Wednesday, June 29, 2011

The 'Value' Mindblock

Each of us have got different views, different opinions and different mindsets when it comes to investing. Some of us like to 'play' in stocks, some like to get into under-researched stocks with good businesses and some are content investing in 'bluechips'.
However, as investors, each and every one of us should properly understand one thing; what do we properly understand?! We should know our circle of competence/our comfort zone and invest accordingly. This will ensure not only decent returns, but also a good night's sleep.
This brings us to the topic of the post - a mindblock that 'value' investors face. The value gang typically goes for stocks that are cheap vis-a-vis their future potential and which also offer a decent margin of safety in case things go a bit wrong. Personally, I also look for a 'trigger' which will help the discovery of value in such stocks. Otherwise, such stocks will remain perennially cheap. (Look at Ultramarine Pigments for example).
In this entire exercise of investing, I often face a certain mindblock. Let me tell you about it with an example. Look at the following companies.

The companies I have illustrated are all established, proven and robust businesses. They are not concept stocks like, lets say, Zee Learning or Delta Corp, which have interesting business, but have yet to 'prove' themselves.
Now the question is, will I buy any of the above companies at present market caps? The point is, I just cant!!! Why not? The valuations!! Look at just the PE Ratio to begin with. Such high PE Ratios tell us that Mr.Market expects a lot of growth from these companies in future (As the companies have delivered in the recent past). Mr.Market also likes the business models which could actually deliver the growth expected of them. And yes, these companies really could deliver.
My problem with such stocks is that there is no margin of safety for black-swan/unforseen events. The valuations already discount a high future growth. And as long as the growth comes in, the valuations continue to be high. But what if for some damn reason, the growth does not come in. What would happen to the valuations (and effectively the stock price) then?
Lets take Jubilant Food for example. Personally, I thought that it was expensive at 400 bucks. I thought the same when it became 500, then 600, 700 and now 800!!! Jubilant Food has been nicely growing for the past coupla years. They have recently expanded their products portfolio, which could help sustain and increase future growth. The valuations therefore continue to be high and the stock will give returns as long as the growth sustains.
The question is, what will happen to the valuations of such stocks, if the expected growth does not sustain or some unforeseen event screws up the basic business model? Crash in the stock price is an understatement.

There comes the mindblock:

  • Should one buy into such 'high growth' stories, paying through the nose for the growth? Or
  • Let them be and suffer opportunity losses (like I suffer all the time). Invest in the 'cheap' cheap stories and stick to what you understand and are comfortable with.
Views invited...

Cheers and happy investing!


Mahesh said...

Like the Jubilant , same happened to hdfc..always commanded high p/ case of Jubilant its indian made pizza and tastes good. bug if economic recession hit..there will be less people buying pizza. :-)...there it can hit the growth.

Rajat said...

Hi Neeraj,

Your post accurately reflects the dilemma I have faced in the past with stock such as GSK consumer and Zydus Wellness.

In my view it is very difficult to get into these stocks at high valuations and I am comfortable living with 'opportunity loss'. I do however keep an eye on such stocks to enter if there is deep correction along with the market if the growth prospects still remain strong.


Janak Naik said...

Niraj bhai,

Nice one!!

I could compare this with two stock that i picked.... one is Financial Technologies and other being Ecoplast... first one looks expensive with good future ahead... the other is cheap and not much to talk about, though i have confidence on it...


S@A said...

I also suffer from same bias. I missed Zydus at around 380, due to "high" PE, which I incidentally regret as I like companies product portfolios. But if you look at US stock market, which has more history and available documentation, its value stocks which make more money in the end. But sometimes I feel, is it due to the fact US markey may be more efficient with billions going to mutual funds compared to india. But still I am holding to value stocks. I cannot prove anything from my portfolio as I have just started investing and consider myself learner, learning from guys like you. But I have started to think to buy more bigger companies which will be stable with more diversied base at may be more high PE in 20's.

Rajiv said...

I have had Page, TTK and Zydus on a watchlist for the past few years, and have watched the steady progress, while steadily kicking myself.

