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Markets: To do or not to do?

Sep 26, 2006

The last three months have brought cheers to the stock markets, after the correction witnessed towards the end of May and in June. In fact, the correction opened doors of opportunity to invest in stocks at reasonable valuations, which was hitherto not the case from the start of the year till mid May. However, the journey to the 12,000+ mark has been an arduous one. And now that this mark has been breached, it is time once again for investors to reflect on certain points before investing in a particular stock.India Story - A reality check is important: While buying opportunities at these levels have diminished to a certain extent, it is all the more imperative that investors become choosy while putting their money in a stock. Yes, the Indian growth story is a reality. But the GDP growth may not sustain at the current level, considering that there is no major initiatives to solve the great infrastructure hurdle the country is faced with today. Like every other government, the ruling party also talks about the need to grow at over 10%. But since it came into the power, the government is grappling with mundane issues like disinvestments while the actual need is to boost investment.

Financial strength - Look deep inside: At the end of the day, it all boils down to numbers. Whether the company has been consistently delivering good performances year over year can be gauged by its revenue growth and profitability and more importantly its return ratios. Other important criteria would be the extent to which the company is leveraged (a highly leveraged company will see its profitability getting hurt in a rising interest rate scenario) and its history of dividend payouts. In the last three years, the debt to equity ratios of the corporate sector has improved not only because of the restructuring but also due to the fact that many have raised money through equity issues, which has resulted in lowering the debt to equity ratio (needless to say it is not the case with the NSE 50 companies). In our view, over the next two years, the broader return ratios will dent a bit (because these companies are in a expansion phase). We do not see significant upside potential to return ratios from the current level (individual brilliance of course, can exist).

Management depth - Bite what you can chew! The management's vision in anticipating changes in the sector and steering the growth of the company according plays an important role. Also, as we have mentioned in the earlier point about the importance of strong financials, the same also reflect the management's ability to capitalise on growth opportunities and come out stronger in times of adversities. Every other company we meet these days have ambitious growth plans. When asked whether they have the internal resources to execute their business plan in a timely manner, every company is finding it difficult to retain/attract quality manpower. We have serious apprehensions about many mid-tier companies' growth aspirations over the long-term.

Valuations: While the growth prospects of a company may look good, valuations also have to justify the same. Currently, the BSE-Sensex is trading at a price-to-earnings (P/E) multiple of around 20.8 times its trailing 12-months' earnings, which is by no means cheap. Irrespective of whether it is a large-cap or a mid-cap, valuations based on one-year forward earnings estimates are expensive in most cases. But on a relative basis, we find many attractive companies in the midcap space with a two to three year investment horizon. We suggest investors not to get carried away by fancy valuation parameters like PEG (price to growth), EV/Sales (enterprise value by sales) and market capitalisation to order book. It is a bull market and market intermediaries will a stock a 'Buy' when it is actually a 'Sell' using fancy names.

To sum up...
At these levels, it is time for investors to do some serious thinking.

  1. Why am I investing in equities? If it is short-term gains (stay away!). If it is aimed at meeting one's long-term financial goals (then, allocate your assets according to your risk profile). Remember, equities is 'one' of the asset classes and not 'the' answer to all your financial aspirations.

  2. Why should I focus on the short-term when I can buy a good story for the long-term and not worry about day-to-day price fluctuations?

  3. Do I have the time and the skill-set to monitor my portfolio periodically or should I give my money to a good fund manager?

We cannot answer these questions for you because the risk-return profile of each individual can be different. To sum up, it is time for introspection!


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