The Indian middle class is on the cusp of a fantastic change. The economy is growing by leaps and bound and so is the per-capita income. With all this money in our hands, we are and will continue to buy fridges, TVs, pressure cookers and all other comforts of life.

The white good companies have not even scratched the surface ! We have one of the lowest penetration for all these white goods and consumer goods in the world. It is silly not to believe in a glorious future. Companies like Hawkins, nestle, marico and all other FMCG and consumer companies deserve even higher valuation, because they will all grow at phenomenal rates.

In contrast, the infrastructure companies deserve the kind of lousy valuations we are seeing in the market now. Power companies, power equipment producers and all kind of companies engaged in building the infrastructure deserve the sub par valuation because the environment is  hostile. The government will never fix the policy issues and we will continue to have poor quality roads, blackouts and lack of other amenties.

If the market and a lot of investors are correct, I can visualize a scene where I will be sitting in my house without power, gas and connecting roads but with the best plasma TV and all kinds of soaps, detergents and packaged goods.

 I think I need to figure out a way to run my 100 inch TV without power and use my fancy shampoo without water J

Is it not obvious that this scenario is not consistent?  If consumer goods are to grow, then the rest of the economy has to grow and hence the valuations of all kinds of infrastructure  related companies have to be higher. If the power, water and infra companies are doomed, do you think any of the other consumer companies will do well ?

A personal story

I hear this logic often – India has 50 Cr middle class. The global average is around X per million of population. In india, even if we double the consumption levels from here, we are looking at a huge opportunity. In view of this logic , the consumer companies deserve a higher valuation

Where have we heard this logic before?  Remember the dotcoms  and IT stocks in 2000, infrastructure and real estate in 2007-2008?

Let me give a personal story.  I used to work in the consumer goods industry in the 90s in sales.  Among the many products, we used to sell soaps . The logic would go like this – A family of 4 can use around 2-3 soaps per month. In a town of 100000, there should be a consumption of around 2-3 lacs per month. We currently sell around 10000 bars per month. So even if I can increase the penetration levels by 1%, we can easily double the volumes.

The above argument is very plausible and so easy to follow.  Except reality does not work that way.

An armchair investor like me sitting comfortably in a chair at home and sipping masala chai can come up nice projections on a spreadsheet and justify any price for the stock. But if you have worked in sales, let me tell you that it takes a lot of effort and time to grow sales. The reasons can be varied – such as poor ROI at the micro level due to which production penetration cannot be increased, or high competition – but the end result is that growth is not an easy linear process.

Company specific growth depends on a lot of factors beyond the basic macro opportunity and it is rarely a simple, linear process. If you make simplistic assumptions and pay top valuations for it, then the experience can be bad if those expectations do not materialize.

I have been investing in consumer good companies for some time now and my preference is to look for companies which can tap into a large macro opportunity and have the management capability to do so. At the same time, I don’t want to pay too much for it. Although’ too much’ is a subjective term and any number would be arbitrary, I would rarely pay more than 15-18 times earnings

Survivorship bias

The worst counter argument against the above logic is to give an example of a titan or a nestle. For every titan or such high valuation company which subsequently did well, I can give 2 examples of companies with high valuations which disappointed investors as the business reality did not match  the expectations.

One should pay for quality, but not take the logic too far.  Even if it is arbitrary and one risks missing some good companies, I would still prefer to have some cutoff to avoid buying an over priced stock which disappoints me in the future.

One Comment

  1. […] from Rohit Chauhan’s “Intelligent investing”, an absurdist scene in near-future India: If the market and a lot of investors are correct, I can visualize a scene where I will be sitting […]

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