For a focus investor, taking big swings at a limited set of stocks, I don't think paying more than 20x for even the greatest of stories is a valid option, exactly because of what you said - the black swan risk. In a diversified portfolio, holding these may make sense. That is, if a diversified portfolio makes sense (?)

I think the other issue is one of discipline - once you begin to chase a "hot" sector/stock (aka Jubilant) - when does the madness stop? On the other hand if you have an investing rule that doesn't allow you to invest beyond a certain P/E, then you protect yourself from a certain kind of investing error.

Somewhere between the value traps and hot stocks, live a few great buys, but till I find some I can keep wondering why I bought the former and ignored the latter.

Anonymous said...

Good thoughts Niraj. While I agree with you on principle, I personally feel much attention should not be given to PE of high growth companies with proven track record. HDFC twins were expensive 5 years back and they still are but havent they given excellent returns over that period? Companies with excellent track record and bright future will always command premium also black-swans will probably make only a small dent in such companies.

Just my two cents.


Abhishek said...


First of all, great post. You have highlighted one of the most important problems of "value" in "value investing"? How do you determine value? Should PE determine what is cheap and what is expensive? Or should growth be of primary importance?

Personally, I think it is important to judge this on a case by case basis. e.g. I used to own Zydus but sold out last year when I started to get uncomfortable with the valuation. The stock has not moved since then. That does not prove that I was right. It just proves that I was lucky to make the call at that time.

I think what is really required is to try and gauge to some extent the growth potential of the businesses and moat.

So, as we say, value is in the eye of the beholder!

Shankar said...

Hi Neeraj,

One trick is to find the stocks that are in the middle of the Black Swan event now. Stocks that are having trouble because of macro events and that are equally shunned by Mr. Market. Remember, for every fancy stock that is exuberantly loved, there is one that is illogically ignored.

Who knows, some day even Jubilant will be in that list.

But nobody can look at an overpriced stock and say it will deliver in future. Its like buying a $1 stock that may give $2 after 2 years for $1.50 today.

Its important to keep the powder dry for a value pick to come by.

Rohit Chauhan said...

Hi neeraj
the above stocks represent survivorship bias ..for every jubliant and ttk ..there 5 others which never made it. one has to find such stocks ex-ante ...before they are recognized

there have been several such stocks which had a lot of promise and then a small misstep caused the market to reprice them. i personally do not want to be in such situations.

the key would be find these stocks before they are fully recognized ...i.e i do not want to pay for the growth and more.

there is a body of research that high PE stocks ..usually above 30 ..give low future returns. now one can always point out a pantaloon or something else which defied the logic ...but a single example does not change the probabilities.

if one is to make money in such stocks has to believe that the market still does fully recognize the true value of the stock ..that may be possible, but one has to really do his or her homework then


rapidriser said...

I have been investing in the stock markets for the last 10 years. Having missed out on a lot of great opportunities due to my 'value investing' bias, my conclusion is that Margin of Safety and Black Swans are simply excuses given by investors who have not done enough research.

Out of the 4 cos listed by you, the only one I would stay away from is Jubilant, because a lot of its valuation is based on proposed ventures which are yet to see the light of the day. As far as the other three are concerned, what kind of Black Swan can happen to businesses dealing with Kitchen Utensils and Appliances, Undergarments and Sugar substitutes? In my opinion all three are operating in markets which are far from saturated. The only way they can get into trouble is if they start losing market share to, or enter into a price war with, a competitor. If an investor is alert, he will get adequate early warning of such events and get out well before the share price falls significantly.

Robin Thomas said...

I believe patience is the key here. The party cant go on forever, and there will be a time when the companies will deliver below "expected" (even though slightly) results, that will be the time when the of people holding the stock will tend to change their views about the future of the stock.

And I think this will be the time to enter. A recent example being Hawkins. As soon as the company produced above the "new expected low" growth, the stock ran like mad almost doubling in a few days time. Since the core business was not hit. And everybody forgot why the stock was dumped few months back due to a couple of bad quarters.

