TheMain reason where the P/E cannot be seen in isolation, it due to basically the denominator E - Earnings:
1. The E - does not capture the corporate governance issues and accouting quality. A Sian Paints reporting the 100rs profit as compared to let's say a dewan housing will be valued very differently than the market
2. In capital light business Earnings are basically cash flows whereas in capital heavy business cash flows are much less than earnings due to re-investment rate
3. Take example of TCS Vs Tata Steel from the same corporate group, TCS earnings are just 5 times of tata steel but TCS's free cash flows are 11 times of Tata Steel. Hence looking at just E is not correct.
4. E - does not capture Barriers of entry. Even though Dominoes and Nestle both earns same Earnings market value Nestle much higher because its extremely difficult to capture Market from Nestle whereas Dominoes has got stiff competition
5. In India rather than earnings. it basically free cash flow growth that matters, but as business models evolves due to use Tech, knowledge and Intellectual property its getting difficult to forecast FCFF. This companies are not mean reverting, there return on capital is consistently just shooting up.
6. Ultimately growth has to justify the P/E.
7. Things are getting more & more competitive, the millennial generation and young guys are willing to accept new brands etc and sustainability & longevity of businesses have been declining. Hence its difficult to forecast cash flows for long periods of time today. Hence Technology has made is extremely east to start and launch business, hence threat of entry has increased tremendously.
8. About 10 years ago also Marico, Nestle, Asian Paints, HDFC Bank, Pidilite etc were great businesses. So what has chnaged the such high P/E multiples is being awarded? What story has changed?
9. what has basically happened is modern tech has made it very easy for existing great management to utilize the cash they are generating to scale more & more through Tech and thus using tech has reduced the need for capital and hence the ROIC have been expanding consistently over the last decade.
10. Lets take example of Pidilite the management has build franchise after franchise from Fevicol to water proofing business (M-Seal and Dr. Fixit) to now housing chemical business. The FCFF growth for last 20 years has been 26% and ROCE's have expanded from 28% to 45% in last 20 years. As the company uses the same channel to sell more & more innovative products. Take FCFF from Product A to set up Product B and scale quickly in Product B through tech. That's the main game now for existing big Corporate.
12. But not all great companies like Asian Paints, HUL, Colgate are growing at hardly 2/3% above India GDP growth. The Products they sell there market has been saturated, now from where the growth will come from. but not all business have been saturated, even after loan book growth of 20% since past 20 years HDFC Bank still only accounts for 7% of the market share.
13. The top 20-30 Profit generators of India accounted for 30% of India Profits, but as on 2020 the top 20-25 profit generators of India account for 90% of India's profit. There has been a huge consolidation. The smaller players are getting crushed - the economy is getting formalized.
14. Apple is still growing (being at 1 Trillion Market Cap) at 25-30% and it's ok to buy it at 35 P/E because growth is justifying it. But in India these companies are trading at highest multiple in the world. For example the biggest Paint company of US is growing at higher rate and with higher ROCE than Asina paints still its available at half the P/E ratio than Asian Paints. This is the main issue in the name fo quality you cannot justify any P/E Multiple.
15. There not a single Company there's not a single company which has traded at 70-80 P/E consistently for more than a decade.
16. We also have example of Colgate and Castrol there ROCE is 100-110% but there growth is 4-5%. Where ROCE is high but growth is very low a company cannot trade at High P/E Multiple.
17. There have been a lot of instances which have generated returns for these companies over the last 3-4 years which were not in the control of the business: Rise of ETFs (Called as dumb Money by Sunil- as they need to buy anything and everything in NSE they have no point of view), as proponents of Quality has increased more money has chased them leading to even higher and higher P/E and the tax cuts that happened in India that single day itself the big companies went up 20% in a single day, if we remove that gain the quality has hardly moved because it trades so expensive currently.
18. Saurabh is never in favor of P/E re-rating. He only believes in Earning growth and P/E is mean reverting to Industry Average in long run. The great franchises/extraordinary companies with great management always look expensive based on trailing multiple on a one year forward multiple because due to entry barriers and scale the market is happy to discount coming 5-6 years of earning today.
19. Sunil said in 1980 even in US all the companies called quality also traded at 70-80 P/E multiple than for coming 15-20 years they gave zero returns. Even our great Infosys gave zero returns from 2000 - 2012 and similarly HUL from 2001 - 2011. Last 10 years Castrol and ITC has given Zero returns.
20. Sunil said we should track cycles - for example currently last 6 months profit of a steel company is higher than combined profit of past 10 years of a big paint company.