high P/E – LUCKY IDIOT

We have seen a sharp fall in the market these days. Now, everyone has a question that what can be a probable bottom? where we should start buying? Bottom of the market already made? Should we buy or will we have missed out this opportunity? Yes, Nifty has reached to the fair value zone but pendulum never stayed at the middle zone it will go extreme to both the direction. So, we have seen upside extreme and now have to see downside extreme move.

Before starting answering the above questions, here, I am requesting you to read my old article which I had posted on 4^th August 2019. In that article, I mentioned regarding market fall. Please first go through that article because the current article is a continuation of that article.

THE INTELLIGENT INVESTOR – 3 – A CENTURY OF STOCK-MARKET HISTORY

Now, if we analyze current fall then we can say that Indian corporate and GDP has witnessed a limited growth in the past. Also, Covid-19 virus has disrupted the entire world economy. Majority of the economy has started giving a revival package but if we look at the speed of the spreading of Covid-19 and death of the people then it is very painful for us as well as the economy.

Our PM has announced with the 21 days lockdown to fight against the Covid-19. We have taken this step well in advance so that we can able to control the situation, because if the situation will go out of control then we do not have a proper infrastructure for citizens to cure.

I have taken a few data from HDFC Bank India growth outlook 2020, cost of lockdown.

By looking at the above data and havoc of Covid-19 in the world, it is essential to go for the not only lockdown but to declare an emergency in India. Now, let’s go to the economic impact of this mayhem. People can oppose that government of the majority of the economy has started announcing a revival package. But We have to think that it’s not a financial crisis where you pump liquidity into the system and things will start recovering. It’s taking the lives of people so what will change after the liquidity get infused. People try to save life rather use those liquidities. So, disruption can take time to revive. If this problem can worsen it will be led to a financial crisis which is still pending to come. It’s just my thoughts, don’t know what can happen but this thing looking worse than any financial crisis.

If the normal situation has come where growth remains subdued then the market can remain in range but here this difficult situation can hamper the earning badly. we have to understand that our states of India are equivalent of the many of the country where corona has done huge damage. Here, the world economy gets hamper, trade around the world hamper, supply chain get disturbs, corporates have to fund fixed cost, they only can manage variable cost through the lockdown.

Many of the articles and reports indicating towards global recession and as intense as the recession of 1929. I don’t know that will happen or not but I only can pray that such will not happen because it will take many further issues with many of the lives. Let’s not getting into the debate and do some number crunching which is always my favourite.

Current, Nifty EPS is ~Rs.444 so proceed with the calculation based on that. I am assuming current EPS will remain same for FY20 and all degrowth will account in FY21 and FY22 (if the situation will not come to the control then FY22 will also go for a toss).

I have taken the bank rate as an SBI FD rate after the rate cut.

Now, if we look at the earnings yield to bond yield ratio then it has reached at the 1.03x in the current period. If we take same EPS and take that ratio to the worst happen during the 2008 – financial crisis then it was 1.11x so nifty level come to the 8000 but Covid-19 will going to hamper earning growth and might be a new level of earning yield to bond yield ratio can come, which I have taken a range of 1.25 to 1.50 with a different scenario.

If things will be in control in coming few days then might be 5% degrowth can be possible and then market also maybe get stable at the old worst level of earning yield to bond yield ratio – 1.11x to 1.25x. But if things will get more worst then now and continue with coming 1-2 months then 10% degrowth in earning can be expected. I have made a study in S&P500 of USA and in that market earning yield to bond yield ratio has reached around 3x in worst level which I am not considering as of now. If we see that then past falls in the market have accounted for ~50% fall from the top so that that will also come to ~6215 level.

Now, another point is that earnings growth always essential for generating returns in the market. So that market can be remaining in the range till no sign comes for earning growth revival because, on the hope of earnings growth, the market has already run a lot.

I have posted an article on WHAT CAN BE A PROBABLE RETURN FROM SENSEX IN COMING 10 YEARS? a way back and where I have taken SENSEX level after 10 years on worst earning growth of 3.50% came at 43547 on P/E and 57678 on P/BV based. So, if earning growth cannot revive then the market can remain in range for a longer period. But from the current base, we can have a good chance of making a return in the range of 4-7% CAGR in the index overcoming 10 years. Tax cut reform will also aid in earning growth coming forward. We only have to pray that situation will not worsen from here and for that we have to stay at home, stay safe and fight against Corona.