GreyFool said...

I think another trap that value investors have to watch out for is wrongly judging the re-rating potential for a sector. I've seen many smart people either sell out early or not even buy into stocks coz they were trading at valuations higher than in the past.


Anonymous said...

Why categorize stocks as "value" and "growth"? After all growth is an element of value and if you look carefully you will find value some of these growth stocks.

Indrajeet Singh said...

Well pointed by Rohit these represent survivor ship bias. While some may say there is no difference in value and growth approach but if anyone followed basis difference is about approach to risk. Graham was fixated with avoiding loss of capital at all costs and actually this approach gave best return to him and followers. Growth people are more worried about losing out on potential good business.
It is also about one's attitude about risk. In my opinion if growth story is stretched little more it simply ends up speculation.
And very basic element is predicting growth projections and doing it for next 5-10years. Funny... As a banker for last 12years I can only say I have not seen people being able to get it right even for a year in 80% of cases.
I always wonder how these analysts keep generating these projected EPS number day after day and there is entire industry tracking these ridiculous numbers.

Well it boosts economy anyway.... all highly paid experts??

prakash said...

Hi Niraj,
As a value investor i totally agree with you.Market always chases fancied stocks.If we look at history in 92 cement stocks,in 2000 software stocks,in 2006-07 infra stocks and last in 2010-11 consumption stocks are most fancied.We should always look for stocks that are having bright prospects and unnoticed by markets.

Anonymous said...

This is always a dilemma for value investors. What if HDFC advanced by 50% this year. Does the price advance make the investment decision right or wrong?

JK said...

Nice post, Neeraj... Agree you wouldn't get in at current valuations in these stocks.
Now imagine, you already have one of these stocks (lets say purchased 2-3 yrs ago), would you be holding it or selling it? And why??? Wanna know thought process for selling.

Neeraj Marathe said...

@ Mahesh: Thnx for your views..

@ Rajat: Ya, i do agree with you..

@ Janakbhai: Apt example indeed...although i am not so positive on Ecoplast..

@ S@A: Yes, quality, size and growth do demand that u pay more!

@ Rajiv: yes, i totally agree with u..

@ Rahul: yes, i agree with what u say, but the question is, shud we go for such companies?

@ Abhishek: Yessir, value is indeed in the eye of the beholder..i gave Jubilant, Zydus etc just as examples..

@ Shankar: Yes, the market will give us opportunities like that from time to time..

Neeraj Marathe said...

Hi Rohit,
Yes i agree with u..behind every Jubilant which succeeded, there were the Pyramid Siameras and the Asian Electronics of the world whose business models did not succeed..(i chose not to talk about them so as not to give the post a negative flavour about growth and concept stocks..after all, they can earn very good returns for investors)
The question is what does one do? Go for stocks like these, hoping that our stock will be among the few to succeed or ignore these type of stocks completely.. (I personally choose to do the latter, but its a matter of each one's perspective)

Neeraj Marathe said...

Hi Rapidriser,
I honestly think you have hit the nail on the head in ur first para.. It can indeed happen that one hides behind the 'value' ka concept, in order to justify one's own ignorance and lack of has recently happened to me in the case of 3M India..i honestly did not understand the stock or the story..valuations did not make sense on the face of it..and i missed it..
as far as ur second para, if we could visualise ALL the black swan events that could happen, they wont really be black swan events, would they? :-)

Neeraj Marathe said...

Hi Robin,
You have touched a sensitive topic by mentioning Hawkins..its a cause of heartburn for me..i had bought it at 130-140 bucks..after holding for a coupla years, i sold it off, without revisiting the stock and my analysis of the a result, i missed a good part of the rally..

Hi GF,
Yes, re-rating can indeed b a value trap..often, re-rating happens due to qualitative reasons, not quantitative...qualitative reasons are relative and something which excites me may not excite the mkt, leading to no re-rating in the sector/stock..

Neeraj Marathe said...

Hi MG,
Its not really about the categorisation.. its about paying very high valuations for the growth..

