Asian Paints: A Bluechip Losing its Shine? 

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

At what price levels will the risk-reward equation in Asian Paints will become favourable for the investor?

When will there be a greater possibility of making money in Asian Paints as compared to losing it?

Has that moment finally arrived? Or is there more pain to come?

Let us try and get answers to all these questions and more over the next few minutes.

But first, a small revision.

Asian Paints, the bluest of bluechips, is not having the best of times in the Indian stock market.

The stock is down almost 30% from its 52-week highs at a time when the broader index is down just 4%. This means that Asian Paints has lost 4 times as much as the benchmark.

Asian Paints' performance over the last 3 years hasn't been spectacular either. It is down 20% in the last 3 years.

Compare this with the benchmark index, which is up almost 40% during the same period.

So, while Asian Paints is minus 20% in 3 years, the benchmark is plus 40%. Thus, Asian Paints is a significant underperformer over a 3-year period as well.

Well, there is some good news for Asian Paints investors if you consider the 10-year performance.

Over 10 years, Asian Paints has given a CAGR of 13% versus the 11% CAGR of the benchmark index, thus emerging as a slight outperformer.

So, that's a summary of the past performance.

What about the next 3-year and 10-year period, however?

Will Asian Paints be able to outperform the benchmark index over the next 3-year and 10-year periods? Or will the share price remain under pressure in view of the growing competition in the domestic paints industry?

To answer these questions, we may have to understand why the stock is down 30% from the top and whether those factors are reversible.

Well, the stock fell 30% because one does not expect a company like Asian Paints to record a 40% fall in profits. Yes, that's correct.

Asian Paints suffered a massive fall in profits recently as it had to take a price cut to tackle industry slowdown as well as the intense competition.

I believe the company had to make the difficult choice between protecting market share and protecting margins.

If the results are any indication, it has decided to protect market share and sacrifice margins.

To make matters worse, while it is expected that the second half may do significantly better, the overall performance may still lag that of FY24.

Thus, it is expected that the company could close the year at an EPS that's lower than the Rs 57 per share it achieved in FY24.

Let us assume this number to be around Rs 50 per share. Also, the stock has traded at a median PE multiple of around 61x over the last 10 years. Hence, even a half decent investor can multiply the two numbers and arrive at an intrinsic value of Rs 3,050 for the stock of Asian Paints.

This is around 25% higher than the current share price. If the stock reaches this price within 2 years, it can amount to a decent return for the investor. However, anything more than two years, and it will be considered a below par performance in my view.

Another possibility is that the stock trades at its 20-year median PE multiple of around 50x and not its 10-year median of 60x.

Thus, if you consider 50x as the ideal PE multiple to pay for the stock then the fair value comes to around Rs 2,500 per share which is close to the current share price. This makes the stock unattractive from a risk-reward perspective.

Please note that an average stock in the Indian stock market does not command a PE of more than 18x-20x on a consistent basis. But Asian Paints is certainly not your average stock. It is one of the finest run franchises in the country.

It boasts of a stellar long term track record, a great management team and of course, a bright long-term future.

But what are these qualities worth? Are they worth the 3x premium that Mr Market has given to Asian Paints over the last 10 years or the 2.5x premium over the last 20 years?

You see, one way to look at valuations is to break down the PE ratio into two components. The 'normal' component and the 'quality' component. The normal component is the PE ratio that you would give to a normal business.

The quality component is the premium that you will pay for the superior quality.

So, if a stock is commanding a PE ratio of 40x, the investors are willing to pay a quality premium of 2x over normal business.

Now, Asian Paints has commanded a PE ratio of 60x and 50x over last 10 years and 20 years respectively. This means that investors were willing to pay a premium of 3x and 2.5x over normal business.

At its peak, Asian Paints commanded a PE multiple of a whopping 120x. This means that the premium Mr Market was willing to pay over an average business was a huge 6x.

Now, this 6x premium has already come down to just 2.5x as the stock's current PE is 50x.

But is this 2.5x premium also on the higher side? Is a 50x PE multiple to a stock like Asian Paints on the higher side?

Well, to be honest, the answer to this question lies in the future. The future will decide whether the 2.5x premium is sustainable or even this was on the higher side.

It will be decided by the management of Asian Paints and its game plan to not only tackle the rising competition but also ensure good long-term growth.

If the past is any indication, the management may pass even the current test with flying colours. However, as investors, we should certainly err on the side of caution.

Put differently, the premium that one should give to even the best franchises should not be more than 1.5x to 2x in my view.

From a PE perspective, this translates into a PE of around 30x to 40x.

This is the maximum PE one should pay for any stock, no matter how strong the franchise or how bright the growth prospects.

To be honest, I have no logic to back up this number of 30x to 40x.

I have only experience to rely upon, an experience of almost 20 years. 20 years of tracking and analysing companies. You can consider this as my broad thumb rule for staying out of trouble.

Of course, for Asian Paints to come within the upper end of my recommended range, it will have to fall another 20% from the current levels. Whether it will fall by that much is hard to say to be fair.

But this is the stock market where, to use a cricketing terminology, you don't have to play every ball that is bowled to you.

If the ball is outside your hitting range, you can very well let it go and wait for another ball to come your way.

So, I do love Asian Paints and feel that it has a great future despite the intensifying competition.

But I also believe that there is a certain maximum value that needs to be paid for every stock.

And you have to decide this value yourself and not get influenced by any external source.

Well, based on my idea of maximum value, the risk -reward in Asian Paints does not seem to be in investor's favour just yet. May be I am being too conservative.

What about you though? Do let me know what you think of my estimate and your own approach to this whole matter.

I will see you again in the next session. Good bye and happy investing.