Just Euphoria or a Bubble?

Hello friends,

On 28th November 2023, the world lost Charlie Munger who was one of the most deep-thinking philosophers, thinkers and practitioners of value investing. He was probably the closest to Benjamin Graham, the Adya Guru of value investing, in applying the principles of value investing to modern-day investing. Charlie Munger has written prolifically and delivered hundreds of lectures sprinkling his thoughts and experiences as quotes in each of them. Each of his quotes is indeed a pearl. There would probably be none like him in the future. The community of value investors deeply mourns his demise and will miss him sourly.

The big money is not in the buying and selling, but in the waiting.

Charlie Munger

I had written about the relentless rally in the Indian stock markets on 20th July (Market Euphoria) and then again on 19th September (Markets on fire). I had also discussed various positives and negatives that could indicate the direction of the markets thereon. The Parag Parikh anecdote was very instructive too in this respect.

The rally continues unabated with good corporate results providing further impetus and the recent election results, higher than expected quarterly GDP growth of 7.6%, moderating inflation and possible Fed rate cuts providing further triggers. But the biggest factor is the unprecedented retail participation in the Indian stock markets as never before. The retail investor has been at the forefront of the rally with increasing Dmat accounts, increasing SIP flows and increasing direct stock investment. A lot of data is available to corroborate these facts in the attached article.

The BSE Sensex has surged from 61000 to 71000 this year, a rise of 16.4%, but the BSE small caps index has shot up from 29600 to over 42000 in the same period, an astonishing gain of 41.9%. This is by far the strongest-ever rally in small caps.

Let us now try to evaluate if the markets, especially the Sensex stocks, are overpriced. Good Corporate results have helped the Sensex PE to remain within reasonable limits as can be seen from the following chart.

The BSE Sensex is currently quoting at a PE of 25.32, only a little above the ten-year median PE of 24.43, a rise of just 3.6% over the long-term average. So though the Sensex is gaining new peaks every day, it is not really overpriced after all, thanks to good corporate earnings. The following chart will help you to put this in perspective of the historical data wherein the Sensex PE values are indicated in the overpriced and underpriced categories by Red and blue colours respectively.

The current PE indicates that it is only slightly overpriced and may fall into a reasonably priced category with good earnings show in the coming quarterly results in January.

The story in the small caps and mid caps space is quite different though. Since there are more than 4500 listed companies in this category, it is very difficult to gauge the valuation for this group by a single parameter like PE. Equitymaster (to whom I’m subscribed for many years) use a ratio of small caps Index to Sensex to effectively assess the valuations of small and midcaps as a group. It would be interesting now to have a look at this parameter.

The BSE Smallcaps index to Sensex ratio, currently at 0.6, has crossed the last two peaks but is still below the two previous peaks. As we all know, any correction hits the smallcaps doubly severely as compared to largecaps which are established and secure businesses. Moreover, valuations of select smallcaps and midcaps have gone over the roof. So it is not only time to be cautious and fearful but in my opinion, small-caps investors need to prudently book profits in such stocks and wait for correction.

“We simply attempt to be fearful when others are greedy and to be greedy only when others are fearful.”

Warren Buffet

“The best chance to deploy capital is when things are going down.”

Warren Buffett

I have outlined my own strategy of selling stocks at length in one of my blogs which is to sell at high valuations keeping allowance for extraordinary growth. So this time around, I exited some stocks partially or fully taking into consideration the business growth prospects vis-a-vis valuations and extent of price/valuations run up. Asiana Housing, Mahanagar Gas, Suprajit, Sanghvi Movers, Cyient, MPS, SPAL, Bharat Forge, LG Balkrishnan, Garware Hitech, Care rating, Bajaj Consumer, BSE, Atul Auto and TVS Srichakra are some of the stocks that I exited completely. I also took advantage of the tide to get rid of some non-performers like Muthoot Finance. I even sold some fundamentally good stocks like Cochin Shipyard, Newgen Software, Sonata Software, Saksoft etc. in very small quantities. All this was done in the last three months.

Many of the stocks have gone up after I sold them but really that can’t be helped, One can’t always hope to sell at the peak and buy at the bottom and it is always better to follow a process. Time will tell if I am wrong or right, but I’m easy in my mind and waiting for the next correction.

I had written extensively during COVID (25th March 2020), when the markets were in free fall and during the recovery thereafter (1st August 2020) about specific stocks with valuation data. Interested readers can find this information here and here. It would be interesting to see the current and historical valuations of some of those smallcaps stocks that I had analysed in my blogs. This would probably give you a real feeling of where we stand today in the smallcaps space.

The table below lists some of the stocks that were available very cheap during COVID and I had recommended these through multiple blogs besides increasing my holdings in them during that period. I have now mentioned their status in my portfolio to give you an idea of my selling strategy.

Though there are hardly any stocks to buy now, I recently almost doubled my holdings in Anuh pharma & PSP projects which I found to be still quoting at reasonable valuations.

I have given a lot of thought of late to the concept of focused investing as practised by Warren Buffet and Charlie Munger. I have taken my own baby steps in that direction and I intend to write in detail on this in my next blog.

What are your thoughts and strategies my dear friends? Please let me know by way of a comment.

Often the journey is more interesting than the destination

Yours truly

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