This Repeating Pattern in the Market Offers Quality Stocks at Great Prices

Dear reader, have you noticed a repeating pattern in the market over the last few days?

It's the pattern of completely unrelated stocks suffering from some kind of government/regulatory action.

First, Sarvajeet highlighted the issues faced by PVR and Inox and how the prices of expensive food items in multiplexes have come under the scanner.

Then, it was my turn. I wrote about how the Mumbai municipality asked Nesco to stop all events/exhibition due to traffic issues. (This issue seems to be settled for now.)

Last week, the market regulator, Securities and Exchange Board of India (SEBI), cut the total expense ratio (TER) charged by mutual funds.

In simple words, TER is a percentage of a mutual fund scheme's corpus that the fund house charges towards expenses. These include administrative and fund management costs.

The revised TER slab structure for mutual funds will reduce earnings of AMCs by around 15-20%.

Reduction in Total Expense Ratio

Equity MF AUM (In Rs billion)	Newly imposed TER	Average TER so far
0-5	2.25%	2.40%
5-7.5	2%	2.51%
7.5-20	1.75%	2.21%
20-50	1.60%	2.08%
50-100	1.50%	2.07%
100-500	Reduction of 0.05% for increase of Rs 50 billion AUM	2.07%
> 500	1.05%

Data Source: SEBI, Bloomberg Quint

The stocks of asset management companies have collapsed like a pack of cards. Since the announcement, the stocks of HDFC AMC and Reliance Nippon Life are down 10% and 20% respectively.

The mutual fund advertisement says, 'Mutual fund investments are subject to market risks. Please read all offer documents carefully before investing'.

Advertisements for investing in AMC companies should say, 'AMC stocks are subject to market as well as unforeseen regulatory risks. Please check the valuations carefully before investing'.

Just a few weeks back, HDFC AMC's IPO received a great response and the stock had a stellar debut.

At the upper end of the price band, HDFC AMC was valued at over 31 times its FY18 earnings at the time of the IPO. That seemed quite expensive to us.

We published an Avoid view on the IPO.

This is what Tanushree said in the IPO note...

• The company also faces many regulatory risks such as tightening of fees and commissions, cap on fund expenses, recategorization of schemes, etc.by the market regulator. Any such events can have a substantial effect on the business of the company and affect its profitability.

In the concluding remarks, she wrote:

• Clearly, the valuations are on the higher side, even if one considers a fairly aggressive growth trajectory in AUM over the next few years.
  
  We believe that despite the strong fundamentals and growth potential of the business, the IPO price exposes investors to steep valuation risks.
  
  In our view, therefore, the issue should be avoided.

The other AMC stock Reliance Nippon Life is trading below its issue price. During the IPO, its valuations too were steep (about 37 times its FY17 earnings.)

Despite the long-term tailwinds in terms of financialisation of savings and under-penetrated mutual fund market in India, we gave a pass to both the IPOs.

Clearly, it boiled down to steep valuations.

Instead of recommending such risky AMC stocks, Tanushree did something much better.

She waited for the right opportunity.

And sure enough...an opportunity presented itself last Friday during the crazy sell-off in the market.

She recommended a stock with an upside of more than 50% to her StockSelect subscribers.

In investing, there will always be some uncertainty. You can't escape it. But uncertainty brings with it opportunity.

On this journey, you need to prepare for unforeseen risks And be prepared to grab the opportunities when the present themselves.

You can do this by investing with a margin of safety.

As Seth Klarman says...

• A margin of safety is achieved when securities are purchased at prices sufficiently below underlying value to allow for human error, bad luck, or extreme volatility in a complex, unpredictable and rapidly changing world.

Happy and Safe Investing!

Chart of the Day

Talking about margin of safety, till now, I didn't recommend a pharma stock to my Smart Money Secrets Subscribers. One of the main reasons was a lack of clarity.

But this month, I recommended my first pharma stock.

One of my favourite super investors has bought a 0.5% stake in the company. I believe he will scale it up in time.

My Pharma Recommendation is Growing Faster than the Industry

The stock needs to correct a bit before I can give an outright buy. When it does, I'll inform Smart Money Secrets subscribers via a special report.

Don't miss out on opportunities like this, dear reader. If you haven't signed up for Smart Money Secrets, you can do so here.

Regards,


Kunal Thanvi (Research Analyst)
Editor, Smart Money Secrets

PS: Kunal Thanvi, editor of Smart Money Secrets, is the Sherlock Holmes of investing. He is on a mission to reveal the top picks of India's best investors to you. For clean, high quality stock recommendations that won't put your wealth at risk, subscribe to Kunal's Smart Money Secrets.