Trent Ltd: Is this High-Flying Stock Worth the Risk? 

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

Having spent close to two decades researching stocks, there are a few thumb rules that I hold very close to my heart.

I try not to violate or break them, no matter what the temptation.

One of these thumb rules is to have an upper limit while assigning a PE multiple to a stock. This PE limit for me is a multiple of 35x to 40x.

Yes, that's correct.

The maximum PE multiple that I am willing to assign to a stock is not more than 35x to 40x.

Should I come across any stock that's trading at a significantly higher PE multiple than 40x, it gets immediately rejected, irrespective of its quality or growth prospects.

I hope you remember the famous advice of Ben Graham that you should make Mr Market your servant and not your guide. Mr Market or the stock market is there to serve you and not guide you.

Hence, by insisting on a fixed upper limit, you are making Mr Market your servant.

I am asking him to serve me only those stocks that are available at a PE of 40x or lower. If he does not have enough good quality stocks fulfilling this condition, I simply ask him to leave and come another day.

Let me tell you that a majority of the investors do not follow this advice. They don't have a fixed upper limit for buying and rejecting stocks. In fact, if Mr Market tempts them to buy a stock at a PE of 100x by creating some nice stories around it, they are more than happy to oblige. In effect, they are making Mr Market their guide and not their servant.

Stock market history suggests that buying a stock at a PE of 100x leaves very little room for error.

A lot of growth expectations are built into a stock that's trading at a PE of more than 100x. And even a slight delay or mistake in meeting those expectations and the stock can come crashing down.

Hence, it is always better to make Mr Market your servant and always insist on a stock where there aren't a lot of growth expectations built into the PE multiple.

This way, even if the growth comes slightly lower than expected, there is not a lot of damage done to the stock price.

This thumb rule of having a fixed upper limit has helped me enormously over the years. It has helped me stay away from highly expensive stocks, a major source of wealth destruction in the stock market.

Talking of high PE multiples, there's a stock that has done well despite consistently trading at a PE multiple of more than 100x for many years now.

Trent Ltd, which is a part of the retail venture of the Tata Group has had a phenomenal run in the stock over the last few years.

The stock is a massive 47-bagger over the last 10 years and an equally impressive 11-bagger over the last 5 years. Yes, that's right. Trent Ltd has multiplied invested money by 47x and 11x over the last 5 year and 10-year period respectively.

Do you know what was the PE multiple of Trent Ltd both 5 as well as 10 years ago?

Well, a little less than 10 years ago, Trent Ltd was priced at an extremely high PE multiple on a consolidated basis of close to 140x. Yes, no extra zeroes added. The PE multiple was indeed 140x 10 years ago. It's the same story for the five-year period also. The stock was trading at a consolidated PE multiple of close to 140x five years ago as well.

And do you know what is the PE multiple right now? A whopping 183x. Thus, Trent Ltd trades at a PE multiple of 183x even today.

As a matter of fact, there hasn't been a single day in the last 10 years or so where the stock has traded significantly below a PE multiple of 100x. The lowest it had gone to, was a PE multiple of 97x back in June 2017.

Other than this small dip below 100x, the stock has consistently traded at a PE multiple of more than 100x over this entire 10-year period. Even during the Covid crash of March 2020, the PE multiple stayed significantly higher than 100x.

You see, the markets may run on emotions and sentiments in the short term but in the long run, it is the growth and fundamentals that matter. In other words, a lot of stocks can trade at high PE multiples for a year or two driven by bullish sentiments around them.

However, to sustain those high PE multiples for as long as 10 years requires something special. It requires consistent growth, and it requires management intelligence, energy and integrity.

It won't be wrong to say that Trent Ltd has displayed all these qualities in spades.

The management has done a great job of growing the consolidated net profit from a loss of Rs 19 crores in FY14 to a profit of a whopping Rs 1,500 crores in FY24. The topline has also grown by 6x during the same period.

Almost all this growth has come without putting any pressure on the balance sheet. The company has had negligible debt all these years. Put differently, the company has grown almost entirely through internal accruals i.e. through internal cash generation.

It also has a solid competitive advantage in the form of deriving a bulk of its revenues through its own private labels.

You see, private labels not only ensure high profit margins, but they also give you a better control over the supply chain and lead to massive savings on the working capital front. And the company has milked both these advantages to some great results.

Hence, in a nutshell, I like what the company has done historically, and I also like the aggressive expansion plans that it has rolled out.

What I don't like though are the extremely high valuation multiples, which have remained consistently higher than 100x. In fact, the PE multiple is now touching the 200x mark.

So, what do you do when you like the company, and you like the management quality but are not comfortable with the valuations? Well, there are two options in front of you.

You either accept the sad reality that this is the sacrifice that you have to make for being disciplined and staying within your circle of competence and simply move on.

Or you can carve out a small 5%-10% of your portfolio for making investments in stocks like Trent Ltd, which do not exactly qualify as investments but are more of the speculative type.

You see, speculation is not bad as long as you know that you are speculating and are not doing with a large percentage of your portfolio. The danger arises when you don't know that you are speculating and have taken a large exposure to it.

Hence, Trent Ltd is not an investment for me based on my rule of having an upper limit for all my stocks.

It can be considered as speculation as long as I know what I am doing and allocating only a small percentage of the overall corpus to speculation.

What do you think? Where does Trent Ltd fit in your scheme of things. Is it an investment or a speculation or neither of these? Let me know what you think.