Investment Shastra

February 2020: MoneyWorks4me Outlook

Feb 2020 MoneyWorks4me Outlook

Review

Nifty earned ~4.5% in the last 1 year ending Feb’20 and ~9.3% CAGR in the last 3 years.

Nifty has now corrected more than 20% while most of the stocks are already down 40% and close to 5-7 year lows.

Equity inflows were the highest in the last 3-4 years which means that an average investor’s portfolio hasn’t earned good returns from equity for a long time.

The very risk in equity investing is that returns don’t come in a predictable fashion.

The overall sentiment is low due to consistent FII selling and fear of contagion from CoronaVirus. Stocks in some pockets where there is an absence of growth have been hammered with little or no negative news.

For a stock to fall, the business has to be impacted which isn’t the case.

Outlook

As on date, the average upside of our coverage universe is likely to be more than 12% CAGR over the next 3 years.

Just a handful of companies are delivering moderate earning growth due to slow economic growth.

Some pockets of the market like consumer staples, consumer durables, and insurance/AMCs are trading at stretched valuation.

These companies are enjoying high valuation as more and more investors are chasing them.

This trend will reverse as other sectors start showing signs of improvement. We recommend to avoid pockets of euphoria and be patient.

Do not chase recent performers as it can lead to big disappointment in the future even if there is no price correction seen in a recent market correction.

We find that Nifty 50 now trades below its fair value as stocks with large weightage in the index have come down drastically while some stocks that were already cheap got cheaper.

Even after the correction, we suggest buying stocks with low valuation and good future prospects. They may have come off due to FII selling but the volatility had to come back in equity investing. With one eye on business performance and another eye on behavior, we can tame the volatility.

We are looking at companies that have good earning triggers over the next 2 years as we are not certain whether broad-based recovery will happen immediately. Even if their prices are volatile, their business prospects haven’t changed a bit in the last 15 days.

We are investing in companies i) coming out of sector consolidation, or ii) introducing new products, or iii) commissioning new capacities or iv) executing the order in hand.

An investor can consider investing in value and high dividend yield stocks like Infra & Infra-related companies like capital goodshigh-quality PSUs, private sector corporate banks, pharmaceuticals, and select NBFCs. Now more sectors are correcting, we will recommend it as they reach our desired price.

We are buying small and mid-cap stocks selectively, however, we do not find merit in going overboard in these stocks as we are seeing the very sluggish economy and limited growth triggers in most sectors. Small-sized companies may or may not be able to retain their profit during an economic slowdown. If one buys broad small/mid-cap mutual fund, even if they rise from here, long term returns won’t be commensurate for the risk one takes investing in small and mid-cap companies today.

SIP product may work in such a small & mid-cap but we recommend caution on lump-sum purchases till we don’t see broad-based earnings recovery in mid and small-cap companies.

Risks

CoronaVirus – Global

As on date, total infected cases have crossed 121,000 and 4379 deaths from CoronaVirus. A lot of countries have banned public gathering and business activities.

Business activities have picked up 80% in China while business is affected severely in Italy and Iran.

China is one of the largest consumers of many global commodities and services. A slowdown in China can affect the global prices of these commodities and services. This leads to a temporary slowdown across the world. If the disease spreads further, global economic growth may be affected.

Due to higher R-O (r-naught) of the disease, Covid-19 is spreading at an exponential rate in countries like the US, Italy, Iran, and South Korea.

With public awareness and government’s precautionary measures in immigration and quarantine of infected patients, we believe the spread can be contained.

China and South Korea have already seen a steep fall in new cases due to self-quarantine measures.

Financial Market contagion

Worldwide the central banks are taking measures to ensure better liquidity in the system and reducing the interest rates to soften the blow from a slowdown in business activities.

It is to be seen whether this will actually result in desired effects or will it further scare the markets.

US markets have become very risk-averse as investors are selling stocks and moving the funds to bonds. 10 Y bond yield less than 0.5% p.a. and 2 Y yield is below 0%. This means that the market participants are scared and expecting recession in the near term.

The US has had 10 years of economic expansion. A recession won’t be a surprise but its implication on the assets prices is rather sudden and large.

Even if US goes into recession and later slow recovery, the countries with limited trade with US don’t have an economic impact.

For example, a country like India exports less than $60 billion to US. The impact from the same will be quite limited to the overall Indian economy.

Most of the exports that happen from India lead to cost-saving for US businesses and citizens (ex. IT and Pharma). So in a way, this trade won’t be cut during a slow-growth period in the US. This makes us confident that India’s future prospects won’t be hit adversely from recession in US.

Only trouble seems to be FII investment in public markets of India can be sold out at a moment’s notice taking the stock prices lower in the short term. This leads to huge volatility without material change in the underlying business.

