Equity markets witnessed a severe correction the month, closing the month down 5.7%. This was on the back of a strong performance seen over the prior 8 month period – to that extent, one can view the current weakness as a period of necessary consolidation. Our portfolios also corrected in line with the market.
Over the past 3 1/2 years, equity markets have been trading in a very narrow range. The Nifty has been trading mostly in the range of 5000 – 6000 levels for the past 3 1/2 years. Based on past trends seen in equity markets, this is one of the periods of lowest volatility. Meanwhile, several companies have been doing quite well and to a large extent corporate intrinsic value has been going up well ahead of stock prices over the past few years. This is like a spring, which keeps getting compressed a little bit each year, waiting to get released at some point.
For example, assume a company whose intrinsic value is growing at 16% annually. For any good company, this should be par for the course, as the GDP growth in rupee terms has been averaging around this number. If in any year the stock price of the company is up only 10%, though intrinsic value is up 16%, then the gap of 6% is like a ‘spring compression’, which should get released at some point of time in the future. To an extent, the job of a value investor is to identify these pockets of ‘spring compression’ and take advantage of the same.
Note that, I had mentioned ‘several companies are doing well’, which also implies there are other companies not doing well. One of the reasons for a weak, range bound, stock market is the negative sentiment emanating from several companies that are struggling. There seems to be a severe log-jam in cash flows for several companies. There are significant delays in collecting money from customers. Many a bank is struggling with its restructured loans, which are not fully recognized. The sectors that are hit hardest with these issues are infrastructure and capital goods. These companies are seeing an annual deterioration in intrinsic value, or an intrinsic value that cannot be determined. We have consciously stayed away from such situations. There is a huge gap between the fundamentals of companies doing well, and those that are struggling.
Recently, the global CEO of P&G was quoted referring to his India business – ‘We have had outstanding year-on-year results….growing at 20% a year for more than a decade’. In most of the portfolio companies too, we are seeing very good business growth, driven by strong underlying fundamentals. The recent correction in the market has led to many of them now trading at very attractive prices. The economic environment continues to be poor, and it may take time to work its way out of the poor sentiment. This also gives us an opportunity to build positions in companies that are doing quite well.