I received a couple of emails from readers yesterday, asking about my views on Hindustan Unilever (HUL) after the parent Unilever announced an open offer to buy an additional 22.5% stake in the former.
Email 1: I have 300 HUL bought at Rs 400. Given the confidence the parent has shown in the Indian business, do I buy more?
Email 2: Given an MNC’s confidence in the Indian consumption story, does it makes sense to buy other FMCG companies as well, despite their high valuations?
First, a couple of disclaimers…
- I don’t write on specific stock actions (and may not do in the future), but this is an exception given the size of the action and because I have something to say here (it may be nonsense to you!).
- I own HUL’s shares.
Anyways, here are “my” views.
Email 1: Should you buy more of HUL?
Promoters raising stakes usually signals good prospects for the company and its investors.
And when promoters are willing to pay a huge premium to buy more stake, it’s great news.
What is more, Unilever is supposedly spending its entire free cash flow of last year to acquire the additional stake in HUL, which contributes only 7.5% of its sales and 11% of its profits.
This should make me, as an investor in HUL, very happy.
But should I buy more of HUL at almost the price Unilever is willing to pay?
Not really! It’s important to understand the concept of “opportunity cost” in investing.
Opportunity cost is basically the cost of an alternative that must be forgone in order to pursue a certain action. In other words, it signifies the benefits you could have received by taking an alternative action.
Importantly, opportunity costs differ for different investors. So, the opportunity cost for Unilever (cost of an alternative forgone by it when it invests in HUL) will be different than yours’ (cost of an alternative forgone by you).
Maybe, Unilever has no other alternative to use its cash than to buy stake in HUL at such a premium.
Your decision to buy more of HUL is dependent on whether you have another better opportunity to invest or not.
It also depends on how attractive you see the opportunity in HUL in isolation, not what you see through the eyes of Unilever.
When faced with such situations, always remember the three big lessons taught by Graham in The Intelligent Investor:
- Think of a stock as a part ownership of a business – Okay, HUL is a good business.
- The market is there to serve you, not instruct you – Should I buy more of the stock at Rs 600 just because the parent is buying at Rs 600? No! Please avoid anchoring bias.
- Always require a margin of safety – Is there sufficient margin of safety at Rs 600, when HUL’s P/E will be very high at around 35x? Doesn’t seem to me, but please do your own homework!
Simply put, in such situations – or in any situation while investing – go by the value of the business instead of the stock price.
So my answer to the first email is…
If you think that the current price – that reflects the premium that Unilever will be paying – is more than the value of HUL’s business, you should avoid buying the stock and instead (maybe) sell out irrespective of whatever anyone else (including Unilever) is saying or doing.
Email 2: Should you buy other FMCG stocks?
The answer here is simpler!
Here is what Howard Marks has to say on investing success…
Investment success doesn’t come from “buying good things,” but rather from “buying things well.”
What Marks effectively says is that “price” has to be the starting point for any investment decision making.
No stock (or any asset) is so good that it can’t become a bad investment if bought at too high a price.
So when someone says, “I only buy ABC kind of stocks” or “ABC is a superior stock,” that sounds a lot like “I would buy ABC at any price.”
This kind of thinking is dangerous!
No stock has the birthright of a high return. It’s only attractive if it’s priced right.
So, does it makes sense to buy other FMCG companies as well (like people were buying yesterday after the Unilever announcement), despite their high valuations?
As Marks would tell you…
Investing is a popularity contest, and the most dangerous thing is to buy something at the peak of its popularity. At that point, all favorable facts and opinions are already factored into its price, and no new buyers are left to emerge.
The safest and most potentially profitable thing is to buy something when no one likes it. Given time, its popularity, and thus its price, can only go one way: up.
What do you say?