Karan Deo Sharma
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/30-stades/media/post_banners/Ofxb9ePVpidnwfqeNkrL.jpg "Top 10 stocks with highest cash flows (2)")
The Reserve Bank of India stayed on its inflation-fighting course and raised its policy rate by 35 basis points on Wednesday. With today’s rate hike, India’s central bank has cumulatively raised interest rates by 225 basis points (2.25 percent) and benchmark interest rates such as bond yield are now at a four-year high.
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A hike in interest rates increases the borrowing costs for companies, governments and individuals. For companies and businesses, higher borrowing costs translate into lower profits while for households it means a decline in disposable income as EMIs on their personal and home loans go up.
The governments and taxpayers also feel the pain as a rise in interest rate translates to higher interest on public debt. The result is either lower public spending or higher taxation or a mix of both. All these have consequences for growth, investment and the overall consumer demand in the economy.
Also Read:Five ways to grow your money during high inflation
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The biggest direct impact for investors from higher interest rates is felt in asset markets including stocks. A rise in interest rate makes it financially less attractive to hold stocks and there is a downward revision in stock valuation. The link was summed-up perfectly by the legendary American businessman and investor Warren Buffet. “The value of every business, the value of a farm, the value of an apartment, the value of any economic asset is 100 percent sensitive to interest rates. The higher interest rates are, the less that present value is going to be,” said Mr Buffett at Berkshire’s annual meeting in 1994.
While higher interest is broadly bad for stock prices, the impact would not be uniform for all companies and sectors. In fact, higher interest rates may be beneficial for some businesses and sectors.
According to market analysts, the biggest negative impact will be for the growth stocks, where bigger profits and cash flows are often projected for distant years, even though the company may be generating little or no profits at all currently. Market analysts and large institutional investors use the interest rate to discount future earnings and calculate the present value of a company’s future profits.
The higher the interest rate the lower the present value of future cash flows. This hits the valuation and stock price of growth stocks which project big profits and cash flows ten to fifteen years from now.
Also Read: Four financial ratios to help you buy the best stocks
In contrast, there is only a small decline in the valuation of mature businesses which may be growing slowly but are highly profitable and generate a reasonable amount of cash flows from their existing operations. These mature companies typically tend to have lower valuation ratios such as price-to-earnings multiple and price-to-book value ratios and thus are called value stocks.
Value stocks become more attractive in a rising interest rate environment and thus tend to hold their value better than growth stocks.
These value stocks generally tend to be in sectors such as electricity generation and distribution, oil & gas sector, commodity producers including metals and mining companies, telecom service, IT Services and consumer goods companies. While there has been a rally in most of the high-earnings stocks from these sectors, quite a few of them are still attractively valued and could see a further rally if interest rates rise from here.
Also Read: Rising interest on loans: 5 money tips to lower your anxiety
Many analysts also expect banks to benefit from higher interest rates as it allows them to charge higher interest on their loans. Higher interest rates however also increase the bank’s borrowing cost as they have to raise interest on deposits. Besides, a rise in borrowings lowers corporate profitability leading to business failures and bad loans. Given this, the net gains to banks from higher interest rates, in the longer term, are debatable and uncertain.
Here are the top ten Indian companies that generated the maximum amount of cash flows from their operations in the last three years.The analysis is based on the annual consolidated finances of BSE500 companies for their last three fiscal years.
At the top of the list is Reliance Industries which generated nearly Rs 77,500 crore from its operations in the last three years on average. In comparison, its current market capitalisation is around Rs 18 lakh crore translating into a cash P/E ratio of around 23X.
Next is public sector ONGC which generated Rs 65,300 crore on average in the last three years. At its current MCap of Rs 1.77 lakh crore, the stock is valued at a cash P/E of just 2.7x.
Telecom operator Bharti Airtel is next on our list with annual cash flows of around Rs 40,500 crore on average in the last three years. Its current MCap of Rs 4.82 lakh crore gives it a cash P/E ratio of 11.9x.
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IT major Tata Consultancy Services is the fourth-biggest company as per the parameters and generated cash flows worth Rs 37,000 crore in the last three years on average. Its current market capitalisation of Rs 12.37 lakh crore translated into a cash P/E of 33.4X.
Tata Steel is next on our list as the company generated annual cash flows worth Rs 36,300 crore on average in the last three years. At its current market capitalisation of Rs 1.36 lakh crore, its cash P/E ratio is 3.7X.
Other big cash earnings companies in our list include NTPC (Rs 32,700 crore on average in last three years), Power Grid Corporation (Rs 28,800 crore), Indian Oil Corporation (Rs 27,100 crore), Vedanta (Rs 26,100 crore) and Tata Motors (Rs 23,300 crore).
(Disclaimer: This article is for information purpose only. Readers are advised to consult a certified financial advisor before making investment in any of the funds or securities mentioned above.)
(Karan Deo Sharma is a Mumbai-based finance and equity markets specialist).
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