Time to go bargain hunting?

Aug 26, 2015

In this issue:
» The biggest single day falls in the Sensex...
» Impact of China's tremors on world economies
» ...and more!


2008 was a terrible year for the Indian stock markets. The Sensex witnessed two big single-day corrections that year. The first was in January when the Sensex had peaked post a massive bull run spanning 2003-2007 and then began to feel the tremors from the subprime crisis in the US. The index lost 7% on a single day that January.

The second big single-day fall that year came in October when the Sensex tanked 11%. This was post the bankruptcy of Lehman Brothers in mid September 2008 that sparked a massive selloff across global equity markets.

Investors now have another day they won't likely forget anytime soon. On Monday, 24 August 2015, the Sensex shed around 6%. This time, trouble brewing in China triggered the meltdown and let most global indices deep into the red.

So like the scenario in 2008, has the Monday fall made stock valuations cheap? In Monday's edition of the 5 Minute WrapUp, we highlighted that, if you want to make the maximum out of investing in equities over the next 5-10 years, you'll need to buy in a fearful environment. And big market falls such as Monday's do provide the best opportunities to scoop up stocks.

Having said that, the recent correction in the Sensex by no means makes the valuations very attractive. Those looking to go bargain hunting to capitalise on the Monday crash may not bag the gains they hope.

Allow us to elaborate. A recent article in Business Standard used the price-to-equity ratio to gauge whether Sensex valuations are expensive. The price-to-equity ratio is the price-to-earnings multiple divided by the underlying return on equity. If this ratio stays above one for a sustained period, it means the index is expensive and further corrections are possible.

The Sensex's price to equity ratio currently stands at 1.6. To get a perspective, this ratio reached 1.9 during the dot-com bubble. It's not just that stock prices have run up. The return on equity for most companies has reduced. Indeed, the index companies' return on equity is now down to 13.5%, the lowest in 20 years. This has been largely due to a slowdown in the Indian economy with reforms yet to deliver in a big way.

This is different from what we saw during the 2008 global crisis and the stock market rout that followed. The earnings of India Inc were still growing at a healthy pace. Return ratios were quite strong. As a result, the massive correction that took place provided a very good opportunity to pick up good quality stocks that were literally on sale. Indeed, post the Lehman collapse, the price-to-equity ratio had dropped to below one.

In 2015, stock prices and consequently valuations had shot up considerably. Thus, the recent correction has not necessarily made all stocks cheap. Many, if not most, remain expensive. That is why we don't recommend going bargain hunting or bottom fishing for stocks right now.

We are of the view that you need to stick to companies that have strong business models. Businesses with strong earnings potential even if India's economic recovery has yet to accelerate. Now, earnings growth will certainly improve once an economic recovery gathers pace. So post the recent correction, if these stocks are attractive from a valuations point of view, it would make sense for you to pick them up. Whether more corrections are around the corner doesn't matter. If valuations are still expensive after the crash, then it makes sense to keep away.

Has the recent correction made any stocks on your watchlist cheap enough to Buy? Let us know your comments or share your views in the Equitymaster Club.

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 Chart of the day
As highlighted earlier, on Monday (24-Aug-2015) BSE-Sensex tumbled by 1,624 points, registering a fall of 6.2% in a single day. And if you believe this was one of the biggest falls in the history of the Indian stock markets, think again! Below is a chart which shows the biggest declines in the Sensex in a single day in percentage terms.

Crashes of this kind typically result in colossal losses in stocks, both good and bad. But the bad ones really take a beating. These are companies having huge debt on the balance sheet, higher promoter pledging and a weak management overall. And if such stocks are part of one's portfolio, they can virtually make the entire portfolio come crashing down.

But for quality companies run by a sound management, price corrections such as these provide the perfect opportunity to add them to your portfolio. And we for one are waiting for more such falls.

Should there be more corrections in the coming months, be prepared to see a lot more buy recommendations from us. Both our Stock Select and Hidden Treasure teams have already released special reports on the stocks which investors can look to invest in the current environment.

Single day steep slides in the Sensex

The recent episode of the sharp meltdown in the Chinese stock markets has raised questions of economic implications for global economies. Not only is the Chinese economy slowing down, but China's monetary policies have not really done much to restore faith in the economy. China was already grappling with the problem of an overheated property market, indiscriminate bank lending and the formation of asset bubbles. As global growth slowed down, the country has also been struggling to transition from an exports driven model to a more domestic consumption driven one.

As the weakness has persisted, the Chinese government has resorted to measures such as devaluing its currency, the Yuan. This step was taken to bolster China's faltering exports. But demand in China has taken a backseat as well. And this has been one of the primary reasons for the fall in global commodity prices given how big a commodity consumer China is. Naturally, all these developments are bound to have an impact on the other economies in the world.

Meanwhile, the Chinese central bank has pulled out another trick and has resorted to rate cuts. This is exactly what the governments of the West had done when the 2008 global crisis had deepened. The years since then have proven that central bank intervention in the functioning of the economy does not really work. And we will not be surprised if China ends up with a similar fate as well.

Indian stock markets had a rather volatile trading session today. After opening in the red, the indices managed to push above the dotted line only to fall back into the red. At the time of writing, the BSE-Sensex was trading down by around 150 points. Losses were largely seen in banking, FMCG and auto stocks.

 Today's investing mantra
"The whole concept of dividing it up into 'value' and 'growth' strikes me as twaddle. It's convenient for a bunch of pension fund consultants to get fees prattling about and a way for one advisor to distinguish himself from another. But, to me, all intelligent investing is value investing" - Charlie Munger

Publisher's Note: Vivek Kaul, the India Editor of the Daily Reckoning, just made a bold call - Real Estate priced are headed for a fall. Well, if you are someone who is looking to buy real estate, or is just interested in the space, I recommend you read Vivek's detailed views in his just published report "The (In)Complete Guide To Real Estate". To claim your copy of this Free Report, please click here...

This edition of The 5 Minute WrapUp is authored by Radhika Pandit (Research Analyst).

Today's Premium Edition.

A beaten down sector in a not so cheap market

We take a look at how the recent crash in the stock market has affected commodity stocks, and the opportunity this has created for value investors.
Read On...Get Access

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