February 21, 2008

Correction to the post : valuation – reverse engineering the stock price

There was an error in the analysis of crisil in the post . I had looked at the standalone numbers only and not the consolidated numbers (as an anonymous reader has pointed out in the comments)

So crisil may not be a good example of over valuation. I am not sure how undervalued the company is. It sells at a PE of 33 (approximate Net profit of 100 odd crs for 2007). I have analysed the company earlier
here …and I have underestimated the competitive advantage of this company and its ability to keep increasing its instrinsic value.

That said, if I were make my point in the post again, I would replace crisil with any of the Real estate companies or capital goods company which have a high performance hurdle to cross (due to their high PE) to deliver good returns to investors in the future.

The post was however was not an analysis of CRISL. The key point is this – A good company may not be a good stock and vice versa (important word is ‘may’) . That depends on whether the stock price fully discounts the future performance of the company or not. If one has to make money in such high PE stocks, then the actual performance has to be better than what is implied by the stock

Low PE or low valuation stocks have low expectations built in and hence a small improvement in the company performance can deliver good returns. High PE or stocks selling at high valuations are stars of the Stock market. If they stumble even a bit, the stock price can get butchered. So one has to be confident and sure that the company will meet the high expectations well into the distant future.

I have personal experience of seeing a stock drop 90% when the company was not able to meet its high expectations (see
here).

Ofcourse you can say that I am not as dumb as rohit and will not make a mistake like him :)


Feb 23 :
Following quote from peter lynch is very relevant to the topic of this post

“It’s a real tragedy when you buy a stock that’s overpriced; the company is a big success and you still don’t make any money.” Peter Lynch, “One Up on Wall Street,” New York, Penguin Books, 1989, p. 244.

I am a big fan of Mohnish Pabrai. He is a very succesful investment manager and has recently written a great book - dhandho investor.

Following article from mohnish explains the key point of the post - A good company may not be a good stock and vice versa in a great (and much better) way.

Valuation by intrinsic value.

In addition you can find the links for a lot of mohnish's articles here. I strongly recommend reading each article

4 comments:

Abhishek said...

Hi Rohit,

Using the same concept, dont u think L&T is a very expensive stock trading at PE of above 70.
To sustain this PE, how much growth it must show in the future?
Does this PE look sustainable?

If no, could u please help us understand this calculation by using L&T as an example?

Thanks,
Abhishek.

amit Mehen. said...

Rohit,

Do you consider not selling SSI as a mistake. Selling is as important a part as buying and I guess not even 5% attention is paid to the same. ( buy and hold theory)

Some stocks that quote at higher P/E and even go up. India infoline did an IPO at Rs 70 (P/E of 25), on top it was at 1900 and is now at 1100 ( same like indiabulls and educomp)

The key is selling high PE stocks.

see the latest research by ABN AMro and LBS, it contradicts a lot of the conventional wisdom.

Rohit Chauhan said...

Hi abhishek

I have seen the L&T has a PE of 70. not sure if it is based on the consolidated results. let me have a closer look and let you know

regards
rohit

Rohit Chauhan said...

Hi amit
SSI has been my dumbest investment so far (with more to come :) )

to begin with, i should not have bought at such high valuation, and should have sold as soon as i realised i had goofed up. however i let greed take over my buy decision and hope take over my sell decision.

i would not confuse it with buy and hold. buy and hold should not be done blindly ..the company should be checked and held only if the fundamentals are fine and the stock is not overvalued

regarding educomp, indiainfoline ..who knows ? we have had these kinds of valuations earlier and investor have payed a heavy price for the optimism

i have not seen the research by abnamro and frankly i prefer not too ..it is at best baised and analysis is made to fit the current valuation. better off doing my own analysis