Adani Group Stocks and Pidilite Industries: Two sides of the same coin?

The short seller in its report expected an 85% decline in fundamentals and accused Adani group companies of undue wide use of entities established in offshore tax havens as it raised concerns about high debt levels.

Due to this a Adani Group shares fell heavily.

While the timing of the report can be questioned, given that it was published just 2 days before the mega FPO, the point I am trying to make is different.

If you look at the Adani group entities, except Adani Port and Adani Transmission, all of them have very high valuations and very high debt levels.

There is no margin of safety in most of the Adani Group shares.

In the stock market, valuation and growth should be the starting point that determines future returns as well as the margin of safety.

In Adani’s case, as an analyst, no matter what future projections you make, valuations will never make sense.

Adani group companies are trading at 100-300 times P/E multiple or since they are asset-heavy businesses, even if we consider valuation metrics of value to book, most of them are trading at 20-100 times are doing.

I mean how can an analyst justify a valuation of more than 15-20 times book value?

So as an analyst modeling Adani shares, assuming you make future projections and double profits every 3 years (which is almost impossible), you still need to justify the current price. Will require 8-10 years.

While I personally believe that the timing of the Hindenburg news seems malicious, the important point is that stocks with such astronomical valuations will always be at the mercy of such triggers.

While Adani is the hottest topic for the week, let us talk about some BAAP (Buy At Any Price) stocks that came out with their results during the week.

I am talking about the shares of Pidilite and Asian Paints.

What is common between these two companies is that they both are market leaders and enjoy a strong brand presence in the market.

In fact, Pidilite’s product is synonymous with Fevicol Gum. Such is the brand bridge.

However, the problem again is that people do not differentiate between a good company and a good investment.

A good company is not necessarily a good investment.

Pidilite has a P/E ratio of 95 times with ROCE and ROE of 26% and 21% respectively in FY22.

Its 5-year average P/E ratio is 61x and the stock is currently trading at 2 standard deviations from its 10-year average.

If you look at the last 10 years performance of Pidilite, the company has grown profits at an average of 21% (decent in my opinion) from FY14-FY17, while the average net profit for the next 5 years (FY18-FY22 period) The growth rate was dismal at only 7%.

Why did the share price jump 10 times in 10 years?

The magic of re-rating the P/E multiple…

The PE multiple increased from 37x in FY14 to 95x in FY22.

This shows that the major price movement in the last 5 years has come from multiple re ratings and not from earnings growth.

And mind you, there has been no material ROCE or ROE expansion over the last 5 years.

While Adani and Pidilite are two extremes, the point I am trying to make is that valuation is king of the market.

For all those who believe in buying stocks with high valuations, let me explain 2 scenarios.

Scenario 1: Earnings grow rapidly (I’m talking about 25% CAGR over the next 5 years) which will alternatively bring down the P/E multiples.

Scenario 2: Earnings grow slowly and the stock prices correct as a result, leading to a P/E multiple D rating.

While scenario 1 is less threatening, tell me a company (besides HDFC Bank) which can grow its earnings at 25% CAGR for the long term?

Scenario 2 shows the danger…

Most companies with highly valued quality fall into that category and should be avoided in my opinion.

While the stock market was dominated by Pidilites and Asian Paints in the last decade, which reached astronomical valuations due to valuation multiple re ratings, the next decade will be very difficult for these players as earnings have really shot up for those 80- Have to catch 100x multiplier.

In my view, the actual delta would be created with the following combination:

Small cap or mid cap stock

-ROE and ROCE above 12-15%

– Expected Net Profit CAGR of 15-20% over the next 2-3 years

-Valuation multiples say P/E is less than 30x (depends on industry to industry)

It’s time to be smart don’t overpay and go Can do coffee.,

Disclaimer: This article is for information purposes only. This is not a stock recommendation and should not be treated as such.

This article is syndicated equitymaster.com