The BSE-Sensex has crossed 7,000 for the first time in its history. In fact, on Tuesday, June 21, 2005, the benchmark index actually closed above that level for the first time ever! Such euphoric heights are unparalleled in the history of the Indian stock markets and reflect the strong sense of business confidence that investors have. This has been seen in numerous surveys carried out by global research agencies as well. But, as they say, the proof of the pudding is in the eating and the 'eating' in this case is the meteoric rise of the stock markets!
However, at such levels, it is indeed advisable to practice caution. Numerous stocks have hit either 52-week highs, three-year highs or even all-time highs. It would be sensible to at least book partial profits in such stocks. Now, we have seen what is there on the surface, i.e. Sensex crossing 7,000, NSE-Nifty hitting all-time highs, etc. But we need to do a brief analysis in order to understand exactly how broad-based this rally has been, how have the mid-caps done vis-à-vis the large-caps and so on and most importantly, what can investors do at such levels.
So, what's the broader picture?
Well, unfortunately, in one word - narrow! The euphoria witnessed by the markets during the last few days has been limited to the large-caps. This has again been mainly driven by Reliance Group stocks and to a lesser extent, by technology stocks. As we have mentioned before and is well-known, the positive sentiment towards Reliance stocks is mainly due to the settlement agreed to between the two brothers over the weekend. This move is seen as unlocking hidden value in these stocks and markets are thus, seemingly giving them higher valuations. In fact, the day after the settlement, the stock of Reliance Capital, now an Anil Dhirubhai Ambani Enterprises (ADAE) company, soared by as much as 25%!
The mid-cap stocks have, however, not seen that much of an upmove since the settlement. In fact, they have actually corrected downwards, as the recent euphoria over mid-caps has seemingly started fading. At these higher levels, it does appear that most of these stocks are fully valued, some even on a two-year forward earnings basis! Therefore, buying into such stocks at this juncture could be fraught with danger. While we are not saying that we are bearish on the markets, we do believe that at such high levels, it would be wise to practice caution.
As regards technology stocks, markets hammered them after Infosys announced 'disappointing' guidance for FY06 and TCS reported below-par numbers for 4QFY05. However, since then, these stocks have bounced back, with Infosys and TCS gaining as much as 27% and 21% respectively from their lows in April! They were also among the chief gainers apart from Reliance in the market rally seen since the Reliance settlement was brokered and have been the major drivers of the IT index.
What does this mean?
Quite clearly, the overall markets do not seem to be in such a euphoric mood as the major indices, the Sensex and the Nifty. If we take a look at the overall breadth of the markets in these past three days since the meteoric rise of the benchmark indices, it is, in fact, overwhelmingly in favour of the declining stocks. This clearly indicates a correction in the mid-cap stocks, some of which have run up too far, too soon.
Even taking the indices into account, such a quick run-up might not be warranted. As the saying goes, what goes up, must come down! Also, at these levels, the major indices now trade at price to earnings multiples in the region of nearly 16 times FY05 earnings. This is definitely not 'cheap'. Therefore, it would be prudent to expect some correction at these high levels, especially when we have seen the Sensex touching 7,000 thrice on Monday and then comfortably ending above those levels in the past couple of trading sessions.
Now, while we are not trying to predict doomsday or anything of that sort, what we are trying to say is that investing simply by looking at the level of the overall indices is a foolhardy thing to do. If at all one wants to invest in an index, in that case, an index fund of a renowned mutual fund house would be more suitable for him or her. But we firmly believe that this is very much a stock-picker's market. There are still numerous stocks out there with hidden potential in them, in which true value has not yet been unlocked.
Therefore, in such a market, a bottom-up approach to investing would serve investors the best. Invest in companies with strong fundamentals, a good track record, a credible management team and strong future prospects. And of course, not to forget, reasonable valuations! If you invested in a company like Infosys, but you invested at the height of the 'tech bubble' at around Rs 15,000, then you would not have earned good returns, simply because you would have paid far too much for a company whose earnings growth might not have justified the obscene valuations given to it by the market!
Probably the most important characteristic of any investor in such a market is to be disciplined. In such a market, it is very easy to get carried away and to become greedy and not book profits as and when the stock hits your target price, as you may anticipate a further upmove, given the strong positive sentiment. However, more often than not, it is such indiscipline that ultimately costs investors dearly. It is easier said than done, but we reiterate, disciplined investing is the key to being a good investor. This is often the difference between a successful investor and a not-so-successful one!