In the days when stock prices have crashed like pack of cards, experts cite lower valuations, often lower price to earning multiple (P/E) as a reason to buy the stocks.
Buying a stock at low P/E can yield high returns, but in many cases it is observed that when a stock is trading at very low valuation, its next quarter profits fall bringing down the earnings and inflating the P/E multiple. This happens particularly in the case of cyclical industries, such as auto, paper, sugar, metals and cement.
ETIG analysed the profits and market capitalisation of companies in these industries in FY01 & FY02, the last time when Indian economy witnessed a slowdown. We saw that with every passing quarter, the net profit of companies was falling making mockery of the low P/E logic.
For instance, Ashok Leyland’s stock was trading at a P/E of 6.7 times in September 2001. When the results of the December 2001 quarter were released, it turned out that the bottom line had shrunk by Rs 5 crore as against the September 2001 quarter. Obviously, the investor, who had bought the stock in September 2001 looking at low valuations, would not have been pleased with the performance in the next quarter. There were similar instance in that period with companies, such as ACC, Hindalco Industries, Tamil Nadu Newsprint & Papers (TNPL) and many others.
While, P/E might give wrong signals to investors, we think one should consider other criteria, such as dividend yield, consistency in dividend payments, EV/EBITDA (enterprise value divided by earnings before interest, tax, depreciation & amortisation) to separate wheat from chaff. Most cement companies have consistently paid dividends in the last seven financial years. Madras Cements seems to be the best bet in the cement industry, as it is trading at a dividend yield of 5.1%, the highest among the top cement stocks.
Moreover, the dividend paid out by the company grew at a compounded annual growth rate (CAGR) of 28% from FY00-FY 08. Only ACC and Shree Cements have better record in terms of dividend growth, but the current yield of these stocks is lesser than Madras Cements. At an EV/EBITDA of 4.4 times, the stock of Madras Cement is cheaper than ACC, Grasim Industries and Ambuja Cements.
Unlike cement companies, sugar companies have not exhibited any consistency in the dividend payments. In many cases, these companies have recorded losses making it extremely difficult to pay dividends. Clearly, sugar stocks cannot be considered as value picks. And, it makes more sense for the investor to invest in these stocks, only when he expects capital appreciation and no dividends. While, sugar companies do not pay dividends consistently, steel and metal companies have very low dividend yield.
The situation is even worse for companies in the commercial vehicle manufacturing industry, such as Ashok Leyland and Tata Motors. Tata Motors, in its last downturn, incurred losses consecutively in two financial years 2001 & 2002 and could not pay dividends. Though, Ashok Leyland did not register a decline in profits in the current decade up to the end of FY08, the situation has completely reversed as it has seen massive fall in profits in FY09, which might affect the dividends.
All three paper companies in our sample, such as JK Paper, TNPL, West Coast Paper Mills, are trading at high dividend yield of 11.8%, 7.3% and 7.4%, respectively. Like cement companies, these players too regularly pay dividends. Not only that, JK Paper and West Coast Paper Mills have increased the dividends at a CAGR of approx 20% in the peiod FY00-FY 08. Paper stocks trade at 3-4 times EV/EBITDA, which does not make them expensive by any stretch of imagination. Combined all these factors, paper stocks clearly deserve to be considered as value picks.
In times, such as these, investors are advised to consider all these parameters and only then venture into the stocks market.
Buying a stock at low P/E can yield high returns, but in many cases it is observed that when a stock is trading at very low valuation, its next quarter profits fall bringing down the earnings and inflating the P/E multiple. This happens particularly in the case of cyclical industries, such as auto, paper, sugar, metals and cement.
ETIG analysed the profits and market capitalisation of companies in these industries in FY01 & FY02, the last time when Indian economy witnessed a slowdown. We saw that with every passing quarter, the net profit of companies was falling making mockery of the low P/E logic.
For instance, Ashok Leyland’s stock was trading at a P/E of 6.7 times in September 2001. When the results of the December 2001 quarter were released, it turned out that the bottom line had shrunk by Rs 5 crore as against the September 2001 quarter. Obviously, the investor, who had bought the stock in September 2001 looking at low valuations, would not have been pleased with the performance in the next quarter. There were similar instance in that period with companies, such as ACC, Hindalco Industries, Tamil Nadu Newsprint & Papers (TNPL) and many others.
While, P/E might give wrong signals to investors, we think one should consider other criteria, such as dividend yield, consistency in dividend payments, EV/EBITDA (enterprise value divided by earnings before interest, tax, depreciation & amortisation) to separate wheat from chaff. Most cement companies have consistently paid dividends in the last seven financial years. Madras Cements seems to be the best bet in the cement industry, as it is trading at a dividend yield of 5.1%, the highest among the top cement stocks.
Moreover, the dividend paid out by the company grew at a compounded annual growth rate (CAGR) of 28% from FY00-FY 08. Only ACC and Shree Cements have better record in terms of dividend growth, but the current yield of these stocks is lesser than Madras Cements. At an EV/EBITDA of 4.4 times, the stock of Madras Cement is cheaper than ACC, Grasim Industries and Ambuja Cements.
Unlike cement companies, sugar companies have not exhibited any consistency in the dividend payments. In many cases, these companies have recorded losses making it extremely difficult to pay dividends. Clearly, sugar stocks cannot be considered as value picks. And, it makes more sense for the investor to invest in these stocks, only when he expects capital appreciation and no dividends. While, sugar companies do not pay dividends consistently, steel and metal companies have very low dividend yield.
The situation is even worse for companies in the commercial vehicle manufacturing industry, such as Ashok Leyland and Tata Motors. Tata Motors, in its last downturn, incurred losses consecutively in two financial years 2001 & 2002 and could not pay dividends. Though, Ashok Leyland did not register a decline in profits in the current decade up to the end of FY08, the situation has completely reversed as it has seen massive fall in profits in FY09, which might affect the dividends.
All three paper companies in our sample, such as JK Paper, TNPL, West Coast Paper Mills, are trading at high dividend yield of 11.8%, 7.3% and 7.4%, respectively. Like cement companies, these players too regularly pay dividends. Not only that, JK Paper and West Coast Paper Mills have increased the dividends at a CAGR of approx 20% in the peiod FY00-FY 08. Paper stocks trade at 3-4 times EV/EBITDA, which does not make them expensive by any stretch of imagination. Combined all these factors, paper stocks clearly deserve to be considered as value picks.
In times, such as these, investors are advised to consider all these parameters and only then venture into the stocks market.
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