HDFC Bank: High Quality Expensive Stocks Can Give Great Returns

We’ve really made the money out of high quality businesses. In some cases, we bought the whole business. And in some cases, we just bought a big block of stock. But when you analyze what happened, the big money’s been made in the high quality businesses. And most of the other people who’ve made a lot of money have done so in high quality businesses.

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. – Charles Munger

Anybody who has been investing in the Indian stock market will know about HDFC bank. It is considered a quality stock by most people. It has always traded expensively.

Let us now look at some figures:

HDFC Bank performnce since 2000

The performance of HDFC bank from 2000 till date has been superb when compared to the CNX Nifty index. It has given a cumulative return of 2027% versus 326% for the CNX Nifty index. The CAGR for HDFC bank has been 24.4% while the CAGR for the index is 10.93%. Great performance.

HDFC Bank performance 2000-2008

Let us look at the growth from 2000 to 2008 peak before the financial crisis hit the global stock market. The CAGR during this period has been 33.08% for HDFC bank and 18.47% for the index. 18.47% annually is great but 33.08% is great. At this peak HDFC bank was quoting at a P/E ratio of while the Nifty’s P/E ratio was 27.8 while HDFC bank’s P/E ratio was around 40. Very expensive stock. Now, if you like an ordinary lay man had thought that HDFC bank will never let you down and you buy shares at the peak price in 2008. One share would have cost you around Rs 350.

HDFC Bank performance 2008 to date

Then the financial crisis come and the stock falls close to 60% while the index also falls close to 60%. If you believed in the quality of the stock and bought more, great. Even if you did not and just kept the stock and did not sell it, today the price is close to Rs. 730.So even if you paid a expensive amount for the stock in 2008, the fact that the stock was high quality saved you in the long run. Your CAGR despite losing 60% in the first year has been around 18%  from 2008 till now compared to 1.29% for the index. You see, quality wins.

I do not know whether this will true in future years. But I doubt it will underperform. Buying quality stocks at seemingly expensive prices will still give you a great return than buying cheap stocks of poor quality. This is one lesson we all need to learn.

So learn from the likes of Charlie Munger and you will be safe. The ride may be rocky but you will get there in the end.

So should you buy HDFC bank today. I think so.

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