Return expectations need to be moderated. Over long term, our returns tend to gravitate towards the growth rate of the economy or the set of companies we are investing in.
The legendary Warren Buffet once said “Be fearful when others are greedy and be greedy when others are fearful”.
Why we as investors fail to learn this lesson time and again. Why do we do the exact opposite i.e. sell when there is fear and buy when there is exuberance?
Didn’t the same thing happen in Indian markets during the last 2 years?
Well, demonetisation, low interest rates, low inflation and lower crude coupled with huge inflow of foreign capital looking for that additional returns fired the stocks of all categories in the market. Caution was thrown to the winds, as asset prices reached stratosphere. It seemed as if we were going to re-write Newton’s laws on gravity.
And the inevitable happened. There needs to be a reason for blow out of any bull market & the current one seemingly topped out in January 2018 post the introduction of long-term capital gains tax. Stocks started crashing like nine pins. The smallcaps were first to go, where most of the stocks have lost around 50-75% of their peak values. Then came the mid-cap stocks. But surprisingly, the large ones are still holding and we can never be sure of where the stocks in this particular segment will head in the short term.
As a small-time retail investor, who has primarily invested in small & midcaps, we have all been hopeful that this bear run will end. Our hopes have only magnified and are inversely proportional with the fall in stock prices. The more the stock prices go down, the more our hopes of recovery goes up. Well, the market will test our patience to no extent.
What have we learnt over the last 2 years now?
-Fundamentals & valuations need to converge. Where the stock prices race ahead of fundamentals, which in turn move slowly, the fall in valuations is inevitable. Keep aside small & mid-caps, even many blue chips which raced ahead much in terms of valuations have shown this tendency to converge slowly and painfully.
-Temperament & style of investing needs to be mastered. Not everyone can invest in all kinds of companies or situations. No wonder, people have burnt their fingers while investing in commodity stocks, cyclical stocks, small caps, turn-around stories etc.
For example, to make money in sugar sector or steel, one has to understand the supply/demand dynamics of that sector. Only plain numbers in annual reports won’t work. As they say, buy when the price-equity (PE) ratio is highest and sell when the PE ratio is lowest for commodity stocks. Its counter intuitive, right.
Since commodity prices have historically followed cycles, the earnings power is not sustainable in the long run. You have to buy at the bottom i.e. when the commodity prices are low and the companies generally have low profits or losses, in effect giving it a high PE in numerical terms.
You have to sell when the commodity prices are high, that is when the peak profitability of the company is hit, and the valuations hit single digits in purely numerical terms. Since from there, the way is generally downward for cyclical/commodity businesses.
- Corporate governance is non-negotiable. When it strikes, it strikes hard and darlings of the last few years lose the value created over those years, in a matter of days, not weeks or months.
And the truth is that rumblings are there in market and the financials/numbers for some time. Instances of CXOs resigning, directors or auditors quitting seem to be the final straw.
- Coat tailing or simply copying marquee investors while investing, doesn’t work in isolation. Yes, it can act as an idea or a lead generation, but conviction is personal. We should have conviction on the stock, not the investor whom we intend to follow.
- One sector cannot be a substitute to another sector over long term.
For example, unorganised to organised theme in some sectors like building materials, banks to para banks like NBFCs, etc. as a theme was bound to fail since instead of focusing on adding on they were simply replacing the incumbents without any substantial change in the business model or governance practices.
Return expectations need to be moderated. Over long-term, our returns tend to gravitate towards the growth rate of the economy or the set of companies we are investing in. Very few people manage to beat these rates over long term.
As investors, we have borne the brunt of the bear market and now actually we need to do, what needs to be done best at this point of time.
i. Move to better quality stocks especially which have shown consistent growth in numbers including generating cash flows at operating levels over years.
ii. Yes, corporate governance can’t be predicted, but elimination surely works in this case. Instead of focusing on promoters or CXOs, focus on companies which are people agnostic.
iii. The companies should be debt free ideally or have a minimal amount of debt if any, preferably on the working capital side.
iv. Profitability in operations over a few years consistently is a must. This will help us enjoy the growth in the valuations also consistently.
v. Buy at a reasonable valuation. A good stock might be a bad investment at high valuation as well, since you are left with a few years before fundamentals catch up.
Well, it is a difficult task getting rich and it is a more difficult task when we realize that we can get rich slowly in the markets. Every few years, the bear markets teach us that we need to stay like forever in the markets to make money.
In effect, there is no short cut to either success or riches.The author is Vice President - Kotak Mahindra Bank. The views expressed in this column are purely personal and doesn’t constitute any investment advice.You can now invest in mutual funds with moneycontrol. Download moneycontrol transact app. A dedicated app to explore, research and buy mutual funds.