»Profit Hunter by Equitymaster

On This Day - 1 JUNE 2021
Time to Press the Accelerator on Auto Stocks?

The Nifty along with many indices are trading at all-time highs.

What better time to remember this evergreen saying from legendry investor Warren Buffet.

  • "Be fearful when others are greedy, and greedy when others are fearful."

I can tell you from my interactions with a number of people, that greed is definitely high. The element of fear is virtually nonexistent.

Last weekend, a very close school friend who is a lawyer called me.

He was wondering if I would help him invest his savings in the stock market. His expectation was at least a 12-13% return.

I thought this was extremely realistic in current euphoric times.

Later during the conversation, I told him if he held his investments for more than couple of years, the returns would start compounding at a much higher rate than 12-13%.

To which he abruptly jumped into the conversation and exclaimed...

  • Boss, 10-12% per month and not for the year, is what I am looking at. Haven't you seen the Nifty double in the last 1 year.

That is just one instance I am sharing with you among the many interactions I have had.

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Now, does the current sentiment signal euphoria in the market?

Let me answer this with one of my favorite quotes of Peter Lynch...

  • "Far more money has been lost by investors preparing for corrections, or trying to anticipate corrections, than has been lost in corrections themselves."

Why time the market when we know we can't.

But at the same time, it's important to watch out for valuation bubbles in certain sectors or pockets of the market.

Ever since I started studying entered the market, I have always heard stories about the great crash of 1929 in the US.

At that time, businessman and investor, Joseph P. Kennedy knew it was time to get out of the market when his shoeshine boy began giving him stock tips.

Have we reached that stage?

I do agree, the euphoria in the market is getting crazy.

But here is the thing about excesses in the market. They tend to overshoot on both the sides.

Euphoria breeds more euphoria while pessimism breeds more pessimism.

So with the Nifty at an all-time high, what should retail investors do?

Read the opening quote about greed and fear.

Certain pockets of the markets definitely look overvalued and are approaching bubble territory.

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But to label the entire stock market in bubble territory would be far-fetched. We haven't got to that stage yet.

In my previous editorials, I have emphasised on the insanity in the IPO market.

The stock of Burger King, a loss making company doubled post listing.

When has it been it so easy to make 50-60% returns within hours?

Now that's what a bubble looks like.

Here's some food for thought...

Some chemical companies supplying raw materials to the FMCG industry trade at a higher valuation than the FMCG companies they supply to.

How can these chemical companies which supply bulk commodities to the FMCG giants be valued higher than them?

Now that's what I call overstretched valuations.

I've also written about industries which have lagged over the past decade that will generate alpha for your portfolio.

Sectors like real estate, capital goods and infrastructure are poised to do well as the capex cycle and economic recovery gathers steam.

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The valuations in many of these stocks are also reasonable.

Apart from these sectors, there is one more sector that is unloved at the moment due to the headwinds it is facing: The auto sector.

Even if buying a vehicle is not on your mind, buying a vehicle stock should be at the top of your list.

So then, when people are not buying cars, why am I telling you to buy these stocks?

Here's why...

The auto sector is cyclical. The cyclicality varies for different segments.

Commercial vehicle sales are linked to economic growth. Tractor sales are linked to the monsoons.

They are extremely cyclical while 2-wheelers and passenger vehicles are relatively less cyclical.

A confluence of factors such as steep rise in ownership costs of vehicles due to change in emission and regulatory norms, higher lending rates, muted disposable incomes led to a mere 1.3% growth in auto sales over the last five years.

To add to the misery, covid hurt the recovery.

In short, auto sales are still at FY16 levels in most segments.

When in comes to discretionary consumption, like buying automobiles, demand gets delayed but not lost.

Your decision to buy a vehicle or a two-wheeler will get postponed for a few months.

This is unlike demand for consumer staples like biscuits and soft drinks where lost sales are measured on per day basis.

Would you consume two cola bottles tomorrow to because you didn't drink one today?

After four years of underperformance, I expect the auto cycle to change for the better.

Also, valuations of auto stocks are fairly reasonable compared to certain pockets of market euphoria.

When market leaders are available at 30-35% discount from their all time highs, it certainly merits a look.

I do agree, the sector is down and is likely to stay that way for a few quarters mainly due to the softness in demand.

But it's during such tough times, the best companies can be found with reasonable valuations.

I believe along with auto stocks, a bigger opportunity for investors would be in the auto ancillary space.

Next week, I'll write to you about why the risk reward is looking good in the ancillary stocks.

Warm regards,

Aditya Vora
Aditya Vora
Financial Writer

PS: Join our safe stocks expert and co-head of research, Tanushree Banerjee, at her India's Revival Summit. Tanushree will show you how to profit from the huge upcoming wave of economic prosperity. Register for the summit here.

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