As long as earnings outlook is bad, valuations are not important and stocks can reach any “mad new lows”. Valuation theories will not work.
Why Stocks crash so heavily for small fall in earnings?
Example: Welspun Gujarat was trading at Rs 400 just 8 months back. But it is now trading at 62. Why?
In May, 2008: EPS is 19 - P/E is 21= Price is 400.
In February, 2009: EPS is 15.2 - P/E is 4.1 = Price is 62.
Just 25% fall in earnings but stock crashed by 82%. Opposite will happen on upside in Bull Market. Don't think that price will fall in the same ratio of earnings. Outlook towards sector/company is very important.
Lesson: Rakesh Jhunjhunwala – my favorite investor and source of inspiration till 1 year back. But I lost total trust on him after his recent interviews. He completely lost the way in 2008. In stead of accepting failure and correct his way of thinking, he is now talking about 2012-14. Even a new investor can tell about stock market bounce back by 2012.
But retail investors watch his interviews to get an idea about stock markets and escape from serious losses. When Sensex was at 17,000, he talked about Sensex making new highs after 3-4 years. So, many innocent people who invested money at 20,000 levels kept their money in markets in stead of minimising losses by exiting at that price.
Example: If you invested 5 lakhs when Sensex at 20,000. One investor exited with losses and entered the market in SIP manner from 8,000 levels onwards while another investor still kept their money. Compare their earnings in 2012. New stocks and sectors will lead next rally.
2. Global economies are now tightly integrated and global economic shocks will affect each and everyone. De-coupling theory is the worst theory, I ever heard. Foreign funds play crucial role in deciding market moments than mutual funds and LIC. Unstable investors like FIIs and traders like Nirmal Kotecha are more influential in deciding stock moments than stable investors like LIC and Rakesh Jhunjhunwala.
Lesson: If Nirmal Kotecha has significant holding in your stock/company, your investment is always at risk. He ruthlessly exits from that counter if he finds negative outlook for company. SEL Manufacturing was trading at 600 –just 6 months back. It is now trading at 52. That is Nirmal Kotecha effect! Same happened to Pyramid Saimira investors.
3. Role of Sentiment or Psychology:
Price of large cap: Fundamentals+/- 20-30% sentiment
Price of Mid-cap: Fundamentals+/- 40-50% sentiment
Price of Small-cap: Fundamentals+/- 50-70% sentiment.
Price of a stock: Fundamentals+/-overall sentiment+/ sector sentiment. Sector sentiment is especially very high for stocks in cyclical sectors like Real Estate.
Example: Unitech made small investors into millionaires and made many millionaires into small investors. How?
Unitech stock price:
January, 2006: Rs 18
January, 2007: Rs 280
January, 2008: Rs 520
January, 2009: Rs 40
- If you were a small investor and invested Rs 1 lakh in January, 2006 in Unitech – your investment value was Rs 4.5 crore by January, 2008.
- If you are a millionaire and invested Rs 1 crore in January, 2008 in Unitech – your investment value is now Rs 5 lakh.
Unitech management has not done any frauds like Satyam – Unitech counter was not operated by people like Harshad Mehta. What changed the scenario is sentiment towards Real Estate sector and huge debt.
Note: Sentiment and knowledge on economic cycles are very crucial for cyclic stocks.
But Hero Honda outperformed despite operating in bad sector due to exceptionally strong fundamentals and thanks to outstanding management quality. Such exceptions are rare.
That is the effects of stock markets! New investors should always keep this in mind. Never underestimate stock markets.
4. Understand economic cycles: Economy always operates in cycles especially sectors like commodities, Auto and Real Estate will see massive swings according to business cycles. If you are on the right side of the cycle, you will get exceptional returns. But you may suffer serious losses if you are on the wrong side.
Example: SAIL was trading at Rs 5 when commodities are in downturn in previous bad economic cycle. Just imagine the returns of those investors when cycle turned to positive in 2006.
5. Resistances and Supports: I am never a big fan of these Technicals. I don’t know how stocks will move upwards when economic fundamentals are weak. But these Technicals are extremely helpful for Day traders. But I never gave much importance to these supports and resistances in deciding target price.
Example: DLF was trading at 306 when I gave a target of 160. I gave a target 300-350 for ICICI Bank when it was trading at 520. I gave those targets not basing on supports and resistances. I analysed the pros and cons and used my experience to arrive at those prices. This may not be a scientific chart based decision but I always stick to my experience, knowledge, research and gut feeling in stead of wasting time on charts and other technicals.
6. Banking and Economy: Everyone in India was bullish on Banks in December basing on rate cuts and domestic consumption. At that time, I heard 2 statements which impressed me very much.
Corporation Bank M.D: I am not that much bullish on our banking sector prospects. We are seeing decline in deposits means economy is slowing.
Shankar Sharma: Banking sector is always a reflection of economy. Banks will never perform better in a slowing economy. NPAs and defaults are always concern in any economic slowdown.
Note: You need to have guts to comment against herds.
7. Stock Market Analysts:
Happiest moment in the life of many Indian Investors was most depressive period of my "Blogging life". I wrote regularly about stock markets till October, 2007 but suddenly failed to understand the situation and valuations. I stopped blogging in November and December, 2007 as I couldn’t understand the valuations and fundamentals of many Indian stocks once Sensex crossed 18,000 levels. I stayed away from stock markets and blogging and lived in a depressive environment. At that time, I thought it as my failure to predict "stock market rise".
In this meantime, Sensex crossed 20,000 and all were talking about Reliance Power and listing of R-Power at 900 means P/E of more than 2,000 or infinity. Analysts were talking about Sensex crossing 30,000 levels and legendary investors like Rakesh Jhunjhunwala gave 40,000 target for Sensex in 3 years. Whenever I went to hotels or local shops in Ongole, all were talking about Stocks and Sensex. Many women in my neighbourhood were actively doing day trading and sharing their success stories. Many people started opening new Demat accounts to apply for Reliance Power IPO. I failed to understand the market rise despite doing extensive research. My irritation levels reached new peaks. Irritation was not due to jealousy but on "my inability to understand the situation".
In this meantime, Sensex crossed 21,000 and some faithful readers mailed me to get my opinion on stock markets. At that time, I was in a highly irritated state as I failed to find the logic behind that “mad rise”. Fortunately, in stead of yielding to temptations, I struck to my belief and wrote this post on Stock Market investment advice (my best post). I don’t know how many readers followed my advice and benefited from that article. But I will never forget that post in my life. It gave me complete confidence in my abilities and knowledge. No looking back from that day despite some occasional bad decisions.
8. Indian Government: Indian Government missed a historical opportunity in October, 2008. When long term economic outlook was bad, our Government failed to read the situation despite led by great economist Dr. Manmohan Singh. Government failed to take proactive measures due to lack of vision. At that time, UPA leaders were in blind belief of 9% GDP growth rate. If Government had taken decisions like stake sale in PSUs etc, by this time, India is in safe zone.
Indian Government failed to estimate the effects of fall in GDP, our dependence on Global economy and underestimated the FII outflows and fall in tax collections. We are now suffering from massive Fiscal deficit and Government is not even in a position to announce massive stimulus package.
9. SEBI: Just see their order on “disclosure of pledged shares”. Even lay persons knew about loopholes in that order. But our SEBI people are acting like blind people. When investor community revolted against Satyam management, SEBI remained silent. In stead of proactively enquiring about the Satyam-Maytas deal, they acted like “Blind-Deaf-Dumb People” until Ramalinga Raju voluntarily came out to reveal his misdoings.
Lesson: Investors should take care of themselves. No one is there to save you.
10. Larsen and Toubro: This is one of the best companies in the world (not India) for long term investment. Company even announced better than expected results in the most difficult October-December quarter. But management decided to commit suicide by investing in Satyam Computers. In a tight economy, management wasted money by investing Rs 700 crore in Satyam Computers. In stead of tightly integrating its main business and use that money to get new orders, it is now completely immersed in Satyam. Investors paid the price.
Lesson: Always track your investments even in good companies and exit when situation is looking unpredictable. But don’t exit when stock was corrected and included all the negatives.
11. Tata Motors: Absolute madness. If Tata likes Jaguar and Land Rover cars since his childhood, he can buy 10 cars each but should not waste investor’s money in acquiring outdated companies. It is difficult to believe that a man with “Nano” vision made this unbelievable blunder. Investors paid the price. World is moving towards small cars and hybrid cars but our Tata is moving towards Jaguars.
Lesson: Never fell in the trap of "Awards Mania". Promoters of Publicly listed companies should always think and act according to the interests of ordinary investors (learn from Late Dhirubhai Ambani).
12. Bharti Airtel and Reliance Communications: 6 months back, both companies were neck and neck in acquiring new subscribers. Today, Airtel marched ahead with the help of strong management but R-Com lost the way as our Ambani is busy with Amar Singh and Co. Investors paid the price.
13. Hero Honda Vs Suzlon: Hero Honda is operating in bad sector and Suzlon is operating in good sector. But what happened to their stocks is exactly opposite. Why?
Lesson: In Bull markets, investors give less importance to ethics and management quality. But In troubled markets, companies with “allegation scars” like R-Com, Suzlon, DLF and JP Associates will suffer massive falls.
14. Bharti Airtel, Infosys and Hero Honda: Lesson – companies with strong management pool attract the attention of investors in bear markets. But they may not give you exceptional returns if markets make bounce back as they already factored most of the positives in their prices just like FMCG Stocks.
Lesson: Promoters should have single minded focus when running a Company. I like Mukhesh Ambani, Sunil Mittal, Munjals, Marans and Gautam Adani in that aspect.
15. Sugar Stocks: These companies gave negative returns in 2007 when markets are in “Great Bull Run” but sugar stocks gave 50-100% returns when we are in worst ever bear markets. Stocks in Cyclical sectors always give exceptional returns if you can able to pay your cards right. I successfully predicted turn around in sugar sector in early 2008.
16. Market moments: They will not move according to proper script. 80-90% of time, stocks will move either above or below the fundamental price according to market sentiment. 80% of price moment occurs in just 20% of time means 80% of profits or losses occur in just 20% of trading days. But “Timing the markets” is the most difficult aspect of Stock market investments. It is very difficult to invest at "right price". Just look for "Margin of Safety".
17. Mid-Small caps: These companies will always give greater profits or losses than large caps. So, 200-300% of profits or losses are rare in large cap stocks like RIL, Bharti Airtel and Infosys but common in many small caps and mid caps. So, young risk bearing long term investors should allocate more to small and mid-caps irrespective of short term losses but old age investors or conservative investors should allocate less than 40% to such stocks.
18. Commodities: I successfully predicted stock market moments and sugar commodity moment but miserably failed to predict commodity crash due to my blind belief in Jim Rogers at that time. I believed in the “After Olympics theory” - economic activity will pickup in China after Olympics. Rest is history. I learnt a lesson.
Lesson: I took an oath - “I should Always believe in my research, gut feeling and knowledge only”.
19. Satyam Computers: I wrote enough about this company. But it also destroyed the wealth of other Hyderabad based companies – investors of the other Hyderabad based companies once again understood the role of sentiment and trust. Same happened to ADAG stocks after the debacle of Reliance Power IPO. Your wealth sometimes depends on your neighbour. Difficult to believe but true.
20. Role of Politics in Stock Market moments:
A. ADAG Stocks: They gained when Samajwadi Party supported UPA Government and will make new lows if Mayawati will become PM after Polls. But JP Associates will gain if Mayawati plays crucial role at centre.
B. Stocks like GMR Infra, Lanco infra, Pennar Cements, Jindal, India Cements, Dalmia Cements and GVK Power etc may make new lows if Congress Government fails to return to power at both centre and state (Andhra Pradesh).
C. Stocks like Madhucon and Heritage Foods may gain if TDP returns to power in Andhra Pradesh. Is it just sentiment or some thing more?
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