We started last week with strong gain of close to 1% in all the indices last Monday. The biggest contributor to major indices was because of the sharp jump in the stock price of ITC. ITC jumped up to Rs 342.50, up 6% and at one time it climbed up to Rs 354.80 recording as new 52 week high.

So what was the story behind ITC?

Definitely investors were talking on the street about GST effect on this stock. Many brokerages have come out and changed their outlook on this business. The market cap at the close of Monday for ITC stood at Rs 416,656 crore.

Looking through our lenses, its valuations look outrageous to us. This business is trading at eight plus times to its book value now. So if we look at 2017 equation then they reported Rs 10,520 crore profits, paid 65% of those earnings back to shareholder as dividends and reinvested remaining back into the business. Before GST in the market the ITC business was worth for Rs 378,000 crore. If you had that big money and bought this business at that price then your returns for the past year would be 2.78% (profits). Same money invested in the normal bank account would have fetched you almost double to the reported profits.

So what would be logical to do? Invest in ITC or park your money in bank at 6%? Give a thought and share with me.

But it might be foolishness to buy business looking at past performance. It is all about future prospects. So say they are capable to grow their earnings at 15% for the next 10 years. So they will double their profits in 4.8 years and again in 9.6 years. Running from the calculations it comes that in 10 years’ time its profits will be around Rs 46,000 crore. They almost retain half of their earnings back into the business so let us assume its book value doubles to Rs 100,000 crore by that time.

Assuming it will be valued at same multiple of book value (8 times) of today, its stock price should be trading around Rs 700 per stock. So in 10 years your capital gains will be 100% and dividend returns around say 50%. So your absolute returns is 150% which is 15% per year in absolute terms and in compounded terms 7% per year. Are you happy with those returns? If yes, then go ahead and park your money with ITC and hope it delivers 15% growth in its earnings every year for the next 10 years.

Buying Rs 100 cheap from current price will give you approximately 300% absolute returns for the same time horizon.

So it is you to decide what rate of return is comfortable for you to invest. For us anything below 15% compounded rate of returns is not acceptable.

As we are talking about returns, what real returns are you happy with? So what is real return?

Real return is the adjusted rate of return after inflation. For example, let us assume ITC manages to deliver 15% return every year as expected above. The average inflation for the last 10 years stand at 7% and is expected to fall down to 5% in the coming decade. So if we adjust that 5% from 15% absolute return than your real return will be 8%. You can get more information of real rate of return by clicking here.

We go one step ahead, say we got 15% return after brokerage expenses. I think the capital gain tax in India is 30% (long term) and is taxed on only half of your capital gains. Correct me here if you are accountant and know more about it. So on 15% return I will deduct taxes of 2.25% and then subtract inflation. Hence, the real returns will be: 15% – 2.25% – 5% = 7.75%. If this return is less than country’s real GDP (7.50% for India) than think again investing in that instrument or stock.

Did you ever thought why different brokerage houses have different valuation of same company?

This is because these brokerage house punch different RRR (required rate of return) in their DCF model.

Reliance industries stock price was trading at Rs 1,422 per share last Tuesday, up 2.75% on that day. If I consider that stock price trading at fair value than RRR in those calculations I have taken is 10.25%. If you still think it is cheap stock than its RRR should further go down.

Well, I think RRR @ 10.25% is already too less where risk free rate (bank deposit rate) is sitting at 6% and inflation at 5%, investors are valuing Reliance Industries without adding the risk premium.

Reliance Industries also faces big risks. They operate into competitive world where they already are expected to report 2018 earnings down by 8% from its 2017 but then jump up by 18% next year from 2018 lows.

They expect this growth to come from JIO and joint venture with BP.

Lupin jumped up 4% on the news of launch of its generic product for Vigamox – product of Novartis pharma product on last Wednesday. Last year sale of Vigamox was reported US$267.9 million. It is very hard to judge how market participants behave in the stock market. Last month Lupin launched another 3 genetic products of which had sale in US for US$1.150 billion (1150 million) and its stock price tumbled down 7%.

We are not trained to take investment decisions statistically. We ignore those important information because they are hard to break. For example, those launches by Lupin could bring growth keeping all in its top line in range of 2% – 7% depending on how deep they can penetrate and capture their market share. We own Lupin stocks in our portfolio and are looking forward to see some growth in its top and bottom line this financial year.

There were couple of resources I found that talks about the market condition right now in the Indian market. There were few insight I got when Rahul Bajaj was addressing in Bajaj Auto annual report 2016 -17 meeting last week.

India clocked 7.9% GDP growth in 2016 and 7.1% in 2017. Rahul Bajaj was complaining that it was not as good as 7.9% of 2016 in 2017 for its poor performance. The other issue it pointed out was on the debt issue (NPA) in the Indian bank. Because banks are under stress, there is no appetite for advancing term loans without which it is hard for them to spend which can take them to next level of growth.

Finally, October – December 2016 demonetisation of almost 88% of circulated currency with slower new injection of new Rs 500 and Rs 2000 notes created constraints in various sectors of the economy. He acknowledged that though the statistics did not show any impact of demonetisation but expect to see its impact in the first half of 2018.

Bajaj Auto net sales declined by 3.5% and profit after tax also dipped 2.6% to Rs 3,828 crore in 2017. They also faced poor economic conditions and severe foreign currency constraints in some of key importing countries. Motor cycle exports fell down by 16.5%, three wheeler exports fell by 31.2% and strong Indian currency made Bajaj Auto exports falling down by 19% while in US$ terms it was 23%.

Many analysts expect its earnings for 2018 to grow by 11% and its stock price is today trading within its expected intrinsic valuation zone, so good to have a bit of exposure into it. We do not own Bajaj Auto stocks in our portfolio even when they are trading within valuation zone. The simple answer is our concern towards its earnings growth in the mid – term.

Talking about NPA’s, RBI came out last week with the financial stability report. Chapter two of the report, ‘Financial institutions: soundness and resilience’ is worth to read if you are active investor in the Indian market to understand ground condition.

If you don’t have time to read that document than just watch this video to get understanding of Indian debt crisis. Just ignore the last bit and do not panic if you have accounts in those banks. Your money is not at risk. But if you are the shareholder of those banks than please re do due – diligence of your investments as they might be at risk.

Lupin closed the week with the strongest gain on last Friday and also for the week. A close to US$1.5 billion sales launch of few generic products in USA have lifted the hope of growth returning back into the business. It will be interesting to see the performance of those launches in the quarters ahead.