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...The harder they could fall. Beware! By D Kumar In the early 1990s, Coats Viyella was a growth stock that could do no wrong. Between 1988 and 1994, year after year, it notched up a growth rate of at least 15 per cent in its Earnings Per Share (EPS). Shortly after New Year's Day, 1994, Coats Viyella was sporting a price-to-earnings ratio of 74 -- almost thrice the market's multiple. No one realised that it had gone over the hill. The thread-and-apparel stock started its downhill journey immediately afterwards, losing 90 per cent of its value over the next two years. In a sustained decline, the stock price plummeted from a high of Rs 317 (January 31, 1994) to Rs 32 (November 28, 1996). Today, despite the bullish market, Coats Viyella is not showing any symptoms of a major recovery. Could you have seen the trouble coming? Maybe. If, that is, you had spent as much time looking at the company's topline as you did at its bottomline. Since 1993, Coats Viyella's sales have been erratic, with a moderate earnings stream. What's wrong woth that? Simple: a company cannot increase its EPS significantly faster than its sales for too long. Even if the gains in the earnings come by way of higher productivity, there is, eventually, a ceiling on efficiency. So, the time to buy these growth stocks is before they attain the higher profit margins -- not after they have attained them and a premium gets built into the stock price. Having seen the rise and fall of Coats Viyella, I thought I would identify the next growth stocks that could get into trouble. To do that, I sifted through a sample of the top 500 companies by market capitalisation, looking for those whose EPS had grown at least 30 per cent faster than their sales during the past three years. All the stocks that I have listed in the accompanying table are now trading at 20 or more times their 1997 earnings -- an indication that investors believe in the sustainability of their EPS growth. Take the case of E. Merck, the giant pharmaceutical transnational. It increased its sales from Rs 121.72 crore in December, 1993, to Rs 206.12 crore in December 1996: a 69.34 per cent gain. However, the net profit during the same period went up from Rs 4.26 crore to Rs 14.18 crore on an equity capital of Rs 16.86 crore. That translates into an earnings rise of 318.84 per cent. The sharp rise in the earnings looks unsustainable, given the comparatively modest sales growth over the same period. After my screening, I was left with 11 well-managed companies. Of these five are pharmaceutical majors and the rest, well-run transnationals, barring the 4-stroke motorcycles leader Hero Honda. Although the companies are well-managed, investors may have built unrealistic expectations into their stock prices. These companies are increasing their EPS much faster than their sales, and could well be vulnerable to disappointments. You could still hitch your wagon to their star. But then, don't say I didn't warn you. |
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