A Brief summary of the Micro/Small/Midcap Carnage


Macros do matter if your time horizon is less than 3-4 yrs. Mr Munger had unlimited time and free float to sit on their holdings.

(Devaki Nandan Tripathy) #361

It’s a wrong way to look. Stocks would only seem cheaper for fresh buying. But they already have massive holdings, with every bit of INR depreciation, their portfolio would shrink further and further. Say I am sitting on a 20% loss on Bajaj Finance, but for the FII, the loss would be almost 30% due to currency depreciation as they calculate in USD.

(phreak) #362

Indian equities are like small/micro caps for FIIs so what they hold here would be a small portion of their overall assets to fret about withdrawing completely due to macro headwinds. I think we have to distinguish the hot money from the smart money there, in pretty much the same way an investor with conviction sees a 20% drawdown as an excellent opportunity to buy cheap while someone indulging in short-term trade would look to cut losses.

(KunalKothari) #363

Maybe equities are not for such people?

(zygo23554) #364

Bear markets that occur due to fundamental reasons like earnings disappearing, not enough cash to service debt demands, demand situation getting worse are long and very painful to get out of.

I guess the current fall is a technical/sentiment based bear market if you can call it that. In such markets the reasons given are things like macros, global markets & sentiments, other people selling and hence expectations of lower market levels. Any of those reasons has the potential to impact fundamentals down the line but end of the day it is a probability game. Such corrections are more short lived but the intensity of the pain will be higher during the tenure.

Come to your own conclusions :slight_smile:

(Devaki Nandan Tripathy) #365

There are two kinds of market participants, the smart one and the dumb one. The smart ones tries and finds the inherent reason for every upmove and downmove of the markets.

The dumb one, like me, believes in the collective wisdom of masses. It does not matter whether the market is falling due to economic collapse or Rahul Gandhi stupidity. As long as the market has broken and trading consistently below 200 DMA or flashed any other reliable indicator of market direction, it’s a bear market. We do not have any reliable model to forecast its duration or intensity.

Similarly, the opposite also holds true.

(EL) #366

Why did India not hedge its crude exposure whem crude was at say 40-50
The country knows solar won’t meet our needs and 40-50 is the price we can afford for our growth
Better than pouring money into air india that continually makes a loss

(Tolaha) #367

Mexico is a oil exporter. It hedges 200-300 million barrels of oil a year. The hedge costs US$1.25 billion.

India imported 1600 million barrels in a year. A similar hedge may cost around US$8 billion.

Highly doubtful that such a thing will be ever implemented. We may have moved on from opposing Shatabdhi, colour TVs, computers and mobile telephony. But we still have to deal with stringent opposition to bullet trains, space programs and a National Highway with standard width of 60 metres. Spending US$8 billion on a hedging strategy? Unlikely.

No more comments on this from my side as I realise all this has nothing to do with the topic.

(EL) #368

You don’t look at it as a total figure
What’s the percentage extra it will cost on oil and besides we are not exporters like Mexico, we are importers like China

By hedging I don’t mean taking a hedging contract with jp Morgan and company bank

China does it by buying oil companies in Africa at the rate of oil that is prevalent times the barrels that can be recovered less the cost to recover those

It’s not rocket science, don’t shoot a theory based on total price without doing a calculation. Use the slow road from slow and fast thinking few times

(EL) #369

Isn’t this bear market not fundamentally driven
Oil prices are high which will cut into profits of most companies. Ofcourse we have had high oil prices before but companies are now selling their goods based on lower oil prices so when prices go high there has to be an adjustment
Besides banks are sitting on big npa loans that will need rescuing so money from the system will be sucked out. Most of the rally is based on money in the system
Thirdly interest rate is going up making leveraged companies’ cost of capital expensive

(zygo23554) #370

There are advantages to being the dumb one (the way you have defined it). The dumb one has a more consistent basis for decisions, is faster at calibrating to ground reality and more importantly knows that he ain’t the smart one. The smart one on the other hand tends to intellectualize too much and does not know that he is/can be dumb. So the smart one is more prone to losing money heavily when the market moves against his view, the dumb one more often than not lives to fight another day!

