|»5 Minute Wrap Up by Equitymaster|
On This Day - 26 AUGUST 2015
Time to go bargain hunting?
In this issue:
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.
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.
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.
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...
Copyright © Equitymaster Agora Research Private Limited. All rights reserved.
Any act of copying, reproducing or distributing this newsletter whether wholly or in part, for any purpose without the permission of Equitymaster is strictly prohibited and shall be deemed to be copyright infringement
Disclosure & Disclaimer: Equitymaster Agora Research Private Limited (Research Analyst) bearing Registration No. INH000000537 (hereinafter referred as 'Equitymaster') is an independent equity research Company. The Author does not hold any shares in the company/ies discussed in this document. Equitymaster may hold shares in the company/ies discussed in this document under any of its other services.
This document is confidential and is supplied to you for information purposes only. It should not (directly or indirectly) be reproduced, further distributed to any person or published, in whole or in part, for any purpose whatsoever, without the consent of Equitymaster.
This document is not directed to, or intended for display, downloading, printing, reproducing or for distribution to or use by, any person or entity, who is a citizen or resident or located in any locality, state, country or other jurisdiction, where such distribution, publication, reproduction, availability or use would be contrary to law or regulation or what would subject Equitymaster or its affiliates to any registration or licensing requirement within such jurisdiction. If this document is sent or has reached any individual in such country, especially, USA, Canada or the European Union countries, the same may be ignored.
This document does not constitute a personal recommendation or take into account the particular investment objectives, financial situations, or needs of individual subscribers. Our research recommendations are general in nature and available electronically to all kind of subscribers irrespective of subscribers' investment objectives and financial situation/risk profile. Before acting on any recommendation in this document, subscribers should consider whether it is suitable for their particular circumstances and, if necessary, seek professional advice. The price and value of the securities referred to in this material and the income from them may go down as well as up, and subscribers may realize losses on any investments. Past performance is not a guide for future performance, future returns are not guaranteed and a loss of original capital may occur. Information herein is believed to be reliable but Equitymaster and its affiliates do not warrant its completeness or accuracy. The views/opinions expressed are our current opinions as of the date appearing in the material and may be subject to change from time to time without notice. This document should not be construed as an offer to sell or solicitation of an offer to buy any security or asset in any jurisdiction. Equitymaster and its affiliates, its directors, analyst and employees will not be responsible for any loss or liability incurred to any person as a consequence of his or any other person on his behalf taking any decisions based on this document.
As a condition to accessing Equitymaster content and website, you agree to our Terms and Conditions of Use, available here. The performance data quoted represents past performance and does not guarantee future results.
Equitymaster Agora Research Private Limited (Research Analyst) 103, Regent Chambers, Above Status Restaurant, Nariman Point, Mumbai - 400 021. India.
Telephone: +91-22-61434055. Fax: +91-22-22028550. Email: email@example.com. Website: www.equitymaster.com. CIN:U74999MH2007PTC175407