Thursday, July 30, 2009

Is Growth Overvalued?

It's fairly clear that the pursuit of returns by investors generally was a significant reason for the financial crisis we seem to be now recovering from. The argument goes like this:
- Boards and managements believed their ultimate objective was to maximise their stock prices
- Growth in revenues and particularly in profits (specifically earnings per share) is what pretty much everyone in the investment community (investors, intermediaries, the media etc.) believes is what drives stock prices (and therefore it does)
- Managements translated overall revenue and profit growth targets down the line
- In today's age of quarterly reporting, everyone has a short term horizon so near term revenues and profits were chased with abandon
- Risk management controls and regulatory (and semi regulatory i.e. ratings agencies) oversight that should have curbed excesses early proved ineffective or non-existent
Post crisis, this search for yield is manifesting itself in renewed international investment in certain emerging markets (the few regions that are still growing relatively strongly) where valuations may have been driven up to unsustainable levels. Click on the title to link to an interesting WSJ article.
However, I think we should also look at the following chart - of the Bombay Sensitive Index vs the Dow and the FTSE over the last five years:
Pretty significant outperformance - so significant returns can be achieved in at least some emerging markets.
Where I do agree with the study described in the article is that often due to relatively low liquidity, valuations in emerging markets get driven up quickly, leading to inevitable corrections - while those result in the reduced returns over time described in the article, they also present an opportunity for the more discerning investor.

I also believe that one result of the crisis will be that markets will begin to better value companies that build the infrastructure to deliver stable and sustainable growth over the long term. In India at least, Colgate Palmolive's Indian subsidiary could be an example. The company has built a vast and efficient distribution network in a complicated and often inefficient market and, aided by the low price points of its products and feeding directly into the Indian consumption story, consistently delivers good if not spectacular revenue and earnings growth. Relatively low trading volumes so often under the radar of foreign and domestic institutional investors but a strong outperformer of the overall market as the following chart shows:
In the interests of full disclosure, I am a shareholder. Also, given the recent run up in the price probably not wise to buy unless there's a bit of a correction.

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