indian fmcg, and the fang

Here's an article published today, which says that Dabur's market valuation is absurd, and is not supported by earnings growth.

The author has singled out FMCG stocks for their crazier valuations. He also makes some fancy statements like the gap between their valuations and earnings growth is like earth and sky. There are two problems that I see with his remarks. 

One, you don't see only FMCG stocks priced weirdly. There are a whole lot of other sectors where we find gap between price and value; I mean where price is too much compared to their value. Does he think for instance, Dmart cheap just because it has and is expected generate higher growth rate? Of course it is a well run, profitable retail business; but that does not mean we should buy its stock at whatever prices marked by the markets. How about Eicher Motors? or does he consider Kotak Bank a value buy looking at its price to book? What are his thoughts on the NBFCs, or Airlines, or Telecom?

Then there is the second problem which is with his timing of the post. Does he think Dabur stock is expensive now? Its price was high compared to value in 2017 as well. In fact, a bunch of Nifty stocks was expensive back then. Tell us something new; or at least don't single out. We would have appreciated if the post was of expensive valuations in general. 

It is not about earnings growth only as the author emphasizes. It is always about the price of a stock compared to its intrinsic value. And the value is driven by its cash flows, not earnings. Yeah, earnings help generate cash flows; but they are not the same. Value also depends upon the expected rate of return, which again is influenced by the prevailing interest rates. 

The article also makes a statement: that the Indian FMCG valuations are crazier than that of FANG stocks. How profound is that. The author fails to recognize that value is driven by the prevailing interest rates. And the interest rates are influenced by the inflation rates. Other things being equal, the higher the inflation rates, the higher the growth rate.

Of course the FANG stocks cater to the world markets. But if you look at their annual reports, you know their growth rates; and also know how some of them are not yet that profitable. Here's their story. 

Facebook has been a heck of a story. Look at how the market valuations have progressed over the years. It is priced at 25 times earnings. I haven't had a chance to look at its latest financial statements. It's been some time since I noted my thoughts on Facebook. 

Then you have Amazon. A terrific business, but a terrible investment on value terms. In my view this has always been the case. 

Although Netflix has done well to its shareholders, it is not like other FANGs. It is yet to generate substantial free cash flows. I am not sure if its business model is as strong as Amazon's is.

There is no question that Google has performed well on both operating and market fronts. Value of these FANG stocks depends upon their ability to generate free cash flows on a consistent basis. And this depends upon their revenue growth, operating margins, and reinvestment requirements. Because they are technology stocks, we need to do some adjustments to their reported earnings. One big adjustment is how accounting rules treat research and development costs, and how they should actually be treated. Then you have operating leases and advertising costs. While R&D and advertising costs are like investments for future, operating leases are like debt.

Based upon reported numbers, Facebook trades at 25 times, Amazon at 250 times, Netflix at 187 times, and Alphabet at 27 times earnings.

The author of the article appears to be supportive of PP Long Term Equity Fund. I don't have anything against the fund, and it is left to their managers to manage the fund based upon their philosophies.

I think the fund started buying Alphabet from May 2014 onwards steadily increasing to 16,593 shares as of June 2016. They sold 1,500 (not sure why) shares in July 2016, and the remaining shares are in the fund as of March 2018. It bought its first Facebook stock in July 2017, and has consistently increased the holding to 42,580 shares as of March 2018. In addition to these stocks, the fund has also invested in 3M, IBM, Nestle, and Suzuki stocks. Now, it is a bit surprising to me that the fund finds stocks in the US market to be value accretive compared to the stocks in India.

Facebook isn't a 25% growth stock, and Alphabet isn't a 20% growth stock. In addition, both the firms are quite large: Facebook is priced at $500 b, and Alphabet is a $725 b company. Both are technology companies, where the road ahead to growth is difficult to predict. If Facebook and Alphabet it is, then why not Amazon? The fund hasn't bought Amazon as yet. It did buy Apple, first in May 2016, and then sold all of 12,550 shares it owned in October 2017. To each, his or her own. Remember now Warren Buffett has the second largest holding in the Apple stock.

I am not sure if the fund activities are long term oriented as far as foreign stocks are concerned. It would have been much better if it had created a separate fund called say, US markets fund and made that its investment philosophy. Buyers of the US stocks would go there. The existing fund then would be the long term equity fund focused on only Indian stocks. That way investors would be much clear about its objectives.

Here's the thing: The Indian stocks will aways have higher growth rates compared to the US stocks even when we know that certain of their companies are global. Then it comes to comparing the prevailing prices to their values for each of the individual stocks. There are bargains in both the markets; but, more in the Indian markets simply because it is a growing market.

While the fund may have its good intent, the author of the article appears to be a bit biased, as he is towards other companies too. This isn't a complaint, for all of us are biased in some way or the other. For instance, his dislike for Reliance Industries is well known despite the fact that Reliance has been the most valuable firm in India for long. It throws out a lot of free cash flows from its core petrochemical and refining businesses. Just that its reinvestment has been much higher what with retail and telecom ventures. Here's another question: is Reliance expensive too compared to its earnings growth? What about Hero Motors, or Maruti? Want any more names?

Of course stocks are expensive now compared to their value; but that is not limited to Dabur, or FMCG. A careful unbiased analysis will tell us where we stand today. There are always certain stocks available at prices that we want; for that we need to stop listening to others, and have faith in our own analysis.