(This is my column in Deccan Chronicle today. http://epaper.deccanchronicle.com/articledetailpage.aspx?id=10910014 .
Hope is eternal. It is difficult to admit that stocks can get ‘de-rated’ . Specially, when we are holding it. Many of us might have caught on to the momentum very late. And the whiplash would have caught us off guard. I do believe that there is further pain in the markets. It is best to understand the risks rather than getting tuned off from the markets. Maybe it is time for a long wait??)
THE TRADE TURNS…
Over the last year or two, some stocks ran up ten times or more in price. In the last couple of months, many have corrected by thirty percent or more. So, to those with a short-term memory, these stocks look attractive. Should one buy or avoid?
Commodity companies have had a spectacular year, thanks to China. Is this sustainable? I do not know. I have generally used a very passive approach to commodity stocks. I have used the Balance sheet as my basis to buy rather than the Profit & Loss account. This approach keeps me out of mischief of having to estimate profits. I fully believe that commodities will not go out of fashion in a hurry (when they vanish, they do completely- Remember there used to be a metal called “TIN” which was replaced by Aluminum?). However, they do go through cycles of boom and gloom. And it is safe to buy when no one wants it rather than when everyone is out to buy them.
Thus, I am happy to wait out for the next round of neglect that these stocks will be subjected to. It may even take five years. Who knows? But one thing I know is that at current levels, I am playing with uncertainties and probabilities, with no margin of safety.
What I will have to be alert for is ‘value’. Neglect sets in rapidly. Some companies can go below the balance sheet valuation. When the next cycle turns up, these stocks will give returns. The uncertainty here is the timing. The wait can be very long. Or very short. Depends on the flow of funds. Corporate results are unlikely to turn around in a hurry. So, once again, patience is the key. Patience and watchfulness.
One way to keep track of these companies is to take ten-year averages of ROCE or of EBITDA margins. The recent years will show these numbers at the upper end. The time to buy them would be when they are at the lower end of the ten-year averages. Here, I am avoiding the conventional PE ratios. It is very likely that when it is a good time to buy, the PE could be extraordinarily high, since the earnings will be very poor to negative.
One big possibility is that we would be still hanging on to many of these commodity stocks even now. Our minds are anchored to our ‘buying’ prices and there is a reluctance to convert the ‘paper’ losses to actual losses. That may not be a good thing. Surely, there is more pain ahead for most of the commodity sector stock prices. Even now, there are many brokerage reports telling us to ‘buy’ or ‘accumulate’ such stocks. Suddenly, we are discovering that early quarter profits were due to inputs being from old inventory and that new prices are beginning to cut in to margins. When all commodity prices are going up, did we wonder why input costs were not going up in tandem? Now as quarterly results start getting announced, the ‘growth’ in profits seem to be mellowing down as opposed to ‘bellowing’ advertisements and talks in the media a few quarters ago. We are hearing talk like “This quarter has been a subdued one, but we expect the full year to be better..” or words that indicate less confidence in future trends.
No management is going to come and warn the public that they are headed for hard times. It is up to us to read the ‘tea leaves’.
Does it mean that we exit small companies, commodity companies and put our money in to ‘large’ companies? It all depends on whether there is a compulsion to keep remaining invested 24X7 in to stocks. Staying in cash sometimes is also a good option. Global undercurrents are not very conducive to continuing funds flow in to our markets. The US increasing interest rates means that more money will be headed in to US rather than emerging markets. Interest rates in India never came down as was widely believed. And on the contrary, it has started to move up. Increasing interest rates would mean that some of the moneys that chase equities will now chase debt. One is because of returns and the second is because of a perception that rising interest rates are bad for corporate profits, unless you are a bank.
So, if you have made money and have cashed out by and large, good for you. However, if you were late on to the band wagon and are staring at losses, it is still not too late to get out. What will happen is that you will have a long a painful wait and may not make anything. Given your injuries, your wait may be just till prices recover to your ‘anchor’ price of buying. This happens every time the cycle turns. At that point, will you treat it as a ‘new’ trade ? Or will you just blow a big breath of relief, sell the stock and put the money in to a FD? Being the victim of timing is not new. Learning from it is the key.