Hi Inderjeet,
I totally agree with u...and dont even get me started on analysts and their EPS projections! :-)

Neeraj Marathe said...

@ Prakash..
yes, a lot of 'fancied' stocks have been disastrous investments..however, there have been a few 'fancy' stocks, which have given really 'fancy' returns! :-)
lotsa investors chase these fancy stocks, hoping that their stocks will be ones giving the fancy returns..

@ Anonymous,
Selling a stock JUST because the price has gone up is a huge mistake in my opinion..

Neeraj Marathe said...

Hi JK,
Regarding thought process on selling, here is what i usually do...
the most important thing is to have a view on selling a particular stock before buying it itself! this gives the investing decision more structure as well as one knows what one is getting into, without a lot of confusion..
usually, after buying, i keep track on how the business of company is developing..if events happen, because of which the basic reasons why i bought the stock are no longer valid, i would choose to sell it immediately, irrespective of my the selling levels i had in mind originally when i bought the the same way, if events happen which i feel are very positive, i do change my original thoughts and the levels to sell..
it is a very dynamic process and being rigid in it leads to mistakes while selling (selling early or selling too late)

Abhi said...

In my opinion people confuse value and growth. Definition of seeking value is much broader in my book.

You have been focused on Low PE stock that have a catalyst to attain its value. In most cases the companies you would bet on in this category are not really unlocking value. You are betting they will attain better valuation because of the trigger. So the hope is that if trigger plays out well your bet will attained better value. Analysis on this company will be focused on current state and probability of trigger being successful. Therefore to mitigate the risk that comes in with this approach would be to seek margin of safety.

Above approach is logical.

But then problem is what about the high PE bets that you did not take that attained even higher valuation causing you to term this an missed opportunity.
Another problem is there is no margin of safety.
Third problem is, not every High PE really makes it.

How do we over come this?

Instead of being stuck to cheap stock philosophy , specially in a country whose gdp is high and will be high for long period of time it would be a really not be smart on one’s part to neglect ‘growth’ companies.

One way to overcome this problem would be consider a portfolio approach change?

That is for example, 70 % of your portfolio is dedicated to the approach you have taken earlier - that is low pe stock with trigger
30 % of money is focused on opportunity in high PE stock, But in that you still do you research like rapid riser said ( and I agree with him) and spread your bet, as in you look at this in terms of basket of high PE opportunity that you may think can attain high valuation. That is focus on getting this basket of high PE stock to get, manage and improve quality of this basket.
Even if you are 30-40% right on picks of this 30%basket you should expect to get good returns

I am interested to know if you really consider this option as it actually would require hardcore value minded people to change such an approach

Neeraj Marathe said...

Hi Abhi,
Yup, i totally agree with u that having a large part of the portfolio in 'cheap and value' category stocks might mean that we might miss a lot of stories which are a proxy to our growing of the largest risks of being only in the cheap, value stocks is the re-investment risk..u bought a cheap became expensive and u sold..what next? will u b able to buy such cheap stocks and sell them expensive consistently? if not, such continuous research to keep on finding stories can be quite frustrating.
i personally do not have a huge % of my portfolio in the cheap category. e.g. whirlpool, which is my largest position was not at all 'cheap' when i bought it..i would also be very glad to have 70%+ of the portfolio into compounding stories like these..problem is, it is extremely difficult to find the growth/compounding stories at valuations which YOU are comfortable enuf and have conviction to take a decent size position. an easy way out of this is something i call 'extreme cycle investing'..on which i plan to put up a post soon...
thnx a lot for the detailed and extremely relevant comment..

Jigar Punamiya said...

Hi Neeraj,

Firstly, a good post on the dilemma b/w value & growth, which is occurs frequently..
Sir, what would be an ideal call on cos. like Gillette, which have good past performance, great financials, a very stable future outlook, etc.. They are priced at least 20x more than their peers..

Jigar Punamiya.

Neeraj Marathe said...

Hi Jigar,
no i hvnt looked at Gillette in depth, so cant really comment of it..