May 2011 : A market with a split personality

Equity markets were weak for most of the month, and despite a rally towards the end of the month, still ended down 3.3% for the month. For the current financial year starting April 1, 2011 the Nifty is down 4.7%. Our portfolios have held up well through this correction and continue to deliver positive returns for the year.

The equity market as a whole, as measured by the performance of the Nifty or the Sensex, has remained broadly flat over the past 3 years, delivering annualized returns in the 5% per annum range – less than the rate of return on fixed income instruments. On a closer look, one finds that the market seems to have a bit of a split personality – there is a large number of stocks out there which are down 70-90% from their peaks hit 3 years ago and there is another set of stocks which are reasonably higher than the highs they made in 2007. The companies with very poor stock market performance have not only seen their business performance deteriorate significantly, but are also loaded with significant debt on their balance sheets. Despite the steep fall in these stocks, they do not look attractive on valuation terms. On the other hand, there is a category of companies where the stock prices are reasonably higher than their 2007-08 peak levels, but their businesses have continued to perform quite well over the last three years. Our preference continues to be companies which have delivered well over time – some of these companies are starting to trade at valuations that are fairly attractive.

Over the past few years, we have been sticking with a simple investment process of identifying reasonable growth companies with high levels of profitability, having had a track record of stable performance through good and difficult economic conditions. We focus our efforts on buying into these companies at sensible prices. The last 3 years has been a period of test for the corporate world and some of these companies have delivered exceptional performance through this period. As and when the economic environment turn favorable, we believe these companies should perform even better.

The weakness in stock markets since Jan 2011 (the Nifty is down 9.4% since Jan 2011) has started to throw up some good investing opportunities among these exceptionally performing companies. We have started to significantly increase our overall equity exposure over the past few months and expect to continue doing so. Equity markets may remain weak in the coming days, but the opportunity to put together a portfolio of great companies at sensible prices is probably the strongest that we have seen in recent months.