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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.

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About the Author

Vishal Khandelwal is the founder of Safal Niveshak. He works with small investors to help them become smart and independent in their stock market investing decisions. He is a SEBI registered Research Analyst. Connect with Vishal on Twitter.

Comments

  1. One should never use only one ratio like P/E ration to judge a company. Its always wise to use P/E ratio of entire market (Index) as a starting point for individual stock analysis. I have done an analysis on historical PE ratios of Indian market at
    https://essentialassociate.wordpress.com/2011/01/27/dont-try-to-cheat-the-pe-ratio/

  2. Vishal Khandelwal says:

    Thanks for your feedback, Dev. Yes, P/E is not the only tool to value stocks or judge a company. Other important metrics include free cash flows and dividend history.

  3. @Vishal Khandelwal
    We agree with you that apart from P/E ratio, it is important to look at other parameters like FCF and Dividends of the company under evaluation. But it also makes sense to check a few market indicators like Index P/E and B/V also to get a general idea about market sentiments. The problem with market sentiments is that it cannot be measured accurately and directly. There are a few options like A/D ratios but they may not be able to provide the real picture.
    Therefore, it is advisable for investors to stick to companies with high earnings visibilities (like blue chips) and invest decisively when there is a major correction in valuations of these blue chips.

  4. Vishal Khandelwal says:

    Hi Stable Investor,

    Yeah, you are right in your observation about checking the pulse of the overall market while making an investment decision.

    Regards,
    Vishal

  5. Thank you Vishal for highlighting this valuable filter while shortlisting a stock.
    Amongst many other filters, one must compare PE ratios for at least last 5 years. Market has this habit of altering valuation based on company’s changing financial position, industry outlook and Mr.Market’s overall mood. One should evaluate his own decision carefully before investing at higher PE ratios.
    Can you please share the source from which one can get historical PE ratios? NSE lists index’s PE ratio and not that for individual stocks.

    Regards
    Prateek

  6. Dear sir,
    From where can i get the historical p.e ratios?

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  1. […] the last 10 year stock prices and valuations (P/E) of these companies, a majority of them have been great wealth creators and among the most expensive stocks listed in […]

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