Strong Growth + Reasonable Valuations + Insider Buying = Time to Buy - The 5 Minute WrapUp by Equitymaster
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Strong Growth + Reasonable Valuations + Insider Buying = Time to Buy

Nov 21, 2018

Sarvajeet Bodas, Research analyst, The 5 Minute Wrapup

The markets act strange sometimes!

This is what Kunal and I often told each other after the September quarter results.

The reason?

Despite posting a strong set of numbers, the stock market is yet to recognise the performance of the companies we've recommended in Smart Money Secrets.

Nevertheless, the combination of stagnant stock prices and rising earnings means the valuations look attractive now.

But this leads to an important question.

Why is the stock market behaving like this?

Well, there are two perspectives.

The first is short-term.

Here, a whole bunch of factors are involved.

In the current market, factors like RBI vs the Government, crude oil prices, fiscal deficit, the IL&FS saga, the liquidity crunch, interest rates, inflation, NPAs, and many other factors come into play.

Spice this up with investor psychology and you have a different outcome than what you might expect.

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Mind you, no one can predict the short-term outcome.

For example, a few days back, people were predicting crude oil would touch US$ 100. But now, the same people are saying crude oil is in a bear market and will touch US$ 50!

The short-term is too complex as there are an infinite number of variables.

The second perspective is long-term.

This is somewhat easier to predict than the short-term.

You see, ultimately, the value of a company depends on the value (measured today) of all its cash flows in the future.

And in the long run, all investment returns are about earnings.

Think Long-Term

So, when you invest in stocks, you are investing in the underlying business.

You also focus on management quality, business culture, competitive advantages, re-investment opportunities, and so on.

The ultimate determinant of the price of any stock will be the underlying business' performance i.e. the earnings.


First, share prices are volatile and far more so than corporate profits. Share prices are influenced by the emotions of the crowd.

Second, a company's value is a function of its future earnings. If you buy a business whose earnings are higher in the future, it's likely the share price will be higher as well.

Consider a simple example.

You buy a Rs 100 stock earning Rs 10, i.e. a P/E of 10x.

If its earnings grow at 15% annually, in the ten years it will be earning around Rs 35. Assuming the P/E is unchanged, it will be trading at Rs 350 (35 x 10).

If the stock is still trading at the same level i.e. Rs 100, that would mean its P/E would be just 2.8x, which is quite unlikely.

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So, on any given day, market prices are driven purely by sentiment. But as your investment horizon lengthens, sentiment will matter less because returns will be dominated by earnings.

As per the recent results, some companies in Smart Money Secrets did exceedingly well. However, the market has not recognised them yet.

And guess what, promoters of these companies are very positive about the outlook. They are buying shares from the open market.

Yes. Insiders are buying!

It's time to look at such stocks which offer the potential for sustainable earnings growth. Insiders buying their own stock shows their confidence about the business prospects.

Buy them at reasonable prices and the returns will follow.

Happy investing!

Chart of the Day

Previously, Kunal wrote about insider's buying activity and how these promoters are buying their own stock.

He presented a chart tracking the increase in the promoter stake over the last two quarters.

So, I wanted to check how these companies fared in the recent quarter.

Here's the chart showing the growth in net profits coupled with promoters increasing their stake in their own companies.

Insiders Buying + Strong Earnings Growth = Buying Opportunity!

Barring a couple of stocks, all other stocks have registered strong earnings growth in the last two quarters.

This, coupled with the recent market correction provided an opportunity to promoters to increase their stake.

We believe insider buying is one of the strongest smart money indicators.

Combined with strong earnings growth and reasonable valuations you have a good entry point.

Sarvajeet Bodas
Sarvajeet Bodas
Research Analyst, Smart Money Secrets

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