When I was looking to acquire the first client for my writing business in 2011, I had no idea how much to charge. I had no point of reference as far as content writing fee was concerned. For me, there were a few hours of work involved.
Anyways, to my first prospective client, I dared to ask for a hefty sum of Rs 2,500 per article, simply going by the understanding that you charge not for how much work it is for you, but how much the service is worth for the client.
It took me several clients to figure this out. My next client, I tried charging Rs 3,000 per article. He went for it. The next client Rs 3,500. The next client Rs 4,000. I kept charging more and more until finally three clients all turned down my Rs 5,000 fee. So I lowered the price back to Rs 4,000.
Essentially, at Rs 5,000, my prospective clients were telling me, “Your services are overpriced, and not worth it!”
That left me with a very valuable lesson in how to run a business. You cannot keep raising your prices indefinitely. How much ever you want to believe that a company has pricing power, it cannot raise its prices indefinitely because there would come a point where its customers would say, “It’s overpriced, and thus not worth it!” And then, there would emerge competitors who would be willing to offer similar products/services at lower prices.
It’s Not Worth It!
We create boundaries for what something is worth.
A glass of mango juice on the streets of Mumbai costs Rs 100, and it’s considered reasonably priced. The same juice in Agra would be seen as expensive at Rs 50. And the same juice in New York would be seen as bargain at Rs 300.
Clearly, we’re neither discussing the ability to pay nor are we considering the absolute value of a glass of juice.
No, it’s about our expectation of what people like us pay for something like that.
Consider stocks. Apple Inc., currently trading at around 15x P/E on the Nasdaq may not be a stock picker’s delight in the US. But a similar quality business at 15x trading in India would be gobbled up, simply because the stock is not overpriced relative to the broader markets and what similar other stocks are trading at (the relative valuation concept). And then, 15x is what people like us would be very happy to pay for a business like Apple.
What’s ‘Overpriced’?
When you say a stock is ‘overpriced’, you’re actually saying, “It’s not worth it!”
Lots of things aren’t worth it, at least to you. Like, maybe, a watch priced at Rs 1 lac, a family holiday that costs Rs 2 lac, a car that costs Rs 10 lac, or maybe a subscription to my Value Investing Almanack, priced at Rs 9,999. 😉
In the same way, lots of stocks aren’t worth it, at least to you, right now –
- Stocks that are already up – to say 40-50x P/E – appear to be overpriced.
- Stocks that are always going up always appear to be overpriced.
- Stocks you missed at 10-15x P/E, and which are now at 20-25x appear to be overpriced.
Consider these overpriced stocks (at least that’s what the P/E suggests), most of which are amongst the well-managed businesses in India –
Data Source: Screener.in
From this list, I’ve been looking to buy stocks like Asian Paints, Page, Eicher, and Marico for years now. But they always look overpriced!
The harsh, but honest, truth about investing is that good businesses almost always seem overpriced when you want to buy them. Or maybe, you want to buy good businesses only after they have risen to become overpriced.
You did not buy, say, Pidilite when it was selling for a tenth of its current price, and when not many people like you were willing to buy it. Of course, if everyone saw what was about to happen to Pidilite’s stock, it wouldn’t have been for sale at the price being offered.
And you could have bought the stock of, say, Ashiana Housing, for just Rs 30 in June 2011 (Rs 225 currently). But back then, no one thought the company had a chance…which is precisely why the stock was so cheap (not only in terms of P, but also P/E).
The Big Challenge
As an investor, you don’t only spend cash on your investments. You also spend your effort, focus, and your commitment, which come before you spend cash on them. And the good investments always seem like they take too much of your effort, focus, commitment, and money…until later, when you realize what a bargain that effort would have been (hindsight bias).
So, the real challenge today for you and me isn’t in finding an overlooked obvious bargain that people didn’t notice. First, such bargains rarely exist in reality (mostly in hindsight). And if they do, they’re not as obvious as you may expect them to be (again in hindsight).
The real challenge for you and me is in learning to tell the difference between the stocks that feel overpriced and the ones that actually are.
The insight is that when dealing with stock valuations and future, there’s no right answer, no obvious choice.
Every good thing looks overpriced. Until it’s not.
From the list, few are certainly overvalued. How do I reach the conclusion?
I checked FCF for high growth period 10 years for Astral Poly & Page Industries (due to potential market) and 5 years for Eicher Motors (Limited market, if increased beyond a certain mkt share, it will lose its sheen & exclusivity). One should always cross check PE multiple with DCF to give you glimpse of fair PE multiple based on competitive advantage and growth. Symphony looks overpriced if looked only based on the available data of its market. I do not deny Air coolers have huge market but the numbers available based on its presence in select countries and their respective market potential, it looks overvalued. If the company acquires companies or sets up plants in new countries it will certainly increase its earnings potential. Same is applicable for Marico & Info Edge.
For companies like Britannia & P&G Hygiene, the launch of new products and their potential market will define the valuation. Both are not planning any substantial product launches which limit their growth to existing products like high commoditized biscuits/dairy & branded sanitary napkins/Vicks respectively. Pidilite & Shree Cement have economies of scale which helps them retain their market share. However, they do not have significant pricing power to increase their ROCE substantially.
Isn’t is about having margin of safety, when buying a business. As we can see in the above list all of the business are growing at higher rate than market and they may continue that in future, but what if they are not able to due to some reason like Hawkins….So to say its better to look for the businesses were we have good fundamentals in place and the chunk of investors are ignoring it.
Ultimately looking for mis-pricing.
True Abhishek. Thanks!
Thanks Ketan! The list I showed was just for representative purposes and not necessarily to showcase any view that these are expensive stocks. Thanks anyways for sharing your thoughts. Regards.