Opportunity for long term investors (Must Read)

We know you’ve more questions than we can answer. But we will answer all the key questions in the following paragraphs.

Can the market fall more?

Yes, they can. This is pure CAPITULATION. When sellers are desperate to move out, they will take any price to exit. This has absolutely nothing to do with the underlying business.

Long term investing means that we buy stocks for the underlying business. As far as a business does well, we can be sure the stocks would reflect the same growth over the long term.

This doesn’t mean they will not correct from time to time. We have seen 1992-94 crash, 1999-2001 crash, 2008-09 crash, and 2011 crash. They come from time to time.

As far as we are buying good business at reasonable/cheap prices, we don’t have to be perturbed by a temporary fall in market prices.

We have often asked gaze at 10Year X-ray of a company to see how they have performed in the last several years. This gives confidence that they are capable to replicate the same in the future.

Does buying cheap mean the bottom?

Buying cheap doesn’t mean the same as buying the bottom. Stocks can go lower even after we buy them. Bottoms can’t be predicted and not necessary to make good returns from equity.

Why is it so difficult to buy stocks in correction?

The market correction has been the best time to add to stocks always. But it becomes difficult to add as our existing portfolio is also bleeding. This makes us nervous and ‘exaggerate risks’.

What are the risks?

Risk of low returns:

Equity gives long term returns in the range of 7%-20% CAGR. We might be in one phase of 7% CAGR. We discard this possibility as we are right now at a very cheap valuation versus its historical average.

As markets recover to fair price multiples, the returns would look better.

Risk of volatility:

We have already identified a certain portion of savings to be invested in equity. This was done exactly for such kind of volatility.

We have already taken care of the risk of volatility by committing only a portion of Equity. The rest of the savings are in Gold, Real Estate and Fixed income.

So getting afraid to add more funds is ‘double accounting’ for the same risk which has been taken care of.

Risk of delayed recovery:

We have always said that only surplus funds, not needed for more than 5 years must be parked into equities. Even if recovery is at a later date, we don’t have to worry about delayed returns in equity.

Risk from business:

Whatever the calamity, not all businesses get affected. Even a storm can’t destroy every house in a town. Stronger ones remain steady. The same applies while a building a portfolio in equity.

A stock can lose significant value but a portfolio of stocks doesn’t crumble altogether. Let those loser lose and winners recovery ultimately.

As far as you keep checking your overall returns rather than individual stock, you will sail through the fears and come out strongly.

This is not the time to panic or holding on to your fresh investments. You must keep buying, albeit slowly as prices come off.

Follow discipline that you don’t go have more than 5-6% allocation in any stock. This ensures you are holding tomorrow’s winner stocks as well.

What are some of the positives?

The Indian economy has already been on a slow growth path for the last few years. The valuations are not factoring very high profits nor high growth from 80% of the stocks.

However, US and developed countries had a long bull market wherein companies were earning peak margins and high growth rates. This is undergoing a correction.

The fall in those markets is taking Indian markets also lower. This is no merit why the Indian economy would do worse than where it already is.

Valuations in Indian markets have become ultra-cheap in some pockets. Companies are trading below book value and less than 15x even in companies with high ROCE, low double-digit growth, etc. This makes us confident that Indian markets are poised to bounce back faster than other developed economies.

Where do we go from here?

Overall markets may remain subdued until the time earnings growth kick in. But this doesn’t mean individual stocks won’t rise.

We expect superior returns from stock picking as average stock today is trading cheaper than Nifty itself.

Near term uncertainty in structural growth, story spells an opportunity for long term investors. Stocks are beaten down from fear of short term slowdown.

We do not find any merit in second-guessing what’s going to happen in the next 6months-1 year. We leave this field open for speculators, fear mongers, and punters.

We have often seen that after such a sudden fall, the rebound is similar. We recommend to stay put and not worry about looking at prices.

We are managing only long term money and predicting near term events is futile.

We continue to recommend Gold Fund/Gold (up to 5-10% of the portfolio) as a hedge from contagion risks and allocation to safe liquid funds/Fixed Deposits (10-20%) within in equity portfolio for capturing new opportunities.

Act on our calls and restrict your allocation to 3-5% in each stock. And not more than 25% in each mutual fund. This will keep you at peace, and not significantly dent your portfolio performance.

Beyond this, tinkering asset allocation will only reduce long term returns thereby missing one’s target corpus. We have diversified our stocks portfolio, we have diversified assets and we have long term horizon. Together this takes care of all potential risks in investing.

Happy Investing!

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Ketan Gujarathi

Manager - Equity Research; Based in Pune, a Total of 7 years of work experience ranging from equity analysis, credit rating and banking. MBA in Finance and a Bachelor's degree in Engineering. Passionate about studying companies. Likes reading history & business books. Spends free time with friends and family.

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