Outdated approach behind outlandish consumer stock valuations: Kotak

Excessive interest in forecasting quarterly results, cognitive bias and inability of industries to forecast their own performance accurately are behind the ‘outlandish valuations’ of consumer stocks, according to a research by Kotak Institutional Equities. 

“We believe the Street needs to review its valuation approach and arguments for consumer stocks,” said Sanjeev Prasad, who heads institutional equities at Kotak and is among the authors of the report.

According to data from the report, most consumer stocks are trading at 40-60 times the one-year forward price-to-earnings ratio, which is a measure used to verify if a stock justifies its earnings. “Most consumer stocks have delivered poor returns over the past 3-5 years , despite a disproportionate share of positive ratings,” Mr. Prasad said.

He said that popular sentiment had missed the changes in the business model of the companies as they “hope quarterly earnings may recover to 2010 levels”, use historical valuations benchmark even after they had become irrelevant, and excessive focus on quarterly results driven by consumer demand.

“The fact that the stocks have not gone anywhere for years does not seem to be bothering anyone, severe cognitive biases and overconfidence of companies about their ability to forecast events in an era of climate change and technological disruptions and the misguided belief among analysts and investors about their ability to forecast stock prices and developments based on companies’ guidance are the reasons behind this,” the authors said.