Is there any thumbrule to define whats paying up for quality and what is overvalued?
If you go by typical warren buffett theme of margin of safety for not paying up for growth, its very rare or almost imaginary for all these companies. In such cases, how one should determine the thin line between paying up for quality or over-paying?
Thanks, Mohit
Dear Mohit, please check my response to Mihir below. Regards.
I would say there is no such thing as over priced, its a mental perception. If you think the earnings power of something with a moat is going to grow you over pay in advance that causes high P/E like in the case of Royal Enfield doing well even in the next few decades! Next case is the ever green model of Relaxo that has nothing to do except make cheap chappal, which it best knows hot to do using Salman Khans model. hahaha. I guess the bubble part is in Info Edge and Symphony, they are after all choices one has to make and dont demand or command irrational P/E’s like the other biggies in that list. Others are all either cash cows or bluechips.
Hi Arvind, hope you are just not looking at Naukri as they have other gems with great value (atleast at present) like Zomato.
Thanks Aravind!
In my view PE is overhyped tool of valuation. more so on fast growing quality businesses. it doesn’t portray anything other than CURRENT earnings and current price. it doesn’t depict (directly) any of the business characteristics like high roe, high sales, profits growth, excellent balance sheet, good dividend payout ratio, management quality
there is a HUGE difference between 30-35% CAGR versus 18-20% , the market assigns disproportiantely high PE since there are very businesses that are growing at 30-35% CAGR with good visibility. that’s why stocks like Page will always command higher PE. the key is to find such companies growing at 20-25 and are having chances to grow higher without dilution. like Page at 40-50 PE couple of years back. one way to look at PE is not TTM, but in next 2 years. if you project future PE in 2 years you wont feel its high. however the key is to ascertain growth will remain.
so better to spend time on ascertaining whether these businesses can maintain the same growth in next few years instead of always looking at PE. the time to get out of such businesses is when growth slows down. not when PE corrects
Thanks Bala! Regards.
You have explained it well in your article ( with example of Agra , Mumbai & New York ) .
The price to value conversion is made up of two component 1) absolute product quality and 2) Customer Segment Targeted . These two components together converts absolute price & product combo in to perceived value .
A stock @ a price looks over priced to seller and value deal to a purchaser as they are two separate segments of markets , having different views of value equation .
Often Value investors are frog in a well ( loners i) and they don’t like to interact with people who buys at crazy PE valuation . That is where we as value investors make a mistake , for he is customer of our stocks when we sell and basic gyan in marketing tells us Know & Love thy customer
So invert your question , why people still buy @ crazy valuation . You may find answers if stock is really over priced or not ??
Thanks for sharing your thought, Shailesh!
“The real challenge for you and me is in learning to tell the difference between the stocks that feel overpriced and the ones that actually are.”
Vishal, how to learn this?
Deepak, I wish I had an answer here. Though, please look at what I’ve replied to Mihir’s comment.
Actually, the screen is still backward looking. I would say, can the business compound from here to justify the multiple should be key decision making factor. Paying up vs overpaying can always be a thin- line difference. Linear extrapolation of past earning leads to belief that the compounding can continue and the multiple can remain high. Businesses which fail to deliver such high PAT CAGR because of maturing market or increased competition or change in business dynamics suddenly find it difficult to hold the valuations and see non linear fall. I believe similar screen @ Dec 2007 levels would have thrown interesting names.
Few thoughts on stocks
1)Will Berger be a better bet then Asian Paint considering the similar product portfolio and already very high market share of Asian Paint?
2)Eicher Motor- Will consumers continue to love RE forever? on the product life cycle which stage we are on?
3)Britannia- Premiumisation of biscuits have seen overall margin expansion. With renewed focus on health can it not go ITC way..High sugar packaged food (a la Nestle)
4)Symphony- So far enjoyed almost monopoly in branded cooler segment. Already Voltas has announced its foray in the segment… will margins crumble? or will growth slow?
All these thoughts are just some issues to ponder, not a I am sure that a lot of these names would continue to do well but need to exercise caution where there is low margin of safety is necessary.
Unfortunately, whenever a bubble is inflating, it all looks good. I remember 1999-2000 rally of IT stocks. It took 15 years for Nasdaq to regain those levels.
Anyway, it still an objective understanding of earning compounding prospect which should lead to prudent decision making here!
Thanks Jitendra for sharing your thoughts here!
Yes, “margin of safety” and “prudent decision making” are the keywords here.
Dear Vishal
You have handled a complicated subject elegantly and left me more confused! On the one hand overpriced seems a relative term, and on the other there is a fine line, an insight ,between perceived and actual overpricing. Something like price is what you pay and value is what you get. On a lighter note- I am not selling Asian Paints, Eicher, Marico and Pidilite, even if they do a Maggie on them!! As for Page, I lost that page a long time ago and its a closed chapter!!
Thanks RKC! Let me take a page from your experience. 🙂
Vishalbhai,
I completely agree with your point that “The real challenge for you and me is in learning to tell the difference between the stocks that feel overpriced and the ones that actually are.”
Now, the thing is, How to do it?
Always there are chances of loosing out on this front.
How to solve this problem?
Hi Mihir, one way I have been doing this off late is to think in terms of exit multiples, as Prof. Bakshi suggested. I combine this with a reverse DCF using broad assumptions. These ways, I believe, can get you better results than trying to estimate how much P/E is too much. Regards.
Hi Vishal,
I was a student of Prof. Bakshi. I have been following your posts for a while now and they are always full of wisdom. Thank you sharing your thoughts, please keep doing so.
I tried to answer your question of this post on what is Overpriced and wrote a post on it.
I hope you read it and share your thoughts.
Best Regards,
Shreyans
Thanks Shreyans! Will check your post.