Sailing through troubled times


Director, Banyan Tree Advisors

December 20, 2011

The bears are at it, but this too shall pass. Now is the time to sit down and strategise — to live to fight another day.

THERE ARE many kinds of bears. There are the small ones that you often see in street corners with a leash around their necks and doing tricks. They can easily be mistaken for large dogs, and it seems easy to escape from one of those. On the other extreme are the big bullies, the grizzlies. The ones that have been mauling the stock markets of late are definitely one of those big ones. You can’t tame a grizzly, it’s difficult to run from it, and there are no safe havens.

Look around and there are signs of bear market wounds. The technology stocks are all down by 80 per cent (and more) from their peaks. The Sensex is at the same level it was 10 years back. There are large scams all around. The US and Japanese economies are in a recessionary state. There are hardly any stockmarkets that have actually increased investors’ wealth in recent times. Even the consumer product companies have started showing signs of trouble (for instance, HLL’s growth rate has slowed down). The MNC companies that people thought would treat the minority shareholder well have started misbehaving (Gillette’s share swap deal is a case in point). The ‘old economy’ stocks
never seem to announce any good numbers.

The most common question asked today is how to escape from the bear and at the same time position yourself well for the bull ride whenever it happens (and I sure hope it happens!). In times of trouble, get back to the basics. Limit your downside risk and position yourself to cash in on a turnaround as and when it happens. As I see it, there are broadly four categories of stocks. The defensives, the technology stocks, the old economy stocks and the next wave stocks. And there are different issues to deal with in each of these categories.

Defensives, as they are most commonly referred to nowadays, are the consumer and pharmaceutical companies. Most of these stocks are down a good 30-50 per cent from their peaks. The only concern here is that, why should you buy a stock at PERs in excess of 30, for growth rates less than 15-20 per cent when you have other kinds of stocks available at either much lower PER levels or much better growth rates?

The reason, quite simply, is that they are defensives. Your downside is limited and if you are positioned in the right companies, you could make in excess of 50 per cent over the next year. For instance, HLL has averaged a PER of about 40 in each one of the past 10 years, and average growth in excess of 20 per cent despite a stagnant market.

Technology stocks. Most techs are down more than 80 per cent from their peaks. The PERs of most stocks are less than their annual percentage growth rates. There are three issues to remember with technology stocks. Firstly, the chances of these stocks getting back their old valuations (like PERs in excess of 100) are quite remote. Secondly, growth rates in excess of 80 per cent that many companies averaged over the past 3-5 years, would be difficult to repeat. Thirdly, not every company will survive these turbulent times.

Old economy stocks. These are the likes of auto, cement, and capital goods companies. Most of these stocks have seen their average PERs drop from highs of 25X-plus about six years back to single-digit levels now. Not all stocks are going to turn around together, some are going to fall by the wayside. Watch out for debt traps. As long as you are with cash-rich companies earning decent return on their investments, and buy them cheap, you could make some extremely satisfying investments. Management quality, dividend yields, debt levels are key issues to watch out for in this arena.

New wave stocks. The stock market is like the sea. There will always be waves. Over the last decade, we have seen the NBFC wave (1994), the auto sector wave (1995) and the cement sector wave. And remember the aquaculture wave of 1995. The most recent waves were in technology and media stocks. There will always be waves and that is the way the markets are supposed to behave. Never think for a moment that it will turn to a ripple-free pond. Simply get your surfing kit ready, and prepare yourself for the next wave, wherever it comes from.

Identifying where the new wave will strike is one of the most interesting fields of study within the stock markets. Watch out for high marginal rates of incremental returns, reasonable valuations (not necessarily cheap), good growth rates and some element of skepticism from investors (you know, people saying, “This can’t continue for long”).

In these turbulent times, being in the stock market is like being in the high sea with a violent storm around you. If you are already committed to the equity markets, it is difficult to quit now. It is time to prepare yourself in times of these storms. Drop anchor, wear your life jackets, tie yourself if need be. But remember — like all storms, this one too shall pass.

Wish you happy sailing in sunny times, whenever they come.