#Stayhomestaysafe #Stayhomesavelives #Fightagainstcorona

Disclosure – Companies mentioned in the article are just for an example & educational purpose. It is not a buy/sell/ hold recommendation.

After the completion of the Bibliophile series on the book “The Intelligent Investors” by Mr. Benjamin Graham; I am hereby starting a series on the book “Mastering Market Cycle” by Mr. Howard Marks. I have already completed bibliophile series on his first book – “The Most Important Things”. He is one of the investors to whom I admire and learn about the cycle and always get to protect my wealth while nobody thinks about it.

As the cycle getting change, our odds also start getting change. It is mainly depending on our position to the cycle at where we stand to the cycle. If we are standing in a favorable position then we can increase our bets and reap the benefits of the cycle. Similarly, in unfavorable situations, we can protect ourselves from unfavorable changes in the cycle. If we are standing at unfavorable situations then we can adjust our position.

If we have the same information as others have and we analyze as similar to them then we cannot outperform the mass. Consistently outperform the mass is already a difficult task to perform.

Mr. Buffett has mentioned regarding the desirable piece of information – it has to be important, and it has to be knowable. Macro definitely affects the market so knowing it helps. But for consistently outperforming through knowing macro is difficult.

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When we are constructing the portfolio then we generally look at the difference between price and value. Also, we bought the company which has the highest value I. E. Company available at a discount to its value.

So, does it not look at the quality of the company?

Yes, it is right that for successful investing, we need to identify the company which understates the value proposition. Higher the upside, we can take a position accordingly. But if we adjust our position as per the upcoming market storm then it can be more profitable and can add further value to our investment journey. This estimation of the upcoming market situation helps us with the decision making to remain aggressive or to be defensive in our portfolio. We only make an aggressive /defensive decision when we know the investment environment and where we stand in a cycle. When we get investment opportunity at cheaper, discounts to value then we should be aggressive and when getting expensive, then we should be defensive.

Nifty PE

Similar we can do for the midcap and small-cap universe. And prepare ourselves from an upcoming cyclone.

We all talk about the risk but what actually risk mean? It can be loss of capital, academic says the risk is volatility in the price of assets. So, Mr. Marks has explained the types of risks in a good manner.

Opportunity loss, this is a missing out a potential gain, our investment has underperformed compared to what we missed and things do not happen the way we want it.

Risk means the occurrence of more things than we have predicted. If we know what is going to happen then there will be no uncertainty or not any risk. And if things are certain then we also get certain returns such as bank deposits. We cannot surely know the outcome of the events but we can assume the probability of the occurrence of the events. We assume the probability of the events that does not mean that we know the occurrence of the events. Anyone event can occur out of the many events. When we do not know the occurrence of the events, then we do not have an edge and we have to stay depended on luck. When we have the knowledge of the occurrence of the events then we have an edge and winning probability will increase with lower down losing probability.

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Superior investors are attentive to cycles and they capture the cycle for reaping profits.

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When a cycle is in our favor, we can earn good profits by taking benefits of it and visa Versa, when the cycle does not favorable to us then we can protect ourselves for loss of capital.

When cycle at extreme of Greed then we have to protect ourselves from capital loss. There will be a higher chance of incurring losses rather than earning profits.

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If we look at the P/E of Midcap and Small Cap index during the year 2017-18 then on the closing basis it was 37.22x and 86.19x respectively and high P/E of both during the same period was ~47x and ~114x respectively. At such valuation, we are not ready to buy a few growing large caps but having a huge hope of getting a return at such high valuation and transformation of small-cap as a future large cap. So that such a scenario is for protecting capital rather than chasing high returns. I had parked ~73% of my portfolio in the liquid fund during the same period which has helped me to survive in such cyclone. We need to focus on the cycle, pendulum where it is moving and where we stand in the cycle.

When in a similar cycle economy, corporate profits and prospects remain the same but pessimism among the participants provides an excellent opportunity to make an investment, increase our position to be more aggressive. And when the economy, corporate profits, and prospects remain the same but having a huge optimism among the participants then we should adjust our position as a defensive investor.

When our position in the cycle changes, our odds also get change and if we do not change our investment accordingly then we miss the opportunity to enhance return or protect capital.

Disclosure – Companies mentioned in the article are just for an example & educational purpose. It is not a buy/sell/ hold recommendation.

Read for more detail: Mastering The Market Cycle: Getting the odds on your side by Mr.Howard Marks