Business Market 31 Jan 2019 Invest talk: Be caut ...

Invest talk: Be cautious in buying commodity co stocks

DECCAN CHRONICLE. | R BALAKRISHNAN
Published Jan 31, 2019, 1:27 am IST
Updated Jan 31, 2019, 1:27 am IST
Commodity stocks are not like consumer goods where there is pricing power with the seller.
Some of us would have played safe long ago and pulled their money off the markets. (Representational Image)
 Some of us would have played safe long ago and pulled their money off the markets. (Representational Image)

Mr Market always wins. Those of us who think that we have mastered Mr Market are living a lie. I recall a tagline from a movie of the 1980s named “Jaws”. The tagline was “Just when you thought it was safe to enter the water….”.

Mr Market seems to be in a vicious mood as of now. Some of us would have played safe long ago and pulled their money off the markets. Some of us have invested long ago and are not bothered by this turbulence. Some of us are peacefully committed to our SIPs and are continuing it. 

 

Then there are some of us who have made quick money and then got caught a few months ago in the first round of mid cap stocks losing their value. Many of us had stayed away from the markets and came back a couple of years ago. And boy! Were we good? Everything we bought was the perfect pick! It reached a stage where we bought first and then wrote the story of the stock.  Then a rude shock.

The first round of panic when the mid-cap stocks got knocked about. Then the stories of poor management, frauds and corporate governance issues. When you lose money, you have time to read all this and then ponder. Now we have lost money and bought wisdom. Alas, wisdom is like ice-cream. It melts when the market gets hot.

Commodity stocks cracked three months ago. We bought. Saying that they have ‘corrected 30%” from their peak. Now, they seem to be cracking yet again. We did not pause and see what happened in the last three years, last two years, last five years. We were focused on the “52-week” highs and low. Our mind got anchored to this number.  We did not look at a three or five year high or low. This probably makes sense to us only after we lose money. As I said, this is the time that the fresh batch of ice-cream is starting to set.

The biggest damage comes from commodity stocks and from stocks that are the beneficiaries of poor governance.  And note one lesson. Companies with “debt” beyond a reasonable level are also going to hurt investors. What is a reasonable level? Debt should be such that the profits after tax and dividend should cover the repayment of interest and principal in three years. This is my safety valve.

I have written in the past about commodity stocks. Once again, I would like to remind you that these are called ‘cyclicals’. It is because they go through a cycle of bust and boom.  Thanks to China curtailing some of its commodity output and exports, our companies had an unusual window of supernormal profits. Sooner or later the earnings will come down.

Commodity stocks are not like consumer goods where there is pricing power with the seller. And periods of excess profits lead to higher investment in the sector and then higher output brings down the profits. And with global trade shrinking (I fear this trend is now set), there is bound to be lower growth and higher pressure on profits.

I like to relate commodity stock to a simple “Price to Book Value” measure.  See a ten-year trend in this and buy when it comes very close to the lower end and sell it when it gets to the upper range. This approach is my preference. I am not guaranteeing that it would always work. Often, the bad cycle lasts a long time and the good times are short. The noise level makes us think that good times are always around.

Another important thing if we are ‘trading’ is to have very strict ‘stop-loss’ and ‘stop-gains’ and faithfully follow it. When we are trading, we are essentially trading prices. Never lose that focus. “Stop Gain” is something that helps to prevent greed from overtaking emotion. When a stock is climbing, we forget everything else and just want one more digit added each time. Then when it slides back, our mind gets anchored to the high price we saw and we wait. Sometimes, this wait can be for over a decade. 

Let us say I keep the ‘stop gain’ at 30 per cent.  Even if I think that the stock may go up 10 times from here, I should sell it and buy it back.

Is the worst over? I have no clue. However, commodity stocks are on my radar for now. If I can see non-cyclicals tumble, I may add some. Otherwise, go ahead with your SIPs and get equipped with more and more learnings.

(The writer is a veteran investment adviser. He can be contacted at  balakrishnanr@gmail.com)

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