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Commentary, Opinion

Prashant Jain: We’re Going Cheap

HDFC’s Prashant Jain says It is always darkest before dawn:

Within it he sports this chart:

Prashant Jain Letter

Prashant Jain is a well respected fund manager, and has done a great job managing money.Some of the above is hyperbole – even BEFORE the general elections and BJP’s rout, in April 2004, the market had a 13 fwd P/E (and yes, returns have been good).

Secondly the Jun 06 trade is JUST WRONG. The collapse of the US Housing Market was in 2007, not 2006. What happened in June 2006? The market was 30% down, after a reaction to increased margins on the NSE, some conveniently placed statements by the then Finance Minister about taxing capital gains, and the general lack of liquidity after people had piled on to the RPL issue.

(Ok, I’ll also show off: I wrote after the RPL issue that it was time to slow down – and to get out of the market then. But I didn’t tell you to buy after the carnage, so that makes me half a good guy. I guess.)

Thirdly, what was Mr. Jain’s fund house – HDFC Mutual Fund – saying at the time? On May 2, 2006, Jain said, in the monthly newsletter that:

    • Two years of growth is now priced in
    • Sensex at this time (12042) according to that newsletter was around 19 times 1-year forward earnings. That means 1 year forward earnings in April 2006 = 635.
    • In two months – Jun 2006, how come (from the above table) 1 year fwd earnings became 715? (Calc:  9296 sensex level divided by the 13 number above=715).
    • Somehow in a month or two, when the indexes absolutely tanked (fell 30%), the sensex forward earnings somehow went up 15%.
    • According to my calculations, Sensex forward P/E even then was around 15.

So yeah, nice to hear and all that but ground situations are always different. We all learn, and I’m sure Prashant has learnt too, and I don’t grudge him his statements one little bit. We all get carried away and thank goodness there is no license required.

Also, note that events are convenient, and the values also. Forward P/E is supposed to be 13, which implies a Sensex EPS of 1300. It’s at 1050 today. Will we see 25% earnings growth across Sensex companies? When interest rates are going up and inflation continues to eat away at manufacturing margins? (My answer: no.)

I’ve been saying this for the last three years – that we will not grow earnings 25% – and we have not. Yet, we hit a new high last year; that high came entirely from P/E expansion, not earnings. So yeah, if you want to bet on another round of P/E expansion, now is a good time.

Jain mentions that a falling crude price will help us. Unfortunately it hasn’t in the recent fall – Brent, which is a big part of what we buy, is above $100. The big oil companies, having taken losses on retail fuels when oil was high, aren’t quite willing to reduce prices easily. With easy money now flowing from Europe (probably trillions, if Italy and Spain are rescued) and Japan (more than $600 billion), I don’t expect crude to stay too low for too long. The one factor that can change things is that the rupee can fall, and help us immensely, but it doesn’t look like anyone has the stomach for that. But to bet on India right now, according to me, involves an implicit bet on the rupee rising.

  • Sanjay says:

    Thanks for such a eye opener. Never believed that people like Prashant Jain tells lies as well. It was okay to take time period as one’s convenience. But to distort the fact is not good.
    I was always knowning that stock market analysis contains half truth. But you have pointed out rightly that it contains elements of false statements as well.

  • The 1st law of business says that buy cheap and sell at higher levels.
    the same law applies to stock markets but sadly very few people are able to invest when the valuations are low

  • Ramanand says:

    Valuations will go still lower in the next 3-6 months. The interest rate increase cycle is not yet complete. Till we peak out on the interest rate increases by RBI, there is a significant risk in entering the markets no matter how low the valuations look. Markets should bottom out over the next 6 months (there is likely to be gloom and doom in the markets) and you will absolutely hate to look at your existing portfolio cuz its all red. That’s when you need to get in. Invest at maximum pain!

