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If things go as expected, Coal India can end up giving good returns over the next 1-2 years.

In fact, my back-of-the-envelope analysis tells me that the upside could be as high as 80%-100%. That is a gain of almost 2x.

Now, don't label me a cold-hearted capitalist who wants to make money at the risk of environmental damage. Please know that I'm nothing of the sort.

I'm all for green energy. I do seriously believe that we need to leave the world in a much better shape than we found it for our future generations.

However, the transition to a predominantly green world will take time. We can't just end our dependence on fossil fuels overnight. Coal will continue to be an important component of our energy matrix.

And it's from this vantage point that Coal India looks like a good risk-reward bet over the medium term. Of course, if given a choice between investing in renewable energy stocks versus fossil fuels, I will always prefer the former over the latter.

But then there's also something known as fundamentals and valuations. And it's here that I'm not getting a good degree of comfort from the green players.

Take Adani Green for example. A stock that earned an EPS of only 3 per share over the last twelve months, is trading for more than 2,000 per share right now.

This translates into a PE ratio of a mammoth 700! That is like investing 1 lakh in a bank FD and receiving only 143 as your yearly interest.

Of course, Adani Green has huge capacities lined up and its earnings may skyrocket in the future.

However, the stock is more a bet on Mr Adani's entrepreneurial skills than on the company's fundamentals itself. And this is something I'm not very comfortable with. I tend to be more about the horse than the jockey.

When it comes to Coal India, I know nothing about the jockey. But I do like the horse to be honest.

The company has a long history, has been consistently profitable, has almost zero debt on its balance sheet and has never once missed paying a generous dividend as far back as I can see.

Over the last 10 years, the company has traded at an average PE multiple of almost 13x in the share markets in India.

Of course, it has swung wildly from as high as 25x to as low as 5x. But an average of 12x-13x is a decent PE multiple for Coal India. This is not just from an absolute standpoint but also compared to the price-to-earnings ratio of Nifty, of which it is a constituent.

Thus, with a PE of 13x, the stock needs an earnings per share of 37 per share for the stock to double over the next 1-2 years.

Is this EPS achievable? This is precisely what the company has achieved over the last 12 months. Its trailing twelve-month earnings currently stand at 37 per share, exactly where we want it to be.

Hence, with both the PE multiple as well as EPS well within the realms of possibilities, the upside from current levels does look like a strong possibility.

I know you are concerned about whether investors would be willing to pay the stock a PE multiple of 12-13x. After all, a lot of them are hostile towards fossil fuel companies. However, not a long time ago, similar concerns were being raised around oil & gas stocks and even tobacco firms like ITC.

But once oil prices rose and it became clear that the transition to green energy may take time, a lot of the sector's stocks were back on investors' radar.

Something similar may happen to Coal India as well. Once the company starts showing results on both the topline as well as the bottomline front, investors won't be able to stay away for long. Besides, the downside from the current levels seems limited due to its strong dividend yield.

Therefore, the stock is a classic 'heads I win, tails I don't lose much' kind of a bet. What do you think? Is our analysis correct or do you see some flaws in it?

Well, a strong upside in a stock like Coal India may not be 100% certain.

But I believe that a portfolio of 25-30 stocks with the same fundamentals and undervaluation as Coal India, has a very strong chance of outperforming a portfolio of 25-30 stocks with the same fundamentals and overvaluation as Adani Green.

Going where Mr Market is quite fearful and exiting where it has turned overly greedy has often worked out well in the past.

Mr Market does seem to be in a fearful mode as far as Coal India is concerned.

Disclaimer: This article is for information purposes only. It is not a stock recommendation and should not be treated as such.

This article is syndicated from Equitymaster.com

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