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What is a cynic? A man who knows the price of everything

and the value of nothing. 

Oscar Wilde 

Price is what you pay. Value is what you get. 

Warren Buffett 

Even peace may be purchased at too high a price. 

Benjamin Franklin 

Indian equity investors are purchasing the “peace” of certainly in uncertain market by investing in the

FMCG stocks for last few years. Are they paying too high price for purchasing the “peace”? We have

tried to look back in the past and future to gauze that.

In the past five years, the consumer sector has outrun market by a whopping 169%. It now quotes at

89% premium to the Nifty, against an average of 65% in the past 18 years. Meanwhile, its weight in

the index is up 710bps. The sector is one of the most overbought by institutions. With the tide

turning towards higher beta companies, we expect it to offer returns only to the extent of

earnings growth (15%) and dividend yield (1%). Food companies are in a better position to

reward investors, with likelihood of stronger earnings growth (above 18% over FY13-15) due

to a fall in raw material prices.

After market peaked at 21,200 on 10 Jan’08, the consumer sector has outrun it 169%. Owing to the

sharp global slowdown, steep inflationary pressures & interest rates, and unstable political

conditions, most companies have reported poor financial performances, reflected in their dismal

share prices.

We believe that, with the possible turning of the tide in favour of stable but higher-beta companies,

the consumer sector may not continue to outstrip the broader market. Though it will continue to post

healthy, over 15% earnings growth in FY14 as well as in FY15. These are ~100% free-cashflow

generating companies, due to rich valuations (most stocks are trading at PE multiples above the

mean + one standard deviation of the past decade) and share-price returns are likely to be low key.

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Multiple expansion will be selective

In the past 18 years, the consumer sector has traded at an average 12-month forward-PE of 25x; it

is now trading at a PE of 29x. We believe returns will extend only to those with earnings growth plus

dividend yield, but any returns from re-rating would be restricted. Multiple expansions will only bepossible for certain companies such as Bajaj Corp. or Nestle India and may not amount to more than

10% from present valuations. Also, the sector now trades at an 89% premium to the Nifty, against

average premium of 65% in past 15 years. With improving fundamentals for other sectors such as

falling interest rates, this premium could shrink.

One of the over-bought sectors

Owing to the underperformance of other sectors, weight of the consumer sector in Nifty has

expanded from 6.1% in FY10 to 13.2% in FY13. Outperformance of other sectors could result in

greater weights for them and investors may be compelled to sell consumer stocks merely to align

with the Sensex or Nifty weightings. Almost all stocks in the consumer sector have seen an increase

in institutional ownership. The inclusion of Asian Paints in the Nifty and of Dabur and Berger Paintsin the MSCI Index in the past two years has led to greater institutional ownership of these stocks.

Except for Emami, GSK Consumer and Nestle India, institutional ownership has gone up 70bps, to

786bps, in the past 11 quarters. Nestle has seen no change in institutional ownership, whereas

GSK-CH has seen it fall 904bps.

Few positive points

  Food inflation on a downward spiral- Prices of primary articles (key input for most FMCG

companies) softened in Mar’13 to a 13-month low of 7.6%, significantly below 11.4% in

Jan’13. Assuming a normal monsoon this year, we expect prices of primary articles to slide

further to 5.4% by Aug’13. 

  Double bonanza for food companies- Easing inflation helps consumer companies in two

ways. One, lower food prices expand gross margins of food manufacturers. Two, with lower

inflation, consumers’ disposable incomes increase, which eventually drives consumption.

Food companies are expected to record 30-95bps gross-margin expansion, which means:

(1) No price hikes for at least three quarters, allowing companies to regain pricing power and

consequently pass on higher costs; and (2) improve brand-building. We had seen a similar

situation in FY10 when raw material prices had dropped, leading to higher gross-margin

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expansion for food companies over non-food ones. We expect similar out-performance of

food companies in FY14.

Indian CNX FMCG index and BSE FMCG index are trading at the historical high not only in

absolute terms but also interms of most of the valuation parametrs. This is not without any reason.

While most of the market is fighting with uncertainly both in the extermal environment and inherent

problems , FMCG is a mirage in the desert. CNX FMCG index’s EPS has grown at CAGR of **** in

FY09-13 againt the Nifty CAGR of *****. Although warren Buffet prefer “It's far better to buy a

wonderful company at a fair price than a fair company at a wonderful price.”, the big question always

remain what is the fair price.

The momentum investment tells that we should always ride the trend and bet on stocks that are

rising even if they are expensive. This also lead us to the classic debate between Value and

Momentum investement.

An investment strategy that aims to capitalize on the continuance of existing trends in the market.

The momentum investor believes that large increases in the price of a security will be followed by

additional gains and vice versa for declining values.

Momentum investing, is a system of buying stocks or other securities that have had high returns

over the past three to twelve months, and selling those that have had poor returns over the same

period. It has been reported that this strategy yields average returns of 1% per month for the

following 3 –12 months as shown by Narasimhan Jegadeesh and Sheridan Titman.

In finance, momentum is the empirically observed tendency for rising asset prices to rise further,

and falling prices to keep falling. For instance, it was shown that stocks with strong past performance

continue to outperform stocks with poor past performance in the next period with an average excess

return of about 1% per month (Jegadeesh and Titman, 1993, 1999).

The existence of momentum is a market anomaly, which finance theory struggles to explain. Thedifficulty is that an increase in asset prices, in and of itself, should not warrant further increase. Such

increase, according to the efficient-market hypothesis, is warranted only by changes in demand and

supply or new information (cf. fundamental analysis). Students of financial economics have largely

attributed the appearance of momentum to cognitive biases, which belong in the realm of behavioral

economics. The explanation is that investors are irrational (Daniel, Hirschleifer, and Subrahmanyam,

1998 and Barberis, Shleifer, and Vishny, 1998), in that they underreact to new information by failing

to incorporate news in their transaction prices. However, much as in the case of price bubbles,

recent research has argued that momentum can be observed even with perfectly rational traders

(Crombez, 2001).

Methodology-