Good quality stocks are clearly at the upper end of valuation
Mumbai: At this juncture, our markets are clearly overvalued. Good quality stocks are clearly at the upper end of valuation. If I buy them now, my prospective return over the future years is going to be poor. Something has to give way. Either the prices have to correct or they have to stagnate till earnings catch up. I am not saying that this is the end of the bullrun. Irrational markets can last long. The reversion to mean is a matter of time.
As an investor, I like to buy high quality (consistently high ROCE, ROE; good dividend payouts, normal tax payouts; long track record; no debt; etc) companies only. Here I like to recall what Warren Buffet told so elegantly.
“If you own your stocks as an investment just like you’d own an apartment, house or a farm look at them as a business,” Buffett advised. “If you’re going to try to buy and sell them based on news or something your neighbour tells you, you’re not going to do well. Find a good bunch of businesses and hold them.”
Once this criteria is applied, the investible universe for me, in India, comes down to less than a hundred companies and most of them are MNCs. These stocks have a typical tendency to give you high compound returns over long periods of time and in any kind of stock market, they will be the least likely to the least in terms of market valuation. In weak markets, everyone chases these stocks and pushes prices high. Once a bull market commences, everyone buys ‘cheap’ stocks to enjoy higher returns.
Over the longer term, the good quality stocks always deliver a superior return as compared to the average or below average quality. Yes, if you take some point to point measures, anything can be proved or disproved. Like ten year returns, if computed today, will throw up stocks that no one would have touched at that point in time.
In times like these, when I find high quality stocks to be overly expensive, I am under no compulsion to be invested. This is where I see people getting suckered in to the market by MFs which are launching new closed ended funds now with exotic themes.
If you buy anything at this juncture where the valuations are rich, your prospective returns are bound to be poor. For you to make money from new investment in stocks now, the markets have to reach crazy levels. I do not say that it is impossible, but I will not bank on it. I prefer to stay in cash.
In fact, I recommend selling some stocks that have gone very expensive. For instance, if you find that a good quality stock you hold has never traded above 40 times its earnings and is now suddenly breached that, it is a good candidate for raising some cash. This kind of an approach will work for established na-mes and not for new fads.
The new age economy stocks are beacons of hope and optimism and over 90 per cent of them will cease to exist meaningfully in less than a decade. Try and track the education companies that were flying high in the last boom of 2008 and you will understand what I mean.
If you buy poor quality stocks, there is no guarantee that a price once reached will be ever reached again. They can simply become duds. However, if you hold on to a good quality stock, this risk is almost zero. If you look at the universe of stocks in India, one can find perhaps around hundred or so good quality stocks.
Another couple of hundred would be perhaps ‘average’ and the rest would be poor quality. These are my relative measures and I know of friends who say that they cannot find a single Indian company that will be of “high” quality. In these times, I would do the following:
i) Don’t commit fresh money to equity funds;
ii) Keep liquidity intact for any specific buying;
iii) Liquidate some holdings if I foresee a need for cash in the short-term ;
iv) Continue my SIPs without fail and not buy stocks where quality is suspect;
vi) Not put money in to any new close-ended MFs. (The writer is an independent analyst and can be contacted at balakrishnanr @gmail.com)
( Source : dc )
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