Tata Motors TANKS after GOOD Earnings: Here's Why! 

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

A have a small quiz for you today.

I am going to show you a financial snapshot of a prominent auto company and you have got to tell me what the earnings of this company will look like over the next three years.

So, here is the snapshot.

You must tell me what the net profits of this company will look like in March 2022, March 2023 and March 2024 respectively.

Now, this is tricky. The net profits have moved within a wide range, starting from close to Rs 10,000 crores in March 2013 to a loss of more than Rs 13,000 crores in FY21. It is difficult to get a handle on what the earnings will look like over the next three years. They can be negative, and they can also be positive. Besides, the magnitude of the profit or the loss is also difficult to estimate.

So, there are two choices before you? You either drop this company from your research coverage, terming it as too difficult or try to understand more about the company.

Let us consider the second option and try to understand more about this company.

Well, these are the financials of none other than Tata Motors, one of India's largest manufacturers of commercial vehicles and passenger cars. It hails from the respected Tata Group and has an exceptionally long history. Thus, it is no small or ordinary company.

But if you must invest in this company, you need to make some sort of prediction about its net profits over the next three years so that you can make an informed decision.

You do not want to be shooting in the dark. You must have some idea of the revenues and the profits it can generate going forward.

However, if you find this exercise difficult, there's another option for you. You can value the company based on its book value per share and not earnings per share. Since earnings are volatile, you can base your valuation on its book value and buy and sell accordingly.

You check the price history of the company and you observe that over a 10-year period, Tata Motors has traded at an average price to book value multiple of 1.7x. In other words, if the book value per share of Tata Motors is Rs 100, then investors have been willing to pay a price of Rs 170 per share to own a share in the company on average.

We started by trying to predict the future earnings of Tata Motors. However, since this prediction is difficult as we just saw, we thought it will make more sense to value Tata Motors through the book value method.

Hence, the thumb rule is clear. Buy Tata Motors when it trades a price to book value multiple of 0.9 x and sell it when the price to book value reaches 1.7x.

Now, why buy at 0.9x and not higher? Simply because, we need a margin of safety and since Tata Motors has a volatile history, the margin of safety should be higher, which in this is case is 50%.

Thus, based on valuation history and margin of safety principle, the buy limit for Tata Motors comes to 0.9x and sell limit to 1.7x.

This is the price to book value history of Tata Motors between March 2011 and March 2021. As you can see, in the 10 years between March 2011 and March 2021, there's a two and a half year window between May 2018 and Nov 2020, where the price to book value of Tata Motors has been consistently below the buy limit of 0.9x book value.

Look at this price chart. It is the chart from the time window where Tata Motors was consistently trading below book value for the most part. So, back in May 2018 when Tata Motors was trading at close to Rs 300 per share, it was available at a price to book value of around 0.9x, our buy limit as we just discussed.

Thus, those who bought the stock at Rs 300 per share because it was trading at below book value did not do well over the next couple of years. They saw the stock lose another 75% of its value and crash to Rs 70 per share by March 2020.

This is why investing is simple but not easy. You buy into a stock hoping that you are getting a very good deal. Then, you see you stock lose another 75% of its value. Its crazy to be honest.

However, in investing, persistence is the name of the game. Your persistence in holding on to the stock would have paid off quite well over the next 3-4 years. After having fallen to Rs 70 per share, Tata Motors staged a remarkable recovery.

In fact, so remarkable that it not only went back to your purchase price of Rs 300 per share but well beyond that. As can be seen, Tata Motors crossed the Rs 1,000 per share price landmark recently.

This is 3x returns over a purchase price of Rs 300 per even though you may have lost 75% in the interim. And hold your breath, this is a huge 14x returns from the lowest price of Rs 70 per share. In other words, Tata Motors is a 14-bagger from its March 2020 low of Rs 70 per share.

Thus, buying Tata Motors below book value and then waiting patiently through all the ups and downs, has proven to be a wonderful investment.

As I record this video, Tata Motors trades at a price to book value of almost 4x. Yes, that is right. This is 4 times greater than the buy limit of 1x and 2 times greater than its historical price to book value of around 2x.

So, is Tata Motors trading at expensive valuations currently? Well, the answer is a huge yes if one goes by its historical valuations.

In fact, the company's share price fell by 9% in a single day even though it posted a record profit of close to Rs 32,000 crores in FY24.

To borrow from Buffett, you see the investment world is made up of two types of investors. The guys who believe in making 'sure' money and the guys who believe in making the 'big' money.

Taking example of Tata Motors, the sure money guy is someone who will buy Tata Motors at 50% discount to its historical averages, make his quick 50%-100% returns and move out. At times, he may even get luck and get to buy Tata Motors at just Rs 70 per share and exit at a price of Rs 500-Rs 600.

The big money guy on the other hand is not looking to make 50%-100% returns but much more.

He will buy at Rs 70 and hold and watch the fundamentals of the company. He will continue holding even at Rs 1,000 per share if he is convinced that there is more growth to come.

The sure money guy will not watch the fundamentals the same way as the big money guy.

All he wants to ensure is that the company like Tata Motors turns around so that he gets to make his 50%-100% in quick time and move out.

He does not wait for the stock to post record profits as he does not believe in doing a deep dive.

I think the reason Tata Motors fell 9% in one day is now becoming clear. Until now, there was maybe consensus among the 'Sure' money and the 'Big' money guys that Tata Motors is an attractive investment candidate.

However, as the stock price touches Rs 1000 per share, their views seem to be diverging.

The 'Sure' money guys seem to be of the view that the profits of the company have now peaked. Tata Motors has a history of profits and losses. Few years of profits followed by few years of losses. It is possible that the company may not report losses going forward but its earnings will still be volatile. And hence, it looks like its profits may go down instead of going up in the next few years. Therefore, the 'sure' money wants to get out of the stock.

The 'Big' money on the other hand feels that Tata Motors is a changed company. Its future will be very different from its past as it has several growth levers up its sleeve. Hence, it is capable of generating still greater profits going forward.

So, which side are you on? Are you on the side of 'Sure' money or 'Big' money. As far as I am concerned, I am more of a generalist than a specialist and hence, on the side of 'sure' money.

I think that the auto sector is inherently cyclical in nature. It will keep going through cycles and therefore, Tata Motors will also experience volatility in profits.

If you have an investment in Tata Motors, you will have to make this choice between being the 'sure' money or the 'big' money guy with respect to Tata Motors. And please note that you are not right or wrong because the crowd agrees or disagrees with you. You are right because your facts and analysis are right.

So, think hard and make your decision accordingly.

I will see you again in the next session. Good bye and Happy Investing.