(this is published in Today’s editions of Deccan Chronicle. The hot favourite of the markets is the mid cap segment.)
If you are the person who is a keen investor in small and mid cap stocks, be aware that you are entering a twilight zone. The mid cap stocks drama is nearing completion of another cycle, notwithstanding the money that is pouring in to the markets.
As this bull run started, somewhere around 2014, the mid cap space looked interesting. Smart investors jumped in early. Valuations for mid caps, that were at discount to large caps, shot up higher and higher. Earnings growth seemed to exist only in the mid cap space. As earnings expectations were met, the next round of forecasting jumped even higher, prompting push in prices higher and higher.
Currently, the BSE mid cap index trades at a thirty times earnings and the small cap index at a healthier 74 times earnings. Of course, the BSE Sensex is at a measly 24 times earnings. Let us see how the indices behaved post the change in government:
|(BSE INDICES)||SENSEX||MIDCAP||SMALL CAP|
(These are month end closing indices of the BSE for the Sensex, Midcap Index and the Small Cap index )
These are amazing returns and for those who stayed invested, the journey must have been exciting. However, there are many who keep buying and selling and it is very unlikely that the returns would have been so much if measured for their money, over this period. Yes, one may have had great returns if there was concentrated investing in one or two stocks that multiplied many times, in this bull run.
However, it does look clear that the party is about to slow down dramatically, if not end. And the latecomers are the ones who will take longest to recover from the hangover. As I am writing this (10th August, 2017) the markets seem worried. Of course, as an investor, I have to keep awake at these times. If there is some irrational correction AND I can spot some value buying WITH margin of safety, I am ready. I think that time where we can get ‘margin of safety’ is still to come.
The worst hit will be those who joined the bandwagon late. The sweet spot in the last three years seem to have been the first calendar half of 2017. In other words, if you joined the party by end December 2016, you probably had a good ride. The indices hide individual stock movements and thus the story would be different for different investors. If you are in pharma and IT, you probably are staring at losses whereas if you are in to cyclicals like steel, you had a good ride.
However, none of these periods offered ANY margin of safety to the investor. We had to bank on crowd behaviour and money flows.
For those in the mid cap stocks, my advise would be to stick to high quality stocks (those with ROEs in excess of twenty percent) and exit the rest, even if it means a loss. Very often, when the exits get crowded, no one gets out. So, I would opt for a conservative approach, cashing out on the speculatives and the ‘hope’ driven small companies. The cash can be useful in the days to come.
Once a sector gets impacted, many people try to buy the stocks on decline. It is not a good strategy, always. Just look at the pharmaceutical sector. The stream of bad news has brought down the prices, but still the multiples are nowhere close to giving the buyer any margin of safety. So, if you just look at the High/Low and keep buying stocks, it is unlikely to work in this bull market. Pharma stocks have just become ‘expensive’ from being ‘very expensive’. Prices are still not related to earnings and are driven by hopes that are getting dashed as events unfold.
Cash is king in these markets. And there is no need to rush in at the sign of first correction. I am not referring to any levels in the indices, but keep your eye on the ‘margin of safety’. Buying closer to that is what will give you better investment returns. Being conservative at this juncture, will ensure that you are around in the markets for a long time. I am sure that one investor named Warren Buffet must not have even averaged three buys in a year. He spends all his waking time on the stock markets and buys and sells far lesser number of stocks than we do, by spending a few hours in a week. And he has not done too badly.