What to Know About Stocks with 200x P/E... 

What does a price to earnings ratio (P/E) of over 200 times for a stock mean?

It means that if you were to hypothetically buy 100% of the company's shares, it would take 200 years for you to earn back your initial investment through the company's ongoing profits.

However, that 200-year estimate would change if the company grew exponentially.

Let's take an interesting example of a very popular stock Dixon Technologies.

The company is a leading manufacturer of electronics products, with two kinds of businesses:

OEM - In this model, Dixon acts as an executing firm. They simply assemble the products based on the customers specification.

ODM - In ODM, Dixon will produce the product from scratch including the design and the selection of raw material using its in-house R&D.

The company has been a key beneficiary of the post Covid China plus one megatrend wherein global electronics majors sought out alternative production hubs.

It also received the bulk of the government's production linked incentives (PLI) for local manufacturing.

Market euphoria about the company's prospects has perched the stock at an earnings multiple of 200.

Is that sustainable?

Let us find out by figuring out what can the earnings growth do to the company's valuation multiple.

Dixon Technologies has grown its earnings at a compounded rate of nearly 40% over the past decade.

Let's assume the company retains the stellar rate of growth and the stock price stays nearly stagnant.

As the earnings grow, the stock's P/E multiple will deflate from the current astronomical 200x. We need to figure out how soon it comes close to its return on equity (ROE) i.e. around 26%.

With 40% annual growth in earnings, it could take just about 6 years for the P/E multiple to settle around 26x, near its ROE.

But sustaining the 40% growth in earnings will be a challenge.

Dixon's recent attempt to partner with a Chinese company is a case in point.

Dixon Technologies, recently filed for regulatory clearance for its proposed JV with Chinese company HKC Corporation. This will be to primarily manufacture liquid crystal modules and thin film transistor liquid crystal display modules.

Going forward, Dixon is also looking at similar partnerships for components such as camera module and bare PCBs (printed circuit board), among others.

As per Foreign Direct Investment (FDI) rules of 2020, entities or individuals based in countries sharing land borders with India require prior government approval.

But Chinese counterparts cannot be majority stakeholders in the JVs.

Therefore, Dixon's China JV could face several prolonged hurdles.

At the same time, news reports suggest that India is looking to offer short-term visas to Chinese technicians, for no more than six months.

This is to help with the implementation of projects related to the electronics PLI scheme.

Given the existing skill gap in the industry, the knowledge and expertise of Chinese workforce will further help boost domestic manufacturing.

About US$ 11 bn worth of electronics components are manufactured in India. And around US$ 30 bn of electronic component requirement is met with imports.

Of the total imports, around 37% is from China.

While domestic production of electronics items has grown by about 2.5 times over the last five years, the domestic value addition is only around 15-20%, as most of the critical components are imported.Over the last two decades, China has built a lot of infrastructure and scale for electronics component manufacturing. India is looking to replicate that success to become a global electronics manufacturing powerhouse.

The Dixon-HKC Corporation partnership might be the first of many to help Indian EMS companies to climb up the components manufacturing value chain faster.

Although India-China relations have been souring for the past couple of years, India's dependence on Chinese imports for electronics has not tempered.

Moreover, electronics exports from India would depend on cost competitiveness.

Indian manufacturers experience an 8 to 10% cost disadvantage compared to global competitors.

Government's sops such as the Production Linked Incentive Scheme (PLI) and Scheme for Promotion of Manufacturing of Electronic Components (SPECS) have addressed these cost disadvantages of manufacturing in India to an extent.

But companies such a Dixon remain heavily dependant on such sops to climb up the manufacturing value chain profitably.

So, coming back to Dixon's possible earnings growth and related valuation.

With around 20% annual growth in earnings, it could take almost 11 years for the P/E multiple to settle around 26x, near its ROE.

And the number of years could go to as high as 15 if the EPS growth moderates to 15% per annum.

Such prolonged phase of sluggishness in the stock price can be hardly acceptable.

The macro picture of the electronics manufacturing sector, meanwhile, is very intruiguing.

It is being said that Electronics is the new Defence for Indian stock markets.

India, today, is a major player in the global electronics manufacturing industry. The country is rapidly becoming an electronics manufacturing hub, with the sector expected to rise to $ 300 billion by 2025-26.

This growth can be attributed to the government's push to promote domestic electronics manufacturing, which has led to increased investment and the creation of new jobs.

The global electronics manufacturing services (EMS) market is projected to reach $ 1145 billion by 2026, registering a CAGR of 5.4% during the forecast period 2021-2026. From $ 9.8 billion in 2021, India's domestic demand for consumer electronics is seeing significant growth and is expected to touch $ 21.18 billion by 2025.

India is also home to the world's second-largest smartphone market, with over 1.3 billion mobile phone users in the country. This presents a huge opportunity for companies and investors looking to tap into the manufacturing of smartphones and other electronic devices.

Key government initiatives aimed at boosting domestic production of electronics and IT hardware include the Scheme for Promotion of Manufacturing of Electronic Components and Semiconductors (SPECS), which offers financial incentives for the production of electronic components and semiconductors.

The Modified Electronics Manufacturing Clusters (EMC 2.0) initiative seeks to establish world-class infrastructure for electronics manufacturing. The government has also liberalized foreign direct investment, allowing up to 100% FDI for electronics manufacturing.

Another important factor contributing to India's emergence as an electronics manufacturing hub is the country's highly skilled workforce.

India is home to a large pool of technical and engineering talent, with many of the country's top universities offering courses in electronics and engineering. This has made India an attractive destination for multinational companies looking to set up research and development (R&D) centers and manufacturing plants in the country.

So the big picture is undoubtedly very attractive and may remain so in the coming years. But investors must be careful of valuations.

While the China JV prospect seems to be powering the stock of Dixon for now, any major bottleneck could dampen investor optimism about the stock to a significant extent.

Hope you like this video. Thanks for watching.