Nomura’s valuation model shows that Hindustan Unilever is overvalued in historical terms
Much of finance and investing today rely on information and forecasting. Investors, after all, are interested in what the market is likely to do well in the future, even though nothing is guaranteed, and a lot of finance firms feed this very need. Usually, forecasting has much to do whether a stock will do well or not. If prospects of the company seem good, the earnings will be revised upwards, from time to time, as more information is gathered. The same thing applies if the prospects are bleak, which will lead to downward revision. However, these revisions of forecasts are based on hindsight information which says nothing about the future. It is only a prediction, which can be true or false. Hence, investors must take all forecast reports with a pinch of salt.
By and large, most forecasted earnings revolve around price-earnings multiple and earnings per share, two of the key fundamental indicators used by analysts. Firstly, earnings is an indicator of profitability. Good news would mean higher earnings and vice versa. Secondly, the price-earnings (PE) denoted how much a stock is overvalued or undervalued. Even though this is a widely used indicator, it can be also a hugely misleading one. A higher PE does not necessarily mean overvalued or such. It can also mean the market is attaching a premium on a particular scrip for growth. Similarly, low PE does not mean cheap or undervalued. More often than not, the market is right and the PE is low, for a reason.
The Equity Research division of Nomura, a global investment bank, has come up with its latest fortnightly equity valuation monitor and has revised some of its NSE Nifty 50 stocks. It revised downwards Sesa Goa, Tata Steel, Bharat Petroleum and Maruti Suzuki, to name a few. At the same time, it revised upwards Mahindra & Mahindra (M&M), Gas Authority of India and Ranbaxy, to name a few. All these were done on the basis of earnings.
However, Nomura does not mention the reasons for downgrade/upgrade. It also came up with list of stocks based on PE valuation. On the valuation front, it says that Hindustan Unilever’s average 12 month PE is quoting at more than two times its standard deviation of its historical average indicating, perhaps, the stock has run its course. The company has been continuously delivering on all fronts and can be considered a long-term pick. Meanwhile, none of the stocks were found below two times historical forward 12 month PE. Stocks such as Ambuja Cement and ITC, Grasim had 12 month PE between one and two times standard deviation of its historical averages, indicating, perhaps, slightly over valued or good growth prospects. However, these are just indicators to give the investor an idea of the stock and not triggers to buy or sell stocks. Further homework needs to be done.
Revisiting the earnings revisions of the stocks, we are not surprised by the downgrade of Sesa Goa— a company owned by Vedanta Group—which has flouted environmental norms and come under heavy media scrutiny (for instance, do check this report we had written here: Vedanta’s Millions: Which political party benefited from it?). The report mentions Sterlite, a company which has been taken over by Sesa Goa but amalgamation has been put on hold pending court orders, which has fallen down by 7.4% and topped the list of laggards. Sterlite, has lagged Sensex over the last two years. These two companies — Sesa Goa and Sterlite Industries — should be avoided due to poor corporate governance record. Sterlite has now been removed from the Sensex.
Recent plant troubles in Maruti Suzuki’s Manesar plant obviously impacted future prospects of the company, with Nomura revising downwards earnings estimates by 3.8%. However, after the plant’s troubles were over the price gained by 13.8% over the last one month, showing that the worst is now over.
Tata Steel (earnings revised down by 5.3%) has been going through a difficult time as steel industry is in the doldrums and largely dependant on global economy. Moreover, it is a heavily fragmented industry. The bellwether, London-based Mittal Group had reported losses recently, which doesn’t bode well for the sector.
On the other hand, Ranbaxy has been revised upwards by 2.8%, though the reason remains unclear. News sources mention that the company has already missed out on the first day of the launch of its hypertension drug, Diovan, as it is yet to get approval of the regulators in the US. The irony is that the market has discounted the information and the report lists it as a laggard in terms of price performance (down 5.4%). Other pharmaceutical companies such as Sun Pharma and Cipla have been upgraded as well, but only by 0.9%, which is nothing.
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