(This column appears in today’s edition/s of Deccan Chronicle- The Markets are firm on the surface. But the churn that is happening beneath the surface is often the thing that impacts many investors.  http://epaper.deccanchronicle.com/articledetailpage.aspx?id=8214344 )

Opportunities Knock

Company results for the quarter ended March 2017 and the full year 2016-17 are tumbling in. Corporate profits are still very poor. Growth in sales and profits seem to be anemic.  And of course, the analyst population has now started to justify its absurd price targets on FY19 earnings!! When they could not forecast three month trends, they expect us to believe a two year in to the future vision.

 

I also see that companies have raised record amounts of debt and equity in the first four to five months. Most of the debt has gone to simply replace maturing debt.

 

If you were one of those investors who kept his wits around you in the last six to twelve months and pursued your hobbies, you might consider shifting your attention back to the markets. No. Do not spend all your monies. But start looking around and keep a list of high quality stocks and their prices handy.

 

When the weak hands panic, the first things to get hit will be the poor quality stocks that have run up (most of the mid cap stocks would fall in this poor quality). The panic will spread to the better-quality stocks also.

 

What will also help a long term investor is that in the last one year, all analysts upped their earnings estimates simply to justify higher price targets. This means that there is a slew of earnings disappointments across the spectrum. And in a market that is on steroids, disappointments are punished severely. I can see the punishment meted out to a stock like Cummins India, where the market seems to think that the company has lost its mojo. (disclaimer- I own a few shares). I make a distinction between this kind of price fall and price fall in the pharma company stocks where the issues are ethical in nature. Of course, corporate crimes are forgiven and if we subscribe to that, maybe the stock prices will recover one day or the other and go back to its old glories. On the other hand, the market seems to love small growth in companies like HUL, which seemed to have been forgotten till a couple of months ago. Now investors seem to be willing to go back to proven quality names.

 

The other thing that I hope will happen is that the large stocks will go in to a listless mode. There will be bouts of disappointment which will bring down prices. All of this makes for a good environment in which to invest.

 

At the point of investing, I am not bothered about the ‘market returns’. My aim is to beat that handsomely. That I can do with minimum risk only if I can evaluate the ‘prospective’ return on my investment. That is, if a stock normally trades in a range of twenty to forty times earnings, our prospective returns are related to the earnings multiple at which we buy. Here, what can distort our analysis, is one instance of earnings failure. So let us use a combination of P/E and price relative to book value. Using both these, we could probably improve our odds.

 

Another factor that will be disruptive to corporate earnings and balance sheets will be the introduction of GST. It will create bumps in earnings as companies try to game the apparent rate differences and the procedural complexities. To me, it is another event that could provide price falls in stocks. In adjusting and managing the new environment, large companies will manage transition better than the smaller ones, who will find the compliance costs daunting.

 

One other thing we will notice now is that transgressions by companies will start getting punished. In a bull market, investors are very forgiving. It is a myth that institutional investors are fussy about governance. There are two kinds of companies-  One set that is known to be unfair and unethical. There is another set that we do not yet know. No company can be presumed to be ethical and fair for ever. Somewhere, the pressure to perform at the stock markets has compromised the way people would behave. So, choosing management quality helps to minimize the damage.

 

All these are symptoms of a nervous market, looking for excuses to correct prices. Yes, it is also possible that prices may be range bound, for a long time, waiting for earnings to catch up.

 

Once again, do not invest all your money. Spread it out over the next two years. And augment your cash balances by getting rid of those impulsive purchases you made, if you think the valuations are high. A nervous market also corrects our valuation metrics. Stick to your processes and do not rush in. Opportunities will keep coming. If we want to buy five stocks at a reasonable price, it makes sense to prepare a list of ten. We cannot chase every opportunity and not every one on our list may come in to a buying price range.

 

 

 

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