40% off NEPSE – End of Cycle Sale

(One of my resolutions for 2019 was to write at least one article per fortnight. But since, KPIS, Khanal Pradhanang Investment Services (www.kpinvestmentservices.com), is in its early days and as a Founder I must wear several hats, I have missed the deadline by a whopping 12 days. I have been rationalizing my inconsistent behavior by telling myself that as long as I write two articles per month, I am on track to meeting my annual target. It’s true what they say – Man is not a rational animal, rather a post-rationalizing being! So on to the topic now.)

I often hear people make statements like “I wish I would have purchased Amazon in 2001 when it was available for only $16 or Facebook for just $38 in 2012!” A few weeks ago we were having a casual conversation in the office along the following line – “If you found a time machine & could go back in time to any place in the world, since you would already know the outcome and performance of the stock market in the future (having travelled to that time from the future),:

(a)  which time & place would you travel to & why (for investment purpose)

(b) which stock/stocks would you purchase”

After thinking for some time I replied– “I would travel to 2011-12 when Nepse was trading at the level of ~300 points. I would sell all my other assets and use that money to purchase high growth stocks. Then in 2016 at the peak of the bull market, ~1800 points, I would sell my position and make enough profits to retire.” Wishful thinking at its best!  

In a different encounter in the same week, I was in a meeting with an elderly gentleman. As our conversation progressed, he asked me what I did. When I told him equity research & investment, he told me about his bitter experience in the bull/bear market of 2008-2012. I casually asked him if the current market level of 1100 points is a good point to invest, to which he replied very confidently – “Only if the market drops to 300 points, as was in the lowest point of 2010 bear market, is it attractive. It’s currently overvalued!”

Now that reply got me all riled up.

Here I was, all excited to deploy my money in the stock market and along comes this person and tells me the time is not right. So I put on my Sherlock Holmes Hat and set out to conduct a research. I needed to investigate if the stock market is currently correctly valued, under-valued or over-valued?

In order to do so, firstly, I had to choose a correct metric. I chose Price to Earnings (PE) Ratio. (I firmly believe that the value of an asset should be linked to the cash flow it produces, and hence PE ratio is a good indicator of value). For non-finance readers a PE ratio of 10 implies that for 1 dollar of earning you are paying 10 dollars.

Secondly, I had to calculate the current PE ratio for the entire market (all the stocks listed in Nepse) and compare this number to its historic levels. Since I lack the time and energy to do such lengthy calculations for the ~220 stocks listed in the market I chose one stock as a proxy for the market – Nabil Bank. The reason I did so was:

(a)  Nabil’s price has always enjoyed a good liquidity and reflects true market sentiments

(b) Nabil has never issued rights shares or issued Further Public Offerings or acquired another bank. It has grown organically. If I owned 10% of the bank in 1990, even today I would own 10% of the bank and would be entitled to 10% of the total income of the bank.       

For the purpose of this study I will assume that I own 100% of Nabil Bank. It will make calculations easier. Also for a brief period of time, in my as well as the reader’s mind , I would be extremely wealthy.

In 2006 there were 4,196,544 shares of Nabil outstanding, each share was priced at Rs. 1,505 and each share earned 129.21. So if I wanted to buy the entire Bank, I could buy it for Rs. 11.01 billion and in that year I would earn Rs. 635 million. For Rs. 635 mn of earnings I would have to pay a price of Rs. 11.01 bn; that’s a PE ratio of 17.34.

After that period Nepal experienced its first bull market and the prices went off the ceiling. In 2009 the total profit (earnings) of Nabil was Rs. 1.09 bn and the stock was priced at Rs 47.31 bn. That’s a PE ratio of 43.19. At this time the Nepse Index was ~1100 points. However, the market realized the mistake it had been making and how it has been overpaying to purchase Nabil. It realized the Bank was overvalued and over the next 2 years the stock lost 46% of value.

To put that in shopping parlance, the same product was available for a discount of 46%. 

Wow! Right?

In shopping, you have end of season sale. In stock market, we have end of cycle sale. The discount offers available in the stock market are far more profitable than the sale available in retail markets. One saves you thousands and the other earns you millions of rupees.

By the end of 2011 the Nabil could be purchased for just 25.4 bn. At that time in 2011 it was earning profit of Rs. 1.43 bn. So Nabil was priced at PE Ratio of just 17.72. Market had made another severe mistake in valuing the stock. This time the stock was priced far below its real value. At this time the Nepse Index was at ~300 points.

So if given a chance this is the point to which I would travel in my time machine and buy the entire Nabil Bank at Rs 25 bn for a PE ratio of 17.72.

If history has taught us anything, it’s that it has taught us nothing. Within two years the market got back to its old ways – it was ready to over pay again. And in 2014 we witnessed another bull market. This bull market peaked in 2016. In 2016 Nabil earned 2.81bn net profit but it was priced expensively at Rs. 111.41 bn. PE ratio stood at 39.55. 

At this point I would sell the entire Nabil Bank I purchased in 2011 (through the help of time machine) and book a profit of Rs. 86 bn!

Soon after 2016, market realized it mispricing folly once more. It realized it had been overpaying for the Bank & that the Bank was overvalued. Over the next 3 years the stock lost 40% of value. Which brings us to today!

Today, the entire bank is available for a discount of 40% from its peak of 2016.

Wow! again?

Now the topic of this article and important questions around it

Is the market undervalued?

Today, on 27th January, 2019, the entire Nabil Bank is available for Rs. 67.52bn. Last year it earned Rs 4.19 bn in profit. So its available for PE of 16.10. That’s cheaper than its ever been since 2006. So looks like the gentleman in the beginning of the story, who claimed the market is over-valued was absolutely wrong. In fact the market is cheaper today than it was in 2006.

Additionally our team at KPIS have calculated the intrinsic value of few companies and they are priced attractively.

Also may be after all you don’t need a time machine to be rich. All you have to do is invest today at this attractive valuation, be patient and wait. Sooner or later the market will again get irrational start to overpay for stocks. At that time you may sell your stock, book a profit and retire!

The time is right today and you must invest.

Should you wait for the market to drop further?

I do not know if the market will drop further. It might, it might not. But few stocks are extremely attractive even at the current valuation levels. You may wait for them to drop further but if the market starts to rise you might miss a chance to enter at these prices. Choice is yours, but even at current prices, some stocks are attractive!

Which Companies should you buy today so that you can maximize your return?

Well, too many freebies for today! For that you must visit our office, KPIS. Or you can message me. In exchange for a small performance based fee, we will tell you which stocks to buy for your portfolio, so that you can get wealthy and retire soon! 😉

Happy Investing!