(This appears in today’s Deccan Chronicle . Buying opportunities are best when there is some fear and pessimism. Interesting times, though I cannot forecast the waiting period. Typically, commodity stocks take a long time after peaking, to bounce back. First they have to crack hard then stagnate before the next round of optimism takes them up. )
The market is a great teacher. There is a list doing the rounds on the social media. It shows the percentage of loss in share price from their highs. Many of the popular stocks have lost between thirty and sixty percent of their price.
These are mostly small cap and mid cap stocks. They climb up rapidly and drop down as easily. Your state of mind depends on when you got in. And when they are first ‘discovered’ they are in short supply. Someone has slowly accumulated the free float and then it keeps shooting up as the only persons who show interest in the stock are ‘buyers’. So, on its journey after discovery, “Upper Circuits” are the norm. The second lesson is that exit from these stocks is an art. You have to sell when there is optimism and people are screaming to buy it. When the tide turns, and everyone is a seller, there is obviously no buyer. These small stocks have a few thousand shareholders at best and there is no institutional interest. So, when everyone is a seller, the “Lower” circuits come in to play. Thus, your timing of entry and exit are both critical. Even mutual fund managers have not got it right. Their fear is that they accumulate large volumes and when they come to sell, it won’t get absorbed.
Very often, the decline in the mid caps also is a signal of the end of a commodity cycle. Those magnificent doubling of profits / sales every year or Q on Q secular growth etc are at some stage going to halt. Once the trend peaks, the next step is for earnings to decline, till many players go in to the red. This is a normal cycle. Each time there is an upturn, there is a new story and each one thinks “this time, it is really different”. Six months ago, no one would even have thought about any price actually going down, forget losing twenty to sixty percent.
And have the prices come to desperately attractive levels? My view is, NO. Nothing has become cheap. Most cases, very expensive has come down to expensive. And even that may not hold good as earnings will very likely show smaller numbers.
For a change, the FII money seems to be trickling out. However, the strong domestic inflows have been kind of holding on so far. While the bigger indices have not shown much decline, the smaller ones have lost considerably. Clearly shows that the smaller company space is losing steam.
Let us flip the coin. Is it time to buy? What if the stock price has gone below its ‘fair’ value as we estimate? For example, we discovered that a mid cap stock “XVL” has historically (last 10 years) traded in a Price to Book range of 1.2 to 4 times. So, if it comes to near 1.2 times or below, should we be buying? Logic says, we should buy. The only caveat is that we cannot look for a quick return. For that, apart from business cycle, investor moods have to change. That time frame is generally unpredictable. Looking at the commodity cycles, perhaps the best is behind. Results will get weaker. New capacities are being planned by those companies that can find the money. Interest rates are on the way up.
So buying now may be fine as far as price goes. However, given the circumstances, your wait could be long. And it is likely that when the sector or company revives and investment climate improves, the returns could be exponential. The important thing is to make sure that the company we have identified will hang in there and do business as we expect it to. It is better to be frugal and not take 100% of our planned exposure right away. You could get more juicy opportunities. However, if you make a list of five or ten small companies which you like, you can keep a checklist and slowly put money in to them in instalments. Do not chase every stock. Do not say ‘yes’ to the first opportunity that comes your way. If we understand business cycles in a commodity, it helps. Dig data from the past and see how much time gets spent at the bottom of a price chart.
The other caveat is not to be anchored to recent highs and lows but to stick to a process and method. Do not violate that. There are companies that lost 70% between 2008 and 2009. And from there lost another seventy.