Jitendra Kumar Gupta
Moneycontrol Research
It’s an opportune time for the deep value investors who are looking for mispriced stocks or ones that are trading significantly below their intrinsic value. Stocks across the sectors are tumbling, oil PSUs such as Hindustan Petroleum Corporation (HPCL), Bharat Petroleum Corporation (BPCL) and recent carnage in Dewan Housing Finance Corporation (DHFL), Yes Bank and many non-banking financial companies (NBFCs) are just examples of numerous falling knives.
While it is difficult to practice what Warren Buffett calls 'buy the fear', here are few points that can help in separating the wheat from the chaff.
Many of the stocks collapse for a reason and few offer an illusion of margin of safety, an idea based on the principles of value investing as taught by Benjamin Graham.
Evaluate: Do not try to predict the bottom
Last year, investors of Infosys were grappling with the important question of who would head the company after the Vishal Sikka and if the growth journey would get derailed as a result of intensifying strife between the management and the founders. Today, Yes Bank’s shares are struggling probably for the same reason as market fear the uncertainty over the exit of its founder CEO Rana Kapoor. Investors love falling stocks and try to make their quick guess about the bottom.
But in most of these cases including the past few like PC Jeweller, Dilip Buildcon, Vakrangee, Manpasand Beverages and Infibeam, the sequence of events and news unfold in an abrupt manner. The first and foremost thing to do is to wait, take a note of the crisis and think before calling the shot.
Does market know something that you are missing?
The investing legend, Howard Marks of Oaktree Capital coined this as ideas of second level thinking. A first-level thinker would always have an opinion about the future in terms of saying the company is good, outlook is favourable and stock will go up.
He says, “The second-level thinker takes many things into account: What is the range of likely future outcomes? Which outcome do I think will occur? What's the probability I am right? How does my expectation differ from the consensus? What will happen to the asset's price if the consensus turns out to be right, and what if I am right?”
Last year pharma stocks such as Sun Pharmaceutical Industries, Lupin and many others were falling and investors were looking at them as perfect opportunities. But a section of the market knew about the pricing pressure in US generics that would impair growth and impact valuations.
Often the market may be reading something more than what the headlines are saying. Management of crisis-hit companies like Manpasand Beverages, Infibeam Avenues and Kwality have issued several clarifications. But that also did not help as market continued to look for information elsewhere. It is better to ask that muted question before taking a plunge.
What is in the price?
At the time when the Nirav Modi-led scam hit Punjab National Bank, its reported net worth was about Rs 43,000 crore. This was in addition to the investments of about Rs 15,000 to Rs 18,000 crore in companies such as PNB Gilt, PNB Housing Finance, National Stock Exchange and others. Investors jumped into the stock hoping that even if the entire amount related to the scam is written off the bank should still be worth about Rs 45,000 crore. But the stock kept coming under pressure.
By the end of Q4 FY18, the bank surprised the market with a quarterly loss of Rs 13,400 crore. It followed that up with a Rs 940 crore loss in Q1 FY19, with net non-performing assets (NPAs) at 10.58 percent, which is massive on advances of Rs 4.38 lakh crore. A lot of these risk were not factored during the initial bouts of volatility. As the famous proverb goes, 'buy the rumour and sell the fact', markets often behave mischievously. It is thus important to separate the rumour from the fact and see what is in the price.
Is it cyclical or a structural issue?
Some stocks would probably never recover or they continue to languish forever. The real test is to understand if it’s a structural or a cyclical issue. Infosys had a bad patch last year due to change in leadership and once that was fixed it is back in the business and investors radar. About few years back, Bharat Heavy Electricals (BHEL) was hit by a crisis, and the company is currently trading at a 14 year low as it face serious threats and challenges to grow it business and find direction as opportunities dry up in the power sector.
Many of the IL&FS group stocks tumbled and the balance sheet of these companies are beyond repair.
Few years back Nestle had a difficult time when its flagship product - Maggi - was in the eye of a storm. For investors who believed that this was a short term phenomena, probably an impact for one or two quarters and company can survive with a few changes, this crisis turned out to be an opportunity. If one plots a 10 year share price graph of Nestle, this incident looks like a minor blip, which today is really difficult to spot.
Check value versus priceA stock falling from its 52-week high or stocks that have corrected the most grab more eye balls and investors often end up buying low price stock without realising what they are buying.
Lot of state-run banks look cheap on the basis of their price-to-book value. Even at half that ratio, market is not willing to buy them as they fear that the current book value may lose its relevance in the light of NPAs and the requirement for provisioning, which will ultimately erode book value.
If you can find a mispriced opportunity there is nothing like it. “Long term value investors have greater scope to produce superior risk-adjusted returns when the seas are rocky. The valid response when there's a crisis is to focus on the end destination, what value investors call intrinsic value, and not worry about whether the next wave is going to push the boat up or down”.
Marks focuses on intrinsic value. A cheap stock could remain cheap forever if the value is destroyed. Stocks like Gitanjali Gems never recovered from that cheap zone as the business was completely wiped out post the Nirav Modi crisis. Thus, price is important but only in relation with the value that one gets.
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