Do not get us wrong. Doing a thorough research on the company you wish to invest in should be integral to your investing process. But at times, the search of some details is undesirable and misplaced. Take the case of banking stocks for instance. The BSE Bankex has gained 37% over the past 12 months. Over this time the valuations of the components of the index moved up from 2.4 times book value to over 3 times. Most stocks in the sector have, however, been at the receiving end of investor apathy of late. The cautious stance on the sector's valuations is appreciated. However, details and speculation over the performance in the next few quarters is what we believe has caused the distress.
Like banking, the fate of most sectors is tied to several economic, political, and social indicators. The economic indicators may be GDP growth, inflation and interest rates. Reforms, political mandates and government approvals are critical to every sector's progress. Again, consumption growth, income levels and demographic profiles have a very important influence. But reading too much and too often into them have higher chances of misleading your investment judgement.
The fact that banks operate with the risk of cyclicality in interest rates is core to investing in the sector. Hence the fact that margins will rise and fall based on the cyclicality also needs to be factored in. What, however, cannot be predicted is the quarter from which the rise or fall will start. And herein lies the problem. For investors who consider quarterly numbers critical to their investment decisions, lack of such clarity on important metrics. Thus it is not the direction of movement of margins, asset quality and growth that bothers such investors. But the timing of the same.
For the Indian banking sector, the prospects of growth can be phenomenal. Especially given the long term opportunity in store (see table on financial inclusion). The key valuation metrics have and will follow broad economic trends. These could be GDP, employment or interest rates. What, however, needs to be looked out for is which players are best suited to offer the highest return on investment.
Level of financial inclusion desired…
Branches per 1,00,000 people
10 to 69
ATMs per 1,00,000 people
47 to 167
Deposit A/Cs per 1,000 people
976 to 1,671
Loan A/Cs per 1,000 people
248 to 513
Data source: RBI
Thus speculation over the details of quarterly numbers has had little bearing on the long term performances of stocks. Short term economic trends and political outcomes too have very negligible impact. Historical performances of stocks across sectors are testimony to this judgement. It is in investors' interest to at times ignore such details.