How much premium will investors pay in the hope of outperformance? For stocks that promise high-growth, valuations can be stratospheric. Phases like the IT boom, the internet boom, and now, Facebook, indicate investors will pay unreal sums in such circumstances.
How much will investors pay for a promise of stable and predictable growth? Here, valuation premiums are less staggering. Non-cyclical industries with decent growth records and stable dividend payouts trade at some premium to the overall market. But they don't go off the scale. Stocks that pay steady dividends without necessarily having high growth prospects are also treated more rationally.
FMCG is a classic non-cyclical industry. A well-run FMCG usually has a strong balance sheet with low-debt and low working capital needs. Demand tends to be steady once there's a degree of brand recognition. People tend to carry on buying toothpaste and shaving cream even during recessions and while they may trade up, to more expensive brands, they rarely trade down. As a result, earnings growth tends to be rather predictable.
India also has an expanding FMCG market due to factors such as poverty reduction and better access. Every year, millions more join the middle class or move slightly further up the income ladder. The road system has also got better allowing more access to rural markets as well.
Most analysts spend sleepless nights looking for market leaders. They slice and dice changes in marketshare, track product launches, ad-spends, etc. This is wonderful intellectual exercise but it doesn't really add very much to returns. Over a longish period, the big companies all tend to beat the market. If you're going to be overweight in FMCG, you may as well hold several shares.
The valuation numbers are interesting. Over the past two years, the FMCG sector as represented by the CNX-FMCG index has consistently traded at PEs about 8-10 notches higher than the Nifty itself. The average PE difference is about 10 more for the FMCG index versus the Nifty.
There's also much less variation in valuations. The high-Low PE range for FMCGs is much less than the high-low PE range for the Nifty. The PBV ratios are much higher for FMCGs as well. The sector offers higher dividends. The yield on FMCG stocks is around 2 per cent despite the higher valuations, whereas the yield on the Nifty is around 1.4 per cent.
Bear market history suggests FMCG stocks bottom out at much higher PEs than the overall market. This is the defensive factor investors love. It's tough to recommend from a valuation perspective. But the predictability does make it tempting, especially in a bear market scenario where capital preservation is a major consideration.
The author is a technical and equity analyst
