- Investors are paying too high a premium for quality right now. Even a good stock can be a bad investment at a very high price.
- While some stocks have performed well and become overvalued, many others are still underowned and undervalued.
As a result, valuations have reached stratospheric levels. For instance, Page Industries, which notched up an impressive 21% compounded annual growth in net profits in the past three years, is trading at a PE of nearly 100.
Astral Poly Technik, which saw profits grow at a compounded rate of 32%, is trading at 70 times its earnings per share. If the stock is of good quality, should one look at the valuation? After all, a good quality stock will always command a hefty premium. “If you are right on the growth part, a slightly higher valuation would not do harm. For example, HDFC Bank was quoting around 25 PE in its initial years and ignoring it because it was valued higher than other banks would have been a big mistake,” says Manish Sonthalia, CIO – Equity PMS, Motilal Oswal Mutual Fund.
Even so, investors are paying too high a premium for quality right now. Even a good stock can be a bad investment at a very high price. You won’t make money from these stocks if you buy them at unreasonable prices. It is what experts call, Growth At Stupid Prices or GASP.
We looked at five stocks that could leave you gasping for breath. Most analysts expect them to churn out poor returns in the next 12 months.
These high quality growth stocks could lead to losses
Most analysts have given a thumbs down to these growth stocks trading at very high valuations
The market has become very polarised. While some stocks have performed well and become overvalued, many others are still underowned and undervalued. “This trend could reverse partially and there could be a reduction in quality premium once the core and cyclical sectors provide better visibility,” says Deepak Jasani, Head of Research, HDFC Securities. “This kind of distortion happens only once in 3-4 years and offers an opportunity to adopt a new strategy,” adds Sailesh Raj Bhan, Deputy CIO – Equity Investments, Reliance Mutual Fund.
Growth at reasonable prices
When the market is close to its all-time high level, it is not easy to find growth stocks that have not touched the stratosphere. “Barring few PSUs, most other growth stocks are quoting at very high valuations and therefore, won’t fit into the GARP strategy,” says Sankaran Naren, Executive Director and CIO, ICICI Prudential Mutual Fund. ET Wealth took a deep dive and identified seven high quality growth stocks that are still quoting at reasonable prices.
We first shortlisted companies that were reasonably large (market cap and revenue of at least Rs 1,000 crore each) and boasted a decent traded volume (average daily traded value of at least Rs 10 lakh). Next, we shortlisted companies that reported at least 15% compounded annual growth in their net profits during the past one year and threeyear periods.
Once this was done, we weeded out companies that are not expected to report at least 15% net profit growth in the coming year. These estimates are based on consensus analyst expectations. To make this future net profit figure more meaningful, we restricted our search to stocks that were covered by at least 10 analysts. To make sure that the growth in net profit was business-led and not an aberration, we also imposed a 5% restriction on revenues for all the time periods.
The valuation challenge
The main challenge was that many growth stocks were quoting at exorbitant valuations. “It is difficult to find GARP companies from consumer facing sectors now because there is clear earnings visibility (contrary to other sectors) and everyone is chasing these 60-80 stocks,” says Jasani. Most of the GASP stocks are consumer facing companies. Some value has emerged in the infra space after the correction in the mid- and small cap segments.
Valuation is not an absolute number and depends on the growth rate of a company. Valuation will be higher for companies with higher growth rates. One solution to this problem is to link valuation (measured by PE) with the growth and create a new PE to growth (PEG) ratio. And as a thumb rule, experts say a PEG ratio below 1 is reasonable valuation. You can calculate PEG ratio based on historical growth or forward growth. We have done this for both the historical growth as well as the expected future growth and shortlisted companies only where both PEG ratios were less than 1.
But one needs to be extra careful while using the PEG ratio. It gets compressed when the current or expected growth rate is very high. For example, if the current or expected growth rate is 80%, a company quoting at a PE of 70 will also look reasonable. “PEG ratio below 1 is reasonable when the expected future growth is reasonable. If the expected growth is very high (50-60%),investors should insist on a lower PEG ratio because the company won’t be able to sustain very high growth rates for the long term,” warns Bhan.
Taking this as a caution, we have eliminated companies where the PEG ratio is below 1 because of the very high current or expected growth rates (defined as growth rate above 30%). Our study threw up eight companies. Since one of them, Escorts is also the Pick of the Week, the remaining seven stocks are covered here.
Also Read: Stock pick of the week: Promise of long-term growth makes Escorts a top buy
A word of caution: the broad market valuation is still very high and therefore, a short-term correction will also affect these GARP stocks. “Valuation depends on several factors and interest rate is one of them. Interest rates are hardening globally and PE multiples are compressing and this can be an issue in the near term,” says Sonthalia.
1. Jamna Auto Industries
“Jamna Auto is a key beneficiary of the shift in commercial vehicle demand towards high tonnage vehicles (leading to higher margins and realisations).” Deepak Jasani, Head of Research, HDFC Securities.
The market has already started rewarding Jamna Auto for its high historical and future growth rates. This explains why the stock has outperformed the Sensex by almost 38% in the past one year, despite a 33% correction in its price during the past six months. In addition to the recent correction in the stock price, experts are bullish on this counter for its improving fundamentals.
First, it has benefitted from the structural changes happening in the commercial vehicles space. “Jamna Auto is a key beneficiary of the shift in commercial vehicle demand towards high-tonnage vehicles (parabolic springs and lift axle will witness enhanced demand, resulting in higher margins and realisations),” says Deepak Jasani, Head of Research, HDFC Securities.
