A Brief summary of the Micro/Small/Midcap Carnage


#380

Amidst all the macro trend following happening in the thread, maybe its a good time to re-assess the investor sentiment indicators as well. I see a few voices convinced that we are in a bear market(winter is coming), some arguing why we won’t go there and a few sage voices saying this too shall pass. Quite a mixed bag really :). At least nobody is gung-ho, so the assets may not be expensive, doesn’t prevent it from getting cheaper though. Now, how long would it take for those “mutual funds sahi hai” ads to stop on prime-time tv?


(EL) #381

Dinesh
I gave a clear calculation
Market cap = dcf of all future dividends

You just said in dcf interest rate is a small portion (or in your related version of capm)
Thats like saying in a cup of cooked rice, the value of uncooked rice that goes into making it is a small portