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Markets: Do stocks and cars have any relation? - Views on News from Equitymaster
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  • Dec 21, 2005

    Markets: Do stocks and cars have any relation?

    In our view, yes, because whenever an investor buys a stock, he is interested in how fast will it move up or reach the target price, and a similar situation arises when one buys a car - the buyer is only interested in how fast (in seconds) will the needle on the speedometer hit the 60 km/h mark, as it is the yardstick for measuring a car's performance. In both cases, the more time it takes, the lower is the rating given, be it a car or a stock. Also, in both these situations, the individual clearly misses out one vital thing.

    In case of a crash or emergency, be it the stockmarkets or the road, how fast will the stock go down, and in case of a car, the buyer is not interested in knowing how much time will it take for his vehicle to come to a standstill, basically from 60 to 0 km/h.

    One can also relate the stock markets to a traffic signal on the road. Aware as everyone is, there are 3 lights - red, yellow and green. In mid-2003, the markets were in the green mode, as we were entering the bull phase and if an investor put his hand in any stock, he soon realised that it doubled within a year. Then, as the markets gained momentum and reached new highs, we entered the yellow signal, wherein investors only with a high risk appetite could invest, as the upside seemed way less then the downside risk, and a similar situation happens on the road, as drivers who are cautious stop with the yellow light, while less cautious ones jump the signal, indicating their risk-taking ability (in case of cars, facing the cop). However, when the signal turns red, its time for everyone to stop, like in the stock markets, when they are overheated, its at least time for retail investors to take the back seat.

    We had recently conducted a poll on our website, asking our viewers, that in the current bull run, in which segment had they made money, was it large, mid or small cap. The outcome was quite stiff - 50% said that they made money in small cap stocks, 24% made money in mid-cap, while the rest made in large cap stocks. With this outcome, we are sure that the passion for mid and small cap stocks amongst investors is not yet over and that they yet see potential in them.

    Even we agree that opportunities exist everywhere, at every level for large cap stocks and even for select, fundamentally strong mid-cap stocks. But if one takes the trouble to go back in history, mid-cap stocks have been the first ones to be gunned down in case of any correction. But, as we wrote in the first paragraph of this article, people do not bother to check how fast is the downward run going to be in case of an event or correction.

    Thus in conclusion, we do not say who is right or wrong, but ultimately, everything melts down to justifying valuations. Today, an institution might be ready to give a stock a P/E multiple of 20x its forward earnings, while a retail investor will be comfortable only with 15x its earnings going forward for the same period. Who in this case should we say is right? The thumb rule says that if a company's profits are growing at 15% YoY for a consistent period, it can be given a P/E multiple of 15x and if 20% then 20x and so on and so forth. However, one must keep in mind that there are other factors, like economy scenario, sector outlook and so on that also need to be clubbed in while projecting, and then arriving at a suitable valuation.



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