Money is made in waiting!

That said, the hard part is, it will be an agonizing wait…

Value investing is simple, yet isn’t easy. The wait for value to emerge and the subsequent wait for value to unlock, in most cases, is a protracted and a painful one. What makes it worse (emotionally of course) is when value emerges, the slide doesn’t stop just because it is undervalued, given market’s manic tendency to undershoot. After all the wait for markets to come off the overshoot, the notional portfolio erosion during the under-shoot after initiating value buying, makes even the staunch value investors shaky. To digest the erosion and still have the nerve to add during the undershoot, knowing well the long wait ahead for the value to rerate (unlock), is what makes the whole process gut-wrenching. Similarly, even the rerating ride (upward value unlocking journey) is equally rocky and bumpy with many false starts and vicious falls. If one adds client’s expectations/pressure into the equation, hardly can anyone envy the money manager who has taken the road-less-travelled path of value investing. If this is not hard enough, such money managers have to go thro’ this cycle multiple times to create value over long-term.

Add to these, the challenges that come frequently while deploying cash in a falling market. After holding cash for a reasonably long time while the market kept rising, when the market turns and cracks, it will be tempting to quickly deploy when valuation turns attractive. If the market undershoots further, as it normally does, depleting cash too quickly tempted by attractive valuation could hurt the portfolio. Alternatively, if the market bounces quickly without undershooting further, decision to deploy quickly could prove to be a genius one. Both are possible outcomes in any market (irrespective of the economic fundamentals at that point of time) depending on to what extent the fear cycle plays in the given point of time.

Let us illustrate this vide an example. Given below is the price-chart that captures this dynamics for a stock that has moved into the deep value zone recently. In the below chart, point A represents the point of overshoot, point B represents the time from which value starts emerging, point C represents the point of undershoot where it becomes a deep value and point D representing the beginning of rerating. As one would infer, the overall time for the entire cycle to play out, from overshoot to undershoot and then to rerating, goes even beyond three long years. In some cases, the wait could be even longer if the undershoot turns ugly or rerating gets retarded, depending on the extent of bearishness in the market.

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The above chart is not an imaginary one. It is a real one (except for the dotted segment) for a stock that has turned deep value in the ongoing correction. It is a price chart of a company that is into renting high tonnage cranes for the wind sector.  With the wind sector suddenly losing shine on serious short-term setbacks, this stock is on a free fall, thereby providing a fat-pitch opportunity for value pickers.

Value opportunities are not limited only to few stocks. With bubble popping out in small and midcaps in the ongoing slump, many stocks have sunk to new lows, thereby providing entry opportunities. For anyone who is willing to invest on the emotional capital of “Waiting”, these are great time to load up one’s shopping carts.

Investing isn’t easy. Superior skill and extra-ordinary nerve are required to achieve above average results in investing. To quote from Howard Marks memo, “So, in the end, there is only one absolute truth about investing. Charlie is right : It isn’t easy”

Happy Value Investing!

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Seller’s Strike…

With Nifty flirting around 10K milestone, it is busy time for business channels and financial portals. All of them compete with each other with screaming headlines on how so and so stock has multiplied so many times in such a short time. Number of such stocks that have skyrocketed keeps growing by leaps and bounds. It is no accident that much of these stellar stocks are from the infamous group of tiny or micro caps. The reasons are not difficult to fathom.

In many cases, the surge in prices is more to do with lack of sellers than to do with aggressive buying. Incessant rise in price has led to sellers going slow on fear of premature exit, leaving many counters with few buyers driving up the prices. As a result, stocks are soaring amid thin volumes. In such a scenario, even a small selling when it comes, could leave a deep crack in some of these celebrated multi-baggers.

Though this trend is more prevalent in tiny caps, the rub-off of this trend on wider small and midcaps is one of key reasons for elevated valuations in the broader markets. As anyone who had attempted to sell even marginal quantities would know, the prices are very unreal and portfolio value could see a big erosion even on small selling. Given such a fragile nature of valuation, one should be very careful not to take the sharp rise in portfolios at face value. Tide does turn and when it turns (no one knows when), it will be a turn for the buyers to strike. When that happens, the whole momentum game  could play in reverse, esp. for tiny and micro caps. It is time for caution for the overall market, esp. when it is driven by surge in liquidity rather than by ever-elusive earnings upgrades.

Pockets of Pessimism

banner-octIndian Pharma: Fat pitch in sight, get ready for a hard swing!

It may seem odd to talk about a fat pitch when Nifty is at a striking distance from a five digit mark (sorry, struck and gone well past that mark is another matter). It is no secret that Sensex has been soaring to stratospheric valuations on surging liquidity from both domestic and foreign investors. If anything, stocks are simmering at frothy levels for a while now. Yes, this is true for much of the sectors where it is a story of trumpets blaring amid ever-rising list of multi-baggers. But that hasn’t stopped the markets to punish prices in certain select pockets to seductive levels on growing uncertainties in the short-to-medium term. If one looks around for sectors where drums are beating amid plunging stock prices, it is unlikely that one would return empty-handed.

No prizes, of course, for guessing the sectors that have been the laggards in this bull run. It is widely known that the top stocks that have spectacularly soured the sentiments are from the infamous group of three sectors, namely IT, Telecom and Pharma. While all of them are going thro’ sectoral short-term setbacks, on measure of mis-pricing relative to long-term business fundamentals, Pharma seems to be more promising.

In a rare instance of unfortunate coincidence, confluence of factors have miraculously come together to conspire a deadly blow to the fortunes of pharma industry. The sector that helped India to build global prominence is suddenly facing huge set of headwinds on account of following developments:

  • Increased regulatory scrutiny (Increasing cases of warning letters and import warnings from US FDA).
  • Consolidation of distributors in US resulting in pricing pressures for generics
  • FDA’s increased focus on fast-tracking drug clearances leading to more competition in generics and hence putting pressure on prices.
  • NPPA (National Pharmaceutical Pricing Authority) bringing more drugs under price control in domestic market.
  • The risk of dictum from Indian govt. on generics prescription in the local market.
  • To top it all, GST hiccups couldn’t have come at a worse time i.e. destocking and delay in restocking in domestic formulations.

Very rarely, such a series of setbacks suddenly surround a particular sector and cause stock prices to get mis-appraised in a disproportional degree. Pharma is going thro such a painful period in this so called perfect storm. Are these setbacks structural or cyclical? If anything, FDA’s vigorous vigil will play a vital role in streamlining the quality process which is positive in the long-term to achieve bigger business scale in generics. Similarly, accelerated drug clearances by FDA, while putting pricing pressures, will also help small and medium players to gain faster access to US generics. In our recent meeting, CEO of one of the promising mid-tier pharma companies, echoed this long-term view. Moreover, much of the domestic challenges listed above should not dent the long-term prospects for the sector, except the dictum of generic prescription, which many industry insiders don’t see it coming given the practical challenges in implementation. With govt. going slow on this, the noise around it has subsided significantly.

As someone wise said, great investment opportunities come around when excellent companies are surrounded by unusual circumstances that cause the stock to be mis-priced manically. Pharma seems to be offering that classical value opportunities to those who have lots of patient capital. More so with small and mid-cap pharma (stock specific, of course) where relative undervaluation can give additional kicker.

Happy Value Investing!

Elevated Equity Placements!

Market Overview..

Story on domestic flows is still going strong with monthly MF investments in equity market sustaining at a record level of 10K cr. But that hasn’t stopped the markets to turn weaker this month too. For the second consecutive month, markets are staring at a negative return in June, marginal though. What explains this divergence? With strong domestic flows, one would have expected the markets to sustain strength. Is it something to do with short-term challenges expected in GST implementation? While markets expect short-term pain in GST, it does not fully explain the sudden weakness in the broader markets. Where did the domestic liquidity go, if not into buying stocks in the secondary market? The answer seems to lie in what is happening outside the secondary markets. The heightened action in the primary probably holds the key on why the markets have turned subdued in secondary. Liquidity seems to have found an outlet in the primary placements.