I guess as long as one is clear in his approach and can be consistent one is fine

I look at it this way. How does the changed macro work for the companies you are holding (this analysis needs to be specific to the companies), are all of them going to see their market get tougher? If I try to answer the questions you’ve posted here for one company that I hold just to take an example

  1. High commodity prices cutting into profits - Not really, since this company saw a rising commodity cycle till 2014 and then saw depressed commodity prices from 2014 till end 2016. Their ability to gain market share has been the same across cycles, they have been able to preserve margins and keep the growth engine going by passing on changes in RM to their customers

  2. Bank NPA’s - NPA as a problem was a surprise in 2010 and 11, today it is a well known problem. Incrementally I do not see how this can cause a systemic issue, sudden inability of banks to lend can hurt the economy which is hungry for capital and wants to expand capacity. We are in an economy which is getting better but not yet hungry for capital.

  3. Interest rates going up - I am yet to meet a half successful businessman who bases business expansion decisions on interest rates. Demand is the more important factor for him, one does not really worry about a 100 bps increase in rates as long as the business can grow at a good rate and make a healthy spread on the funding rate. Interest rates hurting the economy eventually happens but in the initial stages it has more economists and arm chair analysts worried than it has businessmen worried. One needs to worry about interest rates when to much debt is being used to create capacity assuming a good demand scenario will continue for a long time, when the demand eventually falls off the business is left holding assets funded by debt it cannot service. If a 100 bps rise in interest rate can materially change my outlook on a business I would not want to own it in the first place.

All fundamental analysis is by nature bottom up and buffers for macro contingencies. We as a country were doing fine even when crude was much higher, and we will be fine going forward as well after making the necessary adjustments. These adjustments will no doubt be painful in the short run, that is when we end up having the kind of market adjustments that one is seeing right now.

(EL) #371

Let’s say that market cap is a present value of all future dividends
That’s how people arrive at fair and unfair valuations
So if one variable in that changes, the market cap should not reflect that ?
Forget about other variables for the time being

When you compound something at 6pc or 7pc, you say a percent is immaterial ?

(zygo23554) #372

When it comes to compounding obv 1% matters but that is not the point here…

A 10% spike in interest rates for a company that currently pays 2% of sales as interest cost translates into a 2.2% of sales as interest cost assuming all else stay the same. PAT margin does come down marginally but what happens is that PAT then lags sales growth by a small extent (if sales grows at 20%, PAT may grow at 16%) which the markets may be fine with. Hope this example makes my point clear

What would worry me is the prospect of demand falling and interest costs rising which can be a double whammy for highly leveraged companies. If that happens, all my bets are off

To answer your question on a variable changing (say interest rate), I usually work with a good buffer on the cost of capital in my discounting models. Today if the 10 yr G-Sec is going at 8.18%, I would use 9.5% as the risk free rate in my model since I am convinced that rates are headed higher. Even after buffering for this and with conservative estimates of what the business can grow at, if I believe that the market is pricing in a very pessimistic scenario - in my book that’s the time to buy even if macros look bad and the market keeps falling the way it is right now. This is why bulk of the return for buy and hold investors is made during years like 2008, 2013 and 2018 - this is when we get stocks at higher implied growth rates.

All this needs bottom up, company specific models - without that in place it is very tough to take consistent decisions. For the kind of companies I hold, macro risk does not worry me unless it looks like demand has peaked out and is expected to fall from current levels. For the kind of companies that other people hold, this approach may not be the most appropriate.

(EL) #373

Yes you use a buffer of 3pc

Does the rest of the market ?

