Market Euphoria

Dear friends,
It has been four months since my last blog and it has been a very interesting four months. After the moderate meltdown from Nov 22 to March 23, the markets are rising relentlessly triggered by FII inflows. My own portfolio is at an all time high and that obviously gives a very good feeling. However, it is time to be cautious, given the high valuations the stocks are currently commanding. The big question is whether this will sustain or we are likely to have a good correction like we had in March 23. While none can really predict with good confidence what Mr. Market will do in the near or medium term, it would be interesting to look afresh at various reasons broadly responsible for market direction. Let me try to list them out and have a close look at all of them. There are positives and negatives and how they will weigh against each other is a question.

Negatives Possibilities:

1. Ukraine war: It is now 16 months and we don’t see an end to the hostilities still. The commodities have cooled off though to a large extent. Crude oil prices, which have a profound effect on the Indian economy and especially the inflation, have cooled down too. However, we are not getting the Russian crude as cheap as we were getting before. As per a report, the deep discount of up to $30 per barrel has shrivelled to just $ 4 a barrel due to a steep hike in transport costs and other factors.
2. Fiscal tightening by the Feds: All analysts are now saying that there is likely to be no recession in the US and if at all one happens, it will have a very soft landing. US inflation has come down but it is likely to be sticky hereonwards and a couple of interest rate hikes could not be ruled out.
3. Indian economy is likely to do much better but tepid growth in Indian corporate earnings will lead to a fall in stock prices.
4. Elections in India and the US, though quite a few months away, still, can make investors anxious and make them sit on the sidelines.

Positives Possibilities:

1. Ukraine war coming to an end, though now this won’t have much effect except some temporary sentiment boost.
2. Good monsoons: This will help keep inflation in control and lend overall buoyancy to the economy through domestic consumption.
3. Corporate earnings do not get further depressed and GDP growth picks up. This seems more likely than not with every passing month. The GST collections are record high, manufacturing is picking up and despite gloomier pictures around the world, the Indian economy seems to be in a sweet spot. This will no doubt attract foreign capital.

How costly are the markets now: The BSE Sensex is currently quoting at a PE of over 26 against a long term median of 19-20. The ratio of BSE smallcaps index to Sensex is over 0.51 against long term median of 0.44. There is no doubt that the markets are overheated. Valuations of many individual stocks in the smallcaps space are really running far ahead of fundamentals.

The markets are generally efficient but not always efficient. They have their cycles of greed and fear. And these cycles give opportunities to a long term value investor to buy an asset at a discount to its intrinsic value during the fear cycle and to sell at a premium to its intrinsic value during a greed cycle.

Charlie Munger

Calculation of intrinsic value involves qualitative analysis of the business. Simply put, the intrinsic value is the present value of the cash generated by the business in the future years of its operation. This analysis is more of an art than science since the judgement of the investor in assessing the business growth and the foreseeable future period of operation is crucial, in near-correct assessment of the intrinsic value. Needless to say that this calculation can’t be very precise and more often than not, it is a range rather than a single value. It is for this reason, Ben Graham has time and again emphasized on the importance of margin of safety.

The FIIs are buying relentlessly and have poured in money to the tune of Rs. 79139 crores since March 23 till date. In the same period, DIIs too have chipped in with Rs. 23913 crores. After the markets last peaked in October 21, the FIIs continued to withdraw and till the reversal of their stance in March 23, had withdrawn a staggering Rs. 431,946 from the Indian markets. DIIs balanced this by pouring Rs. 418,553 crores during the same period. It is this balancing act by the DIIs that acts as a cushion against drastic volatility in the market in the last few years. Gone are the days when the Indian markets literally danced to the tune of FIIs. Nevertheless, the effect, though not pronounced, is always felt to some extent.

Regardless of where the markets are headed, for a value investor, it is important to evaluate the individual stocks to check if they are currently quoting at a significant premium to their intrinsic values and sell if the answer is in the affirmative. One must necessarily have this process in place. Speaking for myself, I’m not yet evolved to a level where I can calculate the intrinsic values of individual stocks to a reasonable range. And therefore till I attain that skill, I go by the usual valuation parameters like PE versus its five year median, PEG, P/BV, P/sales, EV/EBIDTA, Asset turnover and Graham’s number to assess if the stocks are overvalued. I have taken advantage of this rally to exit all my non performing stocks, sell all stocks whose valuations have gone too high and partially book profits in many stocks where valuations are 50% higher than the five year median.

This is by no means a foolproof strategy and I may have exited some stocks prematurely but a bird in hand is always better than two in bush.

What do you think dear friends? Please share your strategies through comments or Whatsapp for mutual understanding and learning.

Happy investing.

Often the journey is more interesting than the destination

bhushan

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