Auto Stocks: It's Darkest Before Dawn

An important question to ask when investing in the stock market is: What to Buy?

An equally important question is: When to Buy?

But the most important and difficult question in my view is: When to Sell?

However, the million dollar question which helps you decide when to buy and sell is this: How much is already in the price?

Every day, the market prices in both the good news as well as bad news in the price of every stock.

This is because the stock market is a forward looking animal. It discounts a lot of things in advance. And that is reflected in the price.

It's for buyers and sellers to figure out how much of the good news and the bad news is already in the price.

That's why it's the million dollar question.

Take the IT sector for instance.

IT companies have benefitted immensely from covid-led digitisation. After all, these companies were the enablers of digitisation. This has led to the massive growth in IT companies and this is expected to continue.

If I were to put it in terms of a manufacturing firm, I would say IT companies are operating at more than 100% capacity.

And the stock market has certainly rewarded them.

In terms of valuations, large cap IT stocks are trading at a 60% premium to their 10 year average PE ratio. Mid cap IT stocks are trading at a 100-120% premium.

So how much of the good news is already in the price?

Last year, when Covid started to accelerate digitisation, the stock prices were not factoring in the exponential earnings growth and re-rating of the valuations.

This led to 4-5x returns in most midcap IT stocks.

If during that time someone asked the million dollar question, the answer was clearly, no.

But what about today?

I agree some changes in the IT sector is structural in nature as the world gets more connected. This is a big positive.

However, the astronomical rise in employee costs and attrition rates are a headwind for these companies.

These stock prices have run up 4-5 times already. Analysts have revised their earnings forecasts upwards. They now forecast 20-25% growth in earnings for the next three years.

So to answer the million dollar question for IT stocks, yes, the majority of good news is factored in now.

Same question. Different answers at different prices.

That's what valuation is all about.

Let me draw your attention to an unloved and under owned sector in the market today: The auto sector.

Sales volumes in many automobile segments are still at 2017 levels or even lower.

This sector is suffering from every bit of bad news you can think of.

• All time high fuel prices: Up 27% in a year.
• Rising insurance costs. Insurance premiums for vehicles have gone up by 50% in 3 years.
• Price increases by manufacturers: They have hiked prices 15% in one year to pass on high raw material costs.
• Long-term uncertainty due to EVs: What will happen when more people demand EVs?
• Supply-side issues: The ongoing semiconductor shortage has caused serious problems.

These reasons explain why when the headline Nifty hits all-time highs, the auto sector is 15% below its previous high.

So let's us ask the same question: How much of the bad news is already in the price?

There are far are too many negatives and too much pessimism surrounding the auto sector. Market leaders like Maruti Suzuki and Hero MotoCorp are available at 28% and 30% below their historical peaks.

Is the market overly pessimistic or is it justified in shunning auto stocks?

The stock of the world's largest two-wheeler manufacturer is in a bear market. At the same time the benchmark index is scaling new highs.

The threat of electric two-wheelers is clearly making investors nervous.

And for good reason. Many consumers now desire electric two-wheelers. I too fell in love with the newly launched Ola electric scooters.

In the launch video, Ola felt more like a tech company. Bhavish Aggarwal, the CEO, felt like India's Steve Jobs who was making you fall in love with the product.

So does that imply market leaders like Hero and Bajaj Auto are history?

While new players like Ola are likely to be formidable competitors to incumbents, I ask myself this question.

Have the likes of Hero MotoCorp, Bajaj Auto, and TVS Motors done nothing all these years?

After all, they have huge cash balances to prepare for the next technological change. I am sure their managements have been in the business for more than 4 decades. Surely they're smart enough to figure out these things?

Or could the reason why they haven't been aggressive be they don't want to run their business at a loss?

After all, most of them are accustomed to making double digit operating margins in their core business. Focusing on electric two-wheelers would mean diluting those margins substantially.

Or maybe they want someone else to scratch the surface and then learn from it. Perhaps they want to learn how the product, supply chain, services and a host of other issues will develop once the EVs go mainstream.

I was talking to a friend who works on the shop floor of a leading consumer durables company. He told me that running an auto factory line requires years of experience to understand all the intricacies.

If a genius like Elon Musk faces mammoth issues in his product line and most of his Tesla models are delayed, then new players definitely will have to face a steep learning curve.

Based on my personal experience, I think it always pays to buy the leaders in an unloved sector which is fraught with all possible bad news.

I believe huge profits will be made by investors who buy the right auto stocks during times of uncertainty.

If you've been avoiding these stocks, perhaps it's time to starts warming up to them.

Warm regards,


Aditya Vora
Research Analyst, Hidden Treasure