India’s Greatest Companies: But Should You Buy Them?

You know what’s the most asked question in India?

It is – “What’s the score?”

And the second most?

How about – “How much did the Sensex close at?”

If you live in the financial capital of Mumbai, every business paper you read, every business channel you see, most people you meet in the local train…you will always get to hear someone uttering the ‘Sensex’ word.

There is no doubt that India’s benchmark stock market index (that’s what the Sensex is) can claim to have the largest mindshare among people who invest in stocks, or who are at least interested in reading about stocks.

However, the irony is that many people (including investors) don’t realize that the Sensex is not the ‘Indian stock market’ but a collection of India’s largest 30 stocks by market capitalization. Yes, just 30 stocks from around 7,000 stocks listed on the Bombay Stock Exchange (BSE).

But these 30 stocks together form almost 47% of the BSE’s total market capitalization of around Rs 6,240,000 crore.

These are big, important companies (also known as blue-chips) that, taken together, are integral to our economy and will be for years to come.

And for this very reason – they are among the most expensive stocks in India.

Why?

The reason is simple – as I said above, these are big companies and are trusted to perform well even when a majority of mid and small size companies are falling apart in times of economic turmoil.

That’s why investors are willing to pay higher prices for these stocks, sometime so high that the prices don’t justify all the positives that the stocks carry.

Anyways, here is the list of all 30 Sensex stocks as arranged by their respective P/E ratios – from highest P/E to lowest P/E.

Last 5 years’ P/E of Sensex companies

Data Source: Ace Equity, Safal Niveshak Research
If you understand the P/E ratio, it is simply calculated as ‘stock price’ divided by a company’s ‘last 4-quarter’s earnings’ (or 1 year of earnings).

So, often, when you hear someone telling you that the stock has a P/E of 30 times, it means that the stock price is 30 times the company’s last 1 year’s earnings (or profits).

However, what I’ve done here is that instead of looking at just the last 1 year’s earning, I’ve divided the stock price by the average of last 5 years’ earnings.

Why so?

This is because the average of last 5 years’ earnings gives a better picture of the valuations. The last 5 years have seen one complete business cycle – 2 good years of earnings growth for companies, then 2 bad years, and then 1 average year.

So the average of these 5 years is a better indicator of earnings than just last 1 year.

What is more, if a stock is cheap or expensive based on last 5 years’ average earnings, then it is ‘really’ cheap or expensive.

See the stocks that occupy the top 10 list. These are the most expensive stocks from the Sensex.

Since these are great companies with strong brand names, and have a long track record of good performance, investors are paying for them P/E ratios as high as 30-40 times last 5 years’ average earnings.

Great companies, so buy?
Of course, not! Most of the expensive stocks in the list above are great companies with brilliant track record of performance. However that does not automatically mean that you buy their stocks at any asking price.

This is what Warren Buffett told shareholders in his company Berkshire Hathaway’s 1998 Annual Meeting…

“Investors making purchases in an overheated market need to recognize that it may often take an extended period for the value of even an outstanding company to catch up with the price they paid.”

While the stock markets aren’t overheated as of now, the fact remains that even an outstanding company does not justify that you pay a very high price for it.

How much P/E is too much?
Well, it depends from company to company. Generally, P/E ratios of 12 to 20 times are considered normal across companies with neutral to positive outlooks.

Legendary investment guru Benjamin Graham said that a P/E of 20 times is the maximum one should pay for the stock of a good quality business.

Of course, some of these above stocks have never come below a P/E of 20 times over the past many years, but then this is no reason you must invest in them at any price.

You can only make money from the stock markets when you buy and hold great businesses at cheap (or reasonable) prices. Doing anything else, like…

• Buying great businesses at great/expensive prices
• Buying poor businesses at cheap prices
• Buying poor businesses at expensive prices

…is the way to losses, frustration, and sleepless nights.