As per estimates by Prime Database, Indian companies have raised nearly Rs 13,800cr so far through IPOs & FPOs (Follow on Public Offer) and nearly Rs 34,000cr through QIPs (Qualified Institutional Placements) so far in the current calendar year. Two infrastructure investment trusts have raised about Rs 7300cr in the current calendar year. The industry estimates suggest, close to $20Bn will be raised from equity placements alone this calendar year, exceeding last year’s numbers by more than double. With this level of elevated placements in primary market, secondary seems to have lost the vigour it had shown in the earlier months.

So much so for liquidity and bulls can’t rely on that alone for further strength. This coupled with subdued expectation on Q1 earnings from GST related challenges, has turned the sentiment weak and could result in more volatile times ahead. For value investors, this loss of momentum is a welcome opportunity as it provides a brilliant window to add to their portfolios with value emerging in select pockets and in select sectors. Watch out for volatile weeks!

Finding Refuge in Arbitrage

Indian market: Is there a way to ride this reckless phase without taking too much risk?

In normal times, bargains come in broader markets, not in blue chips. Broader small and midcaps quote at a meaningful discount to larger blue chips given their low scale and poor liquidity. But when mercury rises and when market moves up manically into a frothy zone, this equation turns upside down to drive valuation multiples into a bizarre zone. Currently we are going thro’ one such phase where small caps are sizzling at a significant premium to large caps. In an intriguing equation, smaller the size, spicier has the valuation become in this new bull-run. Below chart brilliantly captures this valuation conundrum by plotting the multiple across the market-caps. Micro caps have become the new masters when comes to multiples. On one year forward basis, BSE small cap index is at a scary multiple (of over 40+) while their bigger cousins are peevishly behind at 20+ level. As to be expected, the tiny ones (SME platform) are trading at the top of the table.

BizNotes_July17_Rev1

hese vagaries in valuations are not without any reasons. Changing composition of flows has contributed to this new found charm for the lower and middle rung of the markets. Earlier, flows were dominated by FIIs and hence the skew towards large caps as FIIs usually fancy larger market cap companies. With domestic flows taking the centre stage now, small and midcaps have started shining in a spectacular fashion. Given the long-term drivers for a structural shift in household savings from physical assets to financial assets, dazzle in domestic flows is unlikely to diminish, esp. when the other avenues for savings (fixed income) are much less attractive.

In such a situation, when excess domestic liquidity is expected to keep the valuation elevated for small and midcaps, how does one navigate this reckless run without taking too much risks (till eventual correction sets in).

Here goes the most interesting way one can handle investments in an overvalued market such as the current one:

Go tactical with asset allocation thro’ Arbitrage:

As any value investor would understand, building long term positions in a rapidly rising market, while would make the portfolio shine in the short-run, will dent its long-term performance without exception. As is often said, long-term outperformance comes from short-term underperformance. But there are ways by which one can make the short-term performance little more palatable. The trick is to tout for tactical short-term opportunities, but without taking the market risks. Event based arbitrage is one such tactical model that can help to add glitter to the portfolio without carrying the MTM (mark-to-market) risks. They are primarily short-to-medium term opportunities driven by event based corporate actions like buyback, open-offer and other special situations including mergers, demergers and delisting. The most interesting aspect of this tactical allocation model based on arbitrage is that, while it enhances the portfolio returns in the short-term by serving as a superior substitute for cash parking, it releases the cash at the most opportune time (during corrections) for enabling long-term portfolio building.

Besides arbitrage, there are two other critical ways one can deal with expensive markets. Bull market provides a brilliant opportunity to exit from positions that may not hold huge promise at reasonable prices, so to say to cleanup the past mistakes. Similarly, it also provides a huge window to prune profitable positions by booking profits. Both these actions help raising cash levels which can come handy during the market correction that eventually follows any one-way bull run.

Happy Value Investing!

 

Time for Catching breath…

Indian markets look tired after stupendous rally which took the indices to life time highs. Market breadth measured in terms of Advance-Decline ratio has turned unfavorable (in favor of Declines) over last two weeks and volatility seems to have come back to the market, which otherwise was running in one direction. Moreover, for the first time since long, broader markets have turned negative on month-on-month returns, with BSE Small-cap index at -3.37% and BSE Mid-cap at -2.89% (as on 29th May). Global cues too seem to have turned. With dollar index back to Nov’8th level (pre-US election) and US ten year yield drifting to six month low( to 2.25% level), there are signs of weakness in the tire-less rally we have seen in the US markets post the US election, famously dubbed as Trump Bump.

With earning season coming to an end and with the news flow on monsoon and GST discounted, we have much less to count on for new triggers. If at all, the news flow only can turn negative with the massive de-stocking expected across channels and across sectors during GST rollover. Given that set-up, markets could turn more volatile with possibility of deeper cuts, esp. in small and midcaps, if the global cues turn negative. On the other hand, if the global cues remain stable, markets could consolidate and spend more time in a range with intermittent weakness.

For value investors who have waited too long on the sidelines, the expected correction (in the best case) or consolidation (in the worst case) will present an entry opportunity soon. Given the increased momentum on domestic flows from the much talked about shift in house-hold savings from physical to financial assets, it may be unreasonable to expect a very sharp correction, though can’t be ruled out. More so, with ongoing surge in monthly SIP book (nearing 5000Cr) for the mutual fund industry. Given this, any cool-off or consolidation can be a good entry point for investors who have been sitting on fence for a while.

Snowball Effect

Reforms : Is there a seamless story behind the seemingly disconnected and discrete set of reform measures?

It has been three years since the current regime took the reins of governance. For anyone who had expected the Govt. to unleash big-bang reforms in the early part of its term, it has been a disappointment to say the least. Much to the criticism of free market enthusiasts, Govt. has been slow on sensitive, yet significant bold reforms such as  privatization of public sector banks and other non-strategic PSUs besides the revamping  of archaic labour and land rules. These are bold measures, if unleashed, could have catapulted India structurally into a higher growth orbit. But to achieve a similar objective, Govt. seems to have chosen much less disruptive path (politically), yet significant in its long-term compounding effect, by systematically scripting a plot connected by seemingly discrete set of incremental reform measures. Strangely, this plot has an equal potential to propel India’s growth structurally into a higher pedigree.

To understand the plot, it is important to decipher what is behind the dots that connect the discrete measures. If there is any common thread that runs across the incremental reform measures such as DBT(targeted subsidy), RERA(Real Estate regulations), Demonetization, Bankruptcy Code, Linking of Aadhaar with PAN, Curbs on Cash transactions, Benami Act and lastly the glorious GST, it is a coherent strategy that runs seamlessly across to structurally swell the tax base and tax/GDP ratio to significantly higher levels. Early signs of such a swell is already visible on the individual tax front with personal tax kitty surging by over 20%+ annually over last 2+ years. GST would do the same magic in indirect tax numbers over time, though in the short-term, implementation hiccups would drag the numbers briefly. Deeper mining on DeMon data trail coupled with effective execution of benami act on the ground would add to the swell,  both in personal tax and in corporate tax.

Crux of all these coherent reform measures is in compliance (tax). With India placed abysmally low on tax base as well as on tax-GDP ratio (ref below charts), these were critical measures to change the structural landscape of the economy. With expected spurt in tax kitty (widening tax net) in the coming years, it will lead to higher fiscal space over time, which will in-turn lead to structural downward shift in inflation / interest rates and thereby changing the structural capacity of economy for higher growth. As the economy shifts to more formalized (from unorganized) one on these reform measures, household savings are expected to see a dramatic shift from physical to financial assets, which will structurally push the potential  growth further.

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Over time, with the widening tax net along-with the changing profile of household savings (from physical to financial), India can break out of the 7%+ growth range to join the elite club of 9%+ growth. Though India has seen such a growth rate cyclically (riding on global growth as in the case of 2004-07 up-cycle), to structurally (hence more sustainable) move into that orbit will be a significant achievement for this administration. In summary, the restrained reforms of this Govt., when they play out over next few years, have the potential to have snowball effect to push economy structurally into a higher growth-orbit. No surprise that both FDI and FPI flows are in a rush. Domestic investors too are in a hurry with the trend of changing profile of household savings gathering momentum!