**[investwise]** Bombay : Is This The End Of Euphoria?

 

Bombay-Is This The End? Euphoria, Fads and Mania By all standards of comparison Bombay is over-valued. So much so that we have managements that misuse shareholder money for their own particular agenda-RIL, Sterlite are the front-runners. Worst are the fund managers, market analysts and the hordes of small investors who believe that Enemy neighbours like China and Pakistan can be wished away, separatists in Kashmir and North East can be ignored, and the 6-7 States roiled by the Naxal-Maoist insurgencies are not a part of India. We analyze two peculiar investment phenomena in the Indian market and the propensity to ignore related potential pitfalls—(1) the EV (Embedded Value) syndrome, which is the market's tendency to assign exaggerated value to future assets and (2) the PG (Perpetual Growth) syndrome, which is the market's tendency to extrapolate a benign environment and resultant earnings for a long period while ignoring potential negative changes to the macro-environment. Past Behaviour Reflects In Today's Trends We look at two peculiar investment phenomena in the Indian market based on our past experience of dealing with stocks, which have been symbolic of the market's exuberance at certain periods in the past. We find these relevant in the current market given rich valuations in many stocks and think investors may want to benefit from our learnings—gleaned from our past association with these stocks. Embedded Value Never Gets Unlocked We have seen the market ascribing inexplicable value to future assets of Indian companies, especially in 2HCY07. We see the same phenomenon currently, albeit to a much lesser degree. We would place stocks such as Cairn India, Jindal Steel and Power (JSPL), Reliance Industries (RIL), Reliance Power and some of the new merchant power stocks in this category. Assuming Perpetual Double Digit Growth Is A Myth We have seen the market ascribing very high multiples to earnings of companies under the impression that earnings will continue to grow strongly in perpetuity. This notion ignores potential risks to earnings and consequent de-ratings if earnings fail to meet with street expectations. We see this currently in certain automobiles, consumer, industrial (particularly, BHEL), media and of course, telecom stocks that have got re-rated of late. Can The Analyst Crystal Ball Give The Wrong Image? We do not have a crystal ball to divine future oil and gas reserves of E&P companies or the capability to foresee risks to earnings of high-growth companies. However, we do believe investors can avoid expensive mistakes (as in 2HCY07) by (1) doing simple reverse valuation exercises for 'embedded' asset companies to understand the implied value of such future assets and (2) re-visiting the macro-environment, which supports a high-growth company's earnings. Finally, we would caution against the street's use of (1) improper valuation methodologies and (2) high multiples at near-peak margins and earnings. Safe Harbor Statement: Some forward looking statements on projections, estimates, expectations & outlook are included to enable a better comprehension of the Company prospects. Actual results may, however, differ materially from those stated on account of factors such as changes in government regulations, tax regimes, economic developments within India and the countries within which the Company conducts its business, exchange rate and interest rate movements, impact of competing products and their pricing, product demand and supply constraints.   Nothing in this article is, or should be construed as, investment advice.

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