Secondly, the recent correction was triggered by the government’s decision to allow higher axle load for existing vehicles. Though this may reduce the demand for medium and heavy commercial vehicles, its impact will be in the short term and could affect Jamna Auto’s revenues only for the next one or two quarters. Third, the company is also planning to de-risk its business by expanding into aftermarkets and introducing new product segments (lift axles, air suspension). Its focus is on the replacement exports market, which is growing by around 15% in volume terms. However, investors should note that commercial vehicles is a cyclical business and therefore, need to time their exit as well.
2. Kalpataru Power
“Due to strong order inflow and its bulging order book, Kalpataru Power’s revenue is expected to grow by 16.2% CAGR between 2017-18 and 2019-20.” Recent research report by ICICI Direct.
Part of the real estate developer Kalpataru Group, this company is into design, testing, fabrication, erection and construction of transmission lines, oil and gas infrastructure and railways projects on a turnkey basis. In addition to improving prospects from the power transmission business, there is a strong order inflow from railways, road BOT projects and pipeline businesses.
Its order book increased by 41% y-o-y in the first quarter of 2018-19, giving it clear revenue visibility for coming years. There is also significant improvement in the performance of its subsidiaries like JMC Projects. More importantly Shubham Logistics, which has reported a loss of Rs 10.4 crore during first quarter of 2017-18, has reported a modest profit of Rs 60 lakh during Q1 of 2018-19. Kalpataru Power has also established presence in more than 50 countries and should, therefore, benefit from the recent depreciation in the rupee.
3. KEC International
“KEC International’s earnings growth is expected to continue for the next 2-3 years due to higher margins and its fast growing order book.” Rupesh Sankhe, Power and Capital Goods Analyst, Reliance Securities.
The flagship company of the RPG group, KEC International has a presence in 100 countries across Africa, Americas, Central Asia, Middle East, South Asia and South East Asia. In addition to the 28% underperformance against the Sensex in the past one year, its investment worthiness has also increased due to improving fundamentals.
First, the government’s UDAY scheme has helped state electricity boards and they have in turn increased their capital expenditure, leading to bigger orders for players like KEC. KEC’s order book has hit an all-time high of Rs 18,200 crore (1.8 x of 2017-18 revenues). Since KEC is favourably placed (it is the lowest bidder) in other orders worth Rs 3,180 crore, its order book is expected to bulge further in the coming quarters. Second, concentrating only on high margin orders has led to significant margin expansion during the past four years.
“We reiterate that the pending demerger could enhance value and remains a potential trigger for the CESC stock.” Recent Research report by Edelweiss
While CESC’s core business (power generation and distribution) is going on smoothly, CESC has been forced to split its core business into separate power generation and distribution companies due to regulatory issues. After the split, the management wants to focus more on the distribution business with low capex. This strategy should boost its profitability in the coming years. Since the entity is facing conglomerate discount (when the total value of a firm is less than its sum of parts), the management wants to split the company further. Most experts are bullish on the demerger plans of this Sanjiv Goenka Group company. Some of its subsidiaries such as First Source.
Solutions and Spencers are also doing well. The prospects for Spencer’s have improved after the decision to close down unviable stores. It has already broken even at the EBITDA level and is expected to break even at PAT level in the next 12-18 months.
5. Indiabulls Housing Finance
“Indiabulls Housing’s stage III assets were broadly similar to gross NPAs. So, there is no other earmarked stress pool. This will result in credit costs falling to 20-25 bps.” Recent research report by Edelweiss.
Indiabulls Housing has underperformed the Sensex by about 25% in the past one year. However, there is no change in its fundamentals. The company has been reporting around 30% earnings CAGR and a similar rate is expected in the coming year as well. Since there was no negative surprise despite the shift to Indian Accounting Standards or Ind-AS, experts are hopeful that Indiabulls Housing will sustain its earnings momentum and improvements in key ratios like return on equity in future. The housing loan demand continues to soar due to the government’s push of ‘housing for all by 2022’.
Indiabulls Housing is also protecting its margin by regular hikes in loan rates to offset the increased funding costs. More importantly, there is no let up in its asset quality due to its strict risk management systems. Analysts feel this will bring down its credit costs.
“The acquisition of Arysta is likely to be value accretive if UPL realises 30% of targeted synergy. No worry about details because Arysta is part of a listed company” Aditya Jhawar, Analyst, Investec Capital Services.
UPL is one of the few global agriinput companies with a presence across the agri-value chain. With around 20% historical CAGR and expected future net profit growth, this mid-cap company is also a stable growth player. Its strong performance continued during the first quarter of 2018-19.
Its first quarter revenue from Africa more than doubled and it did well in Latin America despite currency devaluation in countries. The recent acquisition of US-based Arysta Lifesciences for an astounding $4.2 billion (Rs 33,000 crore) is seen as a positive development by experts, who say this deal is value accretive for UPL.
7. Suprajit Engineering
“The next leg of growth will be led by gains in global non-auto cables market; domestic 4-wheeler space and marketshare gains in aftermarket.” Recent research report by Axis Capital.
Suprajit Engineering, India’s largest and among the world’s top five automotive cables manufacturer, has consistently outperformed the industry on revenue and EBITDA growth over the past decade. Its valuation has became reasonable only in the past one year. Since its growth is still continuing, the correction gives investors a good entry point.
The management is taking steps to maintain its high growth rates in the coming years and experts believe that Suprajit Engineering will be able to deliver. With new OEM orders coming from European auto majors and a bigger push planned in North America, the export segment is also doing well.
(Stock prices and index values have been normalised to a base of 100 in all charts. All data as on 14 Sep 2018; Source: Bloomberg; ETIG database)
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6 Comments on this Story
Guru897 days ago
Why there are no disclosures on self or holdings by clients while recommending these stocks? If they are not having any holding then why these stocks are recommended? What could be the reason?
jahpanah save tree899 days ago
most of stocks are not good
SM Shah900 days ago
Would also add-in YES BANK at this stage.