IF NOT SIP, INVEST IN LARGE CAP STOCKS

The markets are apparently lying in wait for the outcome of the Gujarat elections. If there is a BJP win, probably there would be a relief rally and the bulls will become stronger. On the other hand, if the BJP does not win, it could provide an excuse for a correction. I have been cautioning people on the need to lighten one’s exposure to equities and wait for better times for buying.

I also think that the commodity stocks have reached full bloom. They have shown excellent results and valuations are now pricing- in aggressive expectations. Three scenarios can play out: One, that expectations are met. The other two are that expectations or fulfilled or not fulfilled. Two out of three are in the price. So the chances of upside are limited.

The other thing is the impact of poor liquidity of stocks in this sector. Just like moves up were sharp, moves down will be equally violent. When these stocks fall out of favour, no buyer steps in. You could lose a small fortune in a few trading sessions. Let me reproduce a chart of a company here ( chart 1).

Just see the price moves in five trading days of the stock provided here. A 25 per cent move up and a climb back. If you had bought on the rise, you are staring at losses. I confess that I do not know anything about the company and I am merely using this as an illustration of what can happen in a small stock. And that was the five day violence. See the one year movement of the same stock here ( chart 2).

Is it not interesting? Thus, mid caps are enjoyable so long as you are perfect in timing your entry and exit. We have in the past discussed about using the balance sheet as a base to measure cyclical or commodity stocks. Today, most of the stocks are far ahead of their balance sheet values. In many cases, on the ability of the promoter to negotiate debt write offs, etc.

The promoters are the only ones who are logically entitled to using ' hope' as a strategy. An investor cannot use ' hope' as a strategy to make money. It is probably far more entertaining to spend time in a casino with that strategy.

Let us, for a moment, ignore political worries. Our markets have factored in a lot of optimism into the future. For the climb to continue, we need miracles to happen. Either the company profits should grow at scorching pace of over 30 per cent per annum over the next few years or there should be so much liquidity that prices will go higher and higher. To me, the first one seems unlikely and the second one is not reason enough for me to buy.

What I am discussing here is more relevant to small caps and mid caps. The stock prices of large well- owned companies rarely exhibit this kind of behaviour unless there are extraordinary changes in circumstances. In an overvalued market like this, if you have to be in stocks, it is better to be in large caps.

Benjamin Graham, who articulated the theory of ‘ value investing’, seeks a ‘ margin of safety’ in what one should buy. In other words, he advises a ‘ discount’ to the ‘ value’ when buying. Conventionally it means a discount to the book value. Now, in today’s world, everything worth discovering has been discovered. But still prices are violent. Essentially, it is a function of investor behaviour. So one could join the herd and become the herd investor. The other one is to be choosy, quiet and wait to buy. Lessons in investment do not have meaning for those who are traders in prices only. To them, margin of safety comes from their anticipation and their belief that they are ahead of the curve. This trend buying is so complex and predicated on investor behaviour. This is so much unlike ‘ value investing’.

There is also a ‘ fundamental’ argument against ‘ value’ investing. I am told that when we look at ‘ growth’ companies, we should look at discounted cash flows and other things. And to make good money, we must spot an opportunity before the world does! Our investment has to be backed by scorching growth in the top and bottom lines. To me, this investing is very rewarding, but the odds of spotting a winner are very small. Who could have said that Jockey would overtake a VIP? Or that Kelvinator would cease to exist? Or Maharaja would fail and Symphony would succeed? You had to be riding the right horse.

A happy and peaceful 2018 to everyone.

( The writer is a veteran investment advisor. He can be reached at balakrishnanr@gmail.com)