Has Tata Motors Topped & Maruti Bottomed? 

Hello everyone. Rahul Shah here, trying to make investing accessible and profitable for the average investor.

It seems to be the period of milestones. Close on the heels of India achieving the milestone of becoming the 4th largest stock market by market cap and the Tata Group crossing the Rs 30 trillion market cap, there comes another milestone.

This time, the milestone concerns the home grown auto major Tata Motors.

Tata Motors has now gone past Maruti Suzuki to emerge as India's most valuable auto manufacturer.

A leading daily reported that the market cap of Tata Motors and Tata Motors DVR combined stood at Rs 3.24 lakh crores, slightly higher than the 3.15 lakh crore market cap enjoyed by Maruti Suzuki.

Of course, by the time this video reaches you, Maruti may have again taken the lead.

However, this doesn't change the fact that Tata Motors is now neck and neck with Maruti after a huge gap of 7 years.

It was exactly seven years ago that Maruti Suzuki drove past Tata Motors in the market cap race and kept increasing the distance between the two. At one point in time, the gap between the two was as high as 6x i.e. Maruti Suzuki was valued 6x more than Tata Motors. It sounds unbelievable but it is true. The gap was indeed this big back then.

However, the gap has not just narrowed but the tables have also turned with Tata Motors holding a slight edge over Maruti now.

Well, there's a valid reason for this turning of tables and it has to do with the amazing turnaround in the profitability of Tata Motors.

From a loss of Rs 287 bn in FY19, perhaps its highest ever, Tata Motors has earned record profits of Rs 157 bn in the trailing twelve-month period.

And it is this turnaround that has led to investors warming up to the stock and turning it into a 12-bagger since its March 20 lows.

Maruti in contrast is up only 2.5x during the same period.

What this outperformance has done is that it has allowed Tata Motors to close the gap with its more fancied rival and eventually go past it.

Having said that, although Tata Motors is being valued the same as Maruti Suzuki by Mr Market, it is the latter that boasts of better fundamentals and long-term track record.

Tata Motors profits for the last 12 months are 1.5 times higher than Maruti. However, the topline is 3 times higher than Maruti. Therefore, it certainly boasts of much better margins than the Tata group company.

Maruti earns Rs 9 on every 100 Rs of sales whereas Tata Motors earns only 4.5 Rs. So, Maruti earns twice the profits that Tata Motors earns if you take Rs 100 as the base.

In terms of returns ratio, Maruti again has an edge, with 10-year average ROE of 12% compared to Tata Motors' below par ROE of just 5%.

Compare balance sheets and it is Maruti that again has an edge with its debt free balance sheet versus Tata Motors where debt is easily more than twice the equity.

Hence, when it comes to fundamental parameters like profitability, return ratios and balance sheet strength, Maruti is comfortably ahead of Tata Motors.

Why is it then Tata Motors enjoys nearly the same valuation as Maruti? Why is Mr Market considering Tata Motors at par with Maruti?

Well, the answer is simple. Tata Motors may have been an ugly duckling in the past, but it has now turned into a beautiful swan as per investors. They are expecting Tata Motors to perform as well as Maruti going forward or even better.

However, is this true? Has Tata Motors really turned into a beautiful swan with those loss-making years and leveraged balance sheets a thing of the past?

Well, anything is possible, and Tata Motors could certainly become a much stronger company going forward.

However, as value investors, we shouldn't be willing to buy Tata Motors at any price just because its future is likely to be much better than its past.

Now, here comes the million dollar question. How exactly do we know the price at which Tata Motors becomes a good deal and the price at which it becomes a bad deal?

Well, comparing the current valuations with the historical valuations can give you some idea.

You see, over the last 10 years, Tata Motors has traded at an average price to book value multiple of around 2x.

PE or the price to earnings ratio is not a good valuation indicator for Tata Motors as its earnings have been all over the place. Asset heavy companies with volatile earnings can be valued using the price to book method.

So, Tata Motors average price to book value is around 2x. And what is the stock trading at right now?

Well, it is trading at a price to book value multiple of almost 5.5x. This is a huge 175% premium or a multiple of 2.8x to what it has historically traded at.

So, historically, Tata Motors has commanded a price to book value multiple of 2x and right now, it is trading at a whopping 5.5x.

Maruti on the other hand, trades a price to book of 4.9x, around the same level as its long-term average of 4.9x. Hence, unlike Tata Motors, it is not trading at a huge premium to its book value.

Of course, since earnings for Maruti Suzuki have been quite stable, we can also use the PE ratio to value Maruti Suzuki. Even here, the valuations don't seem expensive at all based on its past averages.

Thus, from a risk-reward perspective, Maruti Suzuki seems to be much better placed at the current price point.

Please note that we are not saying that Tata Motors is a bad stock and Maruti is a good stock.

All we are saying is that the risk-reward equation based on how these stocks have performed in the past and how Mr Market has valued them, seem to be favouring Maruti Suzuki over Tata Motors.

Thus, while Tata Motors may have a much better future than the past, what matters is how much of this is already priced into the stock.

If most of it is already priced in, then it may not be a wise decision to consider fresh investments into the company.

In fact, it could even be the time to exit as even a small disappointment or delay in meeting expectations can lead to a significant fall in the stock price.

Investors could do well to remember this important distinction.

Happy Investing.