  • Pajat says:

    “Forward P/E is supposed to be 13, which implies a Sensex EPS of 1300. It’s at 1050 today. Will we see 25% earnings growth across Sensex companies? When interest rates are going up and inflation continues to eat away at manufacturing margins? (My answer: no.)”
    By 1-yr forward PE, Prashant is saying expected FY13 EPS as 1300, not FY12. That’s a trick. So, he is not suggesting 25% earnings growth as you have assumed. He is only assuming a relatively modest 11.25% CAGR between FY11-FY13, assuming FY11 EPS is 1050.
    When August/September arrives, these people assume that the forward year is 1.5 years away….and the start talking about that. Its BS, but that’s how they think or conveniently lie to us.
    **********
    However, I agree with you that its BS to say that 2006 crash was due to housing crisis in US.

    • Hey thanks Pajat – I didn’t know they take FY13 EPS. Wish they’d clarify.

      • Pajat says:

        Yes they do talk about Fy13. In case of Reliance-MF document, at page-5, they explicitly mention Fy13.
        They assume FY11 EPS at 1060. Then, at 16% CAGR, they assume FY13 EPS at ~1426. Consequently, they arrive at 16*1426 = ~22852 as SENSEX target by April-2012, assuming a forward-PE of 16.
        I don’t know whey they use forward EPS, rather than trailing twelve months EPS.

  • Pajat says:

    Another similar BS, this time from Sunil Singhania of Reliance MF:
    http://reliancemutual.com/UPLOAD/ARTICLEATTACHMENTS/RMF-%20Equity%20Market%20Update%20Aug%202011%20Final.pdf
    Another document, same BS.
    **********
    In my personal opinion, I agree with the conclusions of both Sunil/Prasanth that its a good time to invest now. But I don’t agree with some of their arguments, only half.
    ##########
    “Whenever, you ask a barber when is a good time for a haircut, he will always reply “Now!”.
    “Whenever, you ask a Fundmanager when is a good time to invest , he will always reply “Now!”.

  • Pajat says:

    When I checked the document date of both the PDFs, Sunil has a timestamp of 09-Aug-2011, while Prashant has 10-Aug-2011.
    So, Sunil probably got first in this prediction and Prashant followed (copied??) him with his own set of arguments.

  • rrp says:

    – Cool. I saw this and knew that the dates/numbers are conveniently choosen.
    – Forward P/E is a favorite technique. If you cant justify with current P/E, justify with forward P/E
    – No doubt this article is because the mgmt says to PJ “We want you to write something/anything to soothe investors, so they wont start panic/redeeming”. We will take care of marketing the article. Poor guy has to listen.
    – Now, will moneycontrol or any site receiving Ads from HDFC MF publish *your* this post . No way … 🙂
    – Only good thing is investors may not panic/stop their SIPs reading his post and that is a good thing for them. SIPs should continue

  • Arghya says:

    @Pajat
    Wonderful way to explain –
    “Whenever, you ask a barber when a good time for a haircut is, he will always reply “Now!”.
    “Whenever, you ask a Fundmanager when is a good time to invest, he will always reply “Now!”.
    In fact the logic applies for any investment advisor or fund house.
    @Deepak,
    Nice catch, but I think in any report you could easily spot out such kind of pseudo-truth “Aswathama hato(loudly) iti Gaza(in very low voice)”. In fact this is the only reason I follow your blogs and only write on your blog. An honest effort with least hidden agenda 😛

  • Hi Deepak,
    I am not the best of the guys to comment on fundamentals as am more a techie but i think couple of things you have missed out in the above article which is well used by equity research chaps 🙂
    1) The 1300 eps estimate which is mentioned for 1 year forward implies that it is for fy13 ! So it does not imply 25% earnings growth but much much lesser:)
    2) We are right now in financial year 2012 and in 2nd quarter of it so if we were to take fy12 eps estimates it implies one is considering 6 months forward. So maybe this is a convenience used by equity research analyst to shift to fy13 moment we get into 2nd quarter of the financial year.
    3) Now as per the few reports which i have looked into as well as last time i checked into bloomberg the average estimate of all broking houses for 1 yr forward p-e is around 13. The rough estimates by brokers for fy12 is around 1150-1200 and 1250-1350 for fy13. This gives us a growth projection of roughly around 15 % for fy12 and 12-13% for fy13.
    So the catch is when should one start factoring in fy13 🙂
    Now some of my thoughts and things to ponder on
    1) The consolidated results are really exciting ( kudos to sundeep to enlighten on exact nos on this ). There is a good possibility post DTC and IFRS implementations the accounting standards will soon shift to consolidated EPS and P-E. Is there a possibility post 2013 there could be a sudden p-e expansion
    2) I think the sales growth is going to be an issue for at least 12 months.The only savior lies in commodity correction which can improve the margins and bottomline.
    So there might be a lot of bullishness in Prashant Jains article which we may or may not agree but all the data points are accurate as per the standard template:).
    Btw i would rate him pretty high in the community from whatever little knowledge i have of the industry.
    Regards,
    Nooresh

    • 20 month forward P/E isn’t the most appealing of the lot, honestly. I mean at this rate I can take 50 month forward earnings and still feel the market is undervalued. 13 as a number should make sense in some context; worldwide it is the one year forward P/E that is used.
      Forget broker estimates – they are always wrong, so no point botherign with those. One needs to have his own estimates, if you’re predicting.
      p/e expansion is largely a function of sentiment and funds flow; it’s probably the technicals that are better at saying this, but technicals don’t really predict things two years away. I think we see a p/e contraction sometime in the middle.
      Prashant Jain’s a smart guy, as is buffett. But you watch what they DO, not what they say. 🙂

  • Yoshi Lee says:

    Good catch Deepak. You bring out an imp pt abt no licensing; so these people get away with what they have painted. There are very few diligent people, who have the patience to do the research and validate the facts. The rest of the mass will accept things at face value and move on, which allows people like PJ and Sunil to get away.
    We should get serious about promoting and adhering to GIPS (http://www.gipsstandards.org/), so the investors are not taken for a ride. Long way to go.

  • Hi Deepak,
    I think you need to check what are the forms worldwide.If you were to give a 1 year forward p-e then you would not to have a TTM for fwd estimates as well coz if you were to take 7 months fwd.
    Its just that wanted to put across the things which you have missed out and the article has a lot of negative bias and relies on calculations which are flawed.

    • Abroad, they either specify (2012/2011 – though many countries use the Calendar Yr so it’s easy), or they actually use 1 year forwards. It’s not about 7 months – the estimates border mostly on an announcement window, which in India is quarters? Having said that I agere that 1 year forward makes sense if you are close – so in Jan 2012, they might mean March 2013; that’s fine. But 20 Months is very strange to use, largely because they has not been able to get predictions right in that time frame, or even lesser. See: https://www.capitalmind.in/2008/07/sensational-sensex-eps-story/

      But I agree: In India we do have bizarre things. So perhaps we must demand the clarity – and if more people challenge such unqualified statements, they will start qualifying them properly. (If PJ had said P/E of 13 for earnings of 2013, I would instantly discount it a little bit because it’s fairly obvious that prediction that far away will have serious errors)
      I disagree about flawed calculations – his own announcement in 2006 was of 19x forward, and then in two months it became 13x forward, as calculated above. It would indeed be crazy to assume that forward P/Es in June can be so different from April. Why wouldn’t they specify? Bias wise – I tell it as I see it.

  • Vijay says:

    Investing decisions should not be linked to market valuations, but to the valuation of the stock, where you would like to invest.
    For e.g. Over last 5 years, P/E ratio or Price of IGL, Hawkins, SRF, Powergrid, ITC etc. did not have correlation with the market.
    So, if you are an investor, I do not understand how these articles, or the debate here, or the sensex level, or the sensex P/E level would help you???
    You need to find good stocks! Period!

    • There’s bottom up approaches – like you suggest, when you find good stocks. There’s top down – which is where you buy the market when the time is ripe. both work at different times. It would be fallacious to say either one is better, so I look at both 🙂

      • sharestar says:

        Exactly…look at both…I would say ‘bottom up in top down’ approach. Easy to say, difficult to understand and ‘almost’ impossible to point out…but a very near result will give very good results to our portfolio. No need for me to follow PJ or Sunil or Buffet..:)