The same applies to Colgate but the time frame is a bit longer. Instead of ten years, it is fifteen years of nothingness. The following figure shows chart of colgate's share price from 1994 January. The price was at INR 500 in January 1994 and it crossed that price in 2009 June, almost after fifteen and a half years.



The only returns an investor got were dividends and after inflation that too will be wiped out. Stay cautious when you invest.

Refining Margins down to a third?

Searching Refining Margins on Google News gives results as follows:

Total says refining margins down by 64% from USD 40.2 a metric ton to USD 12.4 a metric ton

Chevron warns of sharply lower refining margins

Shell is shutting Singapore refinery and an analyst says it is good time to shut down since refining margins are depressed

Global refining margins were USD 4.98 in Q2 compared to USD 8.25 a year earlier and are at USD 2.17 in July

Refining margins slump says Conoco Phillips, the third largest oil company in the US

US refining margins slip in most regions

Refining returns below Cost of Capital

Deloitte sees trouble for refining industry

And Reliance Industries is up by 3.5% today. This is called liquidity driven buying.

Dow Jones Composition Changes make it Cheap

I keep looking at the djaverages website to know the P/E of Dow Jones Industrial Average. The recent changes to replace Citi with The Travelers Company and GM with Cisco has resulted in P/E decline from 19 to 13 (needs registration). Citi's TTM losses were around USD 20 Billion and that of GM were around USD 33.6 Billion. This has been replaced by profits of USD 2.6 Billion of The Travelers Company and USD 7 Billion of Cisco. A net addition of USD 63 Billion in DJIA profits while the total market cap of DJIA has remained almost similar at USD 2750 Billion. The profits with a P/E of 19 were USD 144 Billion which has increased to USD 210 Billion and P/E has come down to 13. What a great financial jugglery? Does DJIA look very cheap to you now and do you still see it going down to 5500?

How to identify Bubble?

What are the main characteristics of a bubble? How can an investor identify early and take advantage or avoid getting punished? Let me give you some examples which can be used to give a fair idea of a bubble in terms of P/E ratio.

All the gurus agree that 21,000 Sensex in January 2008 was nothing but a bubble. What did the valuation look like at that time? The five companies in the Sensex that led this bull market were trading at following valuations:

Company	P/E of TTM EPS	P/E of 10 year average EPS
Reliance	30	70
Larsen & Toubro	56	135
ICICI Bank	35	80
Bharti	32	150
NTPC	30	45

Companies were trading at 70-140 times ten year average EPS. When the markets corrected many good companies without any debt on their balance sheet giving good dividend in BSE500 were available at TTM P/E of 3-5 with a P/E of 10 year average EPS of less than 5. The examples were Patni and Maharashtra Seamless. Even Bharat Electronics and BEML were available at P/E of 10 of average EPS of 10 years.

The fact shows that investors were paying too much for the near term growth in profits and were not taking into the account the impact of business cycles. The period between 1999-2003 was such that corporates were earning less than their potential but between 2006-2007, most of the companies were earning above their potential.

Can I locate similar trends in some sectors today? Have a look at the following table to compare valuations of some companies:

Company	P/E of TTM EPS	P/E of 10 year average EPS
ABB	31	60
Bharti	19	70
BHEL	33	76
Colgate	29	63
Dabur	29	61
Educomp	50	260
GMR	87	267
GSPL	27	80
GVK Power	35	150
India Infoline	18	76
Jain Irrigation	33	89
JP Associates	55	84
KSK Energy	50	287
Mundra Port & SEZ	50	225
Nagarjuna Fertilizer	75	135
NMDC	31	97
RNRL	188	775
Titan	34	95

Many of the stocks seem to be related to Ports, Airports, Metals, Education and Power. Some overvaluation in FMCG has also started to appear. Manish Chokhani says that there might be companies in power sector that grows from small caps to be a part of Sensex one day replacing NTPC similar to what happened in Telecom. But isn't that hope priced in at this point of time?

The overvaluation of stocks can continue for a long period of time since the liquidity chasing the equities is in huge amount. Investors should stay cautious.

Sensex Nifty EPS for FY2009

Sensex EPS as per BSE Website at INR 762.4 and Nifty EPS as per NSE Website is at INR 214.9. Hindalco, Tata Motors, Suzlon and Tata Steel almost took INR 9 off from Nifty EPS since Nifty EPS was around INR 223.4 till 24 June. This compares with Sensex EPS of INR 807.78 and Nifty EPS of INR 236 at the end of FY2008. Thus EPS of both Sensex and Nifty has decreased by around 5-9%. Nobody, not a single investor, thought this in August 2007 - January 2008.