Investing in stocks is about getting two things right.
The first is to identify a company that has proactive management with good governance, sound fundamentals, and a clear and robust business model. In the long term this is the best recipe for maximizing returns.
The second is to get the valuations right. But, what is the "right" valuation? There is no one answer to this question. As beauty lies in the eyes of the beholder price lies in the eyes of the investor!
But no matter what your approach to valuation may be, would you really buy the world's most expensive stock in its category?
The stock we are talking about is Asian Paints.
In May 2012, a story in a leading business daily said that Asian Paint's stock was one of the most expensive paint stocks, not just in India ... but in the world!
Asian Paints is currently trading at a price-to-equity PE multiple of 37 times its trailing 12 month (TTM) earnings (EPS).
Does the company's fundamental performance justify this high valuation?
Over the past 5 years, the company has seen dynamic growth in both its revenues as well as earnings. On a consolidated basis, revenues grew at a compounded annual growth rate (CAGR) of 21% while net profits grew at a CAGR of 29%.
At the same time it was able to maintain healthy margins and return ratios as well. FY12 operating and net margins were 14.9% and 9.4% respectively; while Return on Equity and Return on Capital employed were 41.4% and 54.7% respectively. All this represented solid results.
But how does Asian Paints stack up against the peers?
Asian Paints versus other Indian Paint Companies - Five Year Analysis
| Akzo Nobel India Ltd | Kansai Nerolac | Berger Paints | Shalimar Paints | Asian Paints | |
| Sales growth (5 yr CAGR) | 4% | 16% | 19% | 14% | 21% |
| Net Profit growth (5 yr CAGR) | -15% | 15% | 15% | 25% | 29% |
| Operating Margin (5 yr avg) | 15% | 13% | 10% | 7% | 15% |
| Net Margin (5 yr avg) | 14% | 8% | 6% | 2% | 10% |
| Return on Equity (5 yr avg) | 18% | 21% | 24% | 23% | 47% |
| Return on Assets (5 yr avg) | 17% | 19% | 15% | 8% | 38% |
| Return on Capital Employed (5 yr avg) | 23% | 27% | 25% | 22% | 56% |
| TTM PE | 16 | 22.7 | 27.3 | 14.5 | 37 |
Source: ACE Equity
Clearly, Asian Paints has delivered superior returns relative to its competitors. And with its PE of 37, it also commands a premium in terms of valuation.
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So we know that Asian Paints has strong fundamentals and financials, and its achievements have been much better than its competitors. But does the PE of 37 reflect the "right" valuation for Asian Paints?
Source: Livemint
Asian Paints' PE of 37 is close to its historic high of August 2005 when the Indian and world economy was stronger. Valuations of other companies in the Paint industry range between 15 and 23, and mirror the average of companies in the economy.
We believe that Asian Paints has demonstrated good governance, sound fundamentals and a solid business model. And its results reflect these parameters.
However, we wonder if the "lustre colour" that paints its valuation is too shiny. We suggest a "wait and watch" approach to see if Asian Paints performance is indeed as rich and sustainable as the quality of the paints it promises. Equitymaster.com is India`s leading independent equity research initiative
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