Let me show you the formula for markercap:

Market cap = 1 year dividend + (2 year dividend x 1/discount rate) + 3rd year (dividend x 1/discount rate for 2 years) …

Markets don’t keep a buffer like you do

Now use the same calculation but increase the discount rate

You get a new market cap
This is true for a company that does not have any loan. I am not talking about the p&l of the company but how assets are valued and how assets compete for money

If you had 5cr and no house, society pressures will mean equity will face a tough competition from real estate for your money

Multiply hay competition for each person who might be rational or irrational

I get your point about buying on crash but the crash is not done yet until interest rates stabilises

This happened in 2013 as well, until you have a prospect of higher interest rate, equity has a competition. When they have topped and the market is assured they can’t climb any further, you will see a rally

Interest rates is one of the best tools regulators have. What difference will quarter percent make, nothing. Why do markets go crazy about it. Answer: the effect it historically had on earnings and valuation

(Devaki Nandan Tripathy) #374


It’s high time you add Large Cap too in the title… :grin:

(Dinesh Sairam) #375

Interest Rate increases do not cause Market Caps to drop. According to CAPM, a Discounting Rate consists of three components:

  1. Risk free Rate
  2. Market Beta
  3. Risk Premium

The government can only control the Risk free Rate (Even that is a tall order… usually the markets even dictate this to some extent). It doesn’t control the other two. At least in theory, these two will adjust to keep the Discounting Rate more or less the same. Of course, this is assuming that there’s no fundamental problem (Which will ideally affect the Revenues, Margins and so on). A fundamental problem will definitely affect the value of a company to a large extent.

(EL) #376

Its good practice to support your thesis with calculations, examples and if possible an alternate reason for the current selloff

As an auditor and a finance professional, I have yet to meet one insider who has accurately budgeted revenue and profit let alone an outside investor

CAPM has a range of value and no one is sure of what it should be. Last time we were arguing if it should be 10% or 10.1%, the point is that managers continually try to fit valuation by adjusting CAPM

CAPM has a cousin called efficient market theory - like all good theories they are good until they remain theories.

(srikanthg) #377

Yes, even Page industries is down 6% today.
Still there is no margin of safety in large caps.
On a lighter note get used to the volatility…

Roz utho. Pito. Nahao. Thora sa aur Pito. So jao.

Disclosure: No Holdings in Page.

(EL) #378

Texts in bold by me for emphasis.
During the last crash, Jeremy Grantham, chief strategist of GMO:

As this crisis climaxes, formerly reasonable people will start to predict the end of
the world, armed with plenty of terrifying and accurate data that will serve to
reinforce the wisdom of your caution. Every decline will enhance the beauty of cash
until, as some of us experienced in 1974, “terminal paralysis” sets in. Those who
were over invested will be catatonic and just sit and pray. Those few who look
brilliant, oozing cash, will not want to easily give up their brilliance. So almost
everyone is watching and waiting with their inertia beginning to set like concrete.
Typically, those with a lot of cash will miss a very large chunk of the market recovery.
There is only one cure for terminal paralysis: you absolutely must have a battle
plan for reinvestment and stick to it. Since every action must overcome paralysis,
what I recommend is a few large steps, not many small ones. A single giant step at
the low would be nice, but without holding a signed contract with the devil, several
big moves would be safer.

It is particularly important to have a clear definition of what it will take for you to be
fully invested. Without a similar program, be prepared for your committee’s
enthusiasm to invest (and your own for that matter) to fall with the market. You must
get them to agree now—quickly before rigor mortis sets in. . . . Finally, be aware that
the market does not turn when it sees light at the end of the tunnel. It turns when all
looks black, but just a subtle shade less black than the day before.

(Dinesh Sairam) #379

By nature, sell offs do not make sense. Attempting to explain them would be ridiculous.

You were trying to explain the drop using a theory (DCF) and I simply stated that interest rates and stock prices do not have such a direct impact, using another theory related to the DCF (CAPM).