Is Asian Paint a good stock to buy on current levels and hold for next 20 years ?

Asian Paints Analysis

COMPANY ANALYSIS

RTI For Money, Lillaney

7/1/20235 min read

Asian Paints
Asian Paints

Next 20 years?


A lot can and will change in 20 years.


But let’s try to make an educated guess about what could happen to Asian Paints by 2 methods.


  1. Quality investing method

  2. Growth investing method


  1. Quality investing method


The best way to think about such a long period according to me is the way Terry Smith thinks about investing. He is a fund manager in the UK who only invests in quality companies and has the following rules for investing in companies where he ideally intends to invest and hold forever.


Rule 1 : Invest in only quality companies which earn high returns on capital.


He often quotes the below from Charlie Munger who is Warren Buffett’s right hand:


"Over the long term, it's hard for a stock to earn a much better return than the business which underlies it earns. If the business earns 6% on capital over 40 years and you hold it for that 40 years, you're not going to make much different than a 6% return—even if you originally buy it at a huge discount. Conversely, if a business earns 18% on capital over 20 or 30 years, even if you pay an expensive looking price, you'll end up with a fine result."


Rule 2 : Don’t overpay


Although there are various studies done where it is shown that the starting price does not matter that much if you invest for the long term (think decades not years) he tries to still try and not overpay by comparing the free cash flow and dividend yields of the companies he is investing in with the following:


  1. Other companies in the same industry/sector

  2. Other companies in the same market

  3. The market itself

  4. Bond yields


Rule 3 : Do nothing


He says that after you have found a good company by following rule 1 and invested following rule 2 during downturns in the stock prices the toughest thing to do is to sit back and let the companies do their thing. This is because human beings are designed to be active all the time whether it is productive or not.


Let’s try to apply the above rules for Asian Paints.


Rule 1 : Invest in only quality companies which earn high returns on capital.


To understand if a company is a high quality company we need to look at the following ratios.


  1. Return on capital employed / Return on equity

  2. Profit margins

  3. Cash Conversion

  4. Debt / Equity

  5. Interest coverage


Lets see how Asian Paints fares on the above ratios.


  1. Return on capital employed / Return on equity


Return on capital employed has been between 30 and 47 percent for the last 10 years.


Return on Equity has been between 23 and 35 percent for the last 10 years.


Ideally the returns on capital / equity should be higher than the 10 year bond yields and the market / index returns for the last 10 years.


  1. Profit margins


Profit margins have been at more than 16% in the last 10 years.


Ideally the profit margins should be high enough to withstand downturns.


  1. Cash Conversion


Cash conversion has been between 20% and 80% with an avg. at 60% in the last 10 years.


Ideally this should be at more than 100%.


  1. Debt / Equity


Debt / Equity has been between 0.11 and 1.65 in the last 10 years.


Ideally the debt should be as low as possible.


  1. Interest coverage


Interest coverage has been between 32 and 97 times.


Ideally the interest coverage should be more than 2 times.


Based on the above data it seems like that Asian Paints has been a high quality company as its returns on capital / equity are high and its profit margins are decent.


The cash conversion could be better and needs to be closely watched over the next few years.


The leverage ratios of debt / equity and interest coverage are good too.


Rule 2 : Don’t overpay


To determine if the stock is overpriced or not we need to look at the free cash flow yield and dividend yield of the company.


Free Cash Flow = Operating Cash - Capex


Free Cash Flow = Rs. 4,193.00 Cr - Rs.1,446.00 Cr


Free Cash Flow = Rs. 2,747.00 Cr


Market Cap = Rs. 305,078.00 Cr


Free Cash Flow Yield = Free Cash Flow / Market Cap


Free Cash Flow Yield = Rs. 2,747.00 Cr / Rs. 305,078.00 Cr


Free Cash Flow Yield = 0.90%


Dividend Yield = 0.81%


Based on the above data of free cash flow yield and dividend yield it seems that the stock price is expensive.


The reason is that I can easily buy a bond which will give me a 6-7% return compounded over a 10 year period which would be a better bet if I have a 10 year view.


If I can take more risk I could buy an index ETF / mutual fund which has historically given double digit returns.


Based on the above rules of Terry Smith it seems that although Asian Paints is a high quality company it is slightly expensive at the moment and can be bought when the stock price corrects for any reason.


If you would like to know more about Terry Smith and his methods you could read it in his book Investing for Growth which you can buy here -> https://amzn.to/42tZNbL


Let’s try to see it from another point of view.


  1. Growth investing method


Sales and profits have grown at more than 12% compounded for the last 10 years which means its sales and earnings could double every 6 years if it continues at the same pace.


Current earnings - say x

Earnings in 6 years - 2x

Earnings in 12 years - 4x

Earnings in 18 years - 8x

Earnings in 24 years - 16x

Earnings in 30 years - 32x


At the end of Mar 2023 , EPS was around Rs.40 and price was around Rs.2,700 giving a P/E of 2700/40 which is approx. 67.5 and a bit on the higher side than normal.


If the above assumptions are correct the EPS in March 2041 would be 40 * 8 = Rs.320.


Assuming a P/E of 40 the price would be 320*40 = Rs.12,800 which is 4.7 times the price of Rs. 2,700 at the end of March 2023.


If we consider a price increase of 4.7 times in 18 years it indicates a growth of less than 10% which is not a good return.


Assuming a P/E of 60 the price would be 320*60 = Rs.19,200 which is 7.1 times the price of Rs.2,700 at the end of March 2023.


If we consider a price increase of 7.1 times in 18 years it indicates a growth of around 12% which is a decent return but we could get a better return by investing in an index ETF/fund.


If you would like to know more about growth investing, you can do by reading the books below:


  1. Common Stocks Uncommon Profits by Phil Fisher - https://amzn.to/420BrGY

  2. Buffettology by Mary Buffett - https://amzn.to/3AU7cWw


Conclusion:


Based on the findings from both the methods above I would not recommend a buy in Asian Paints at the current levels. We could have a look at the stock if its price corrects and it is out of favour without corresponding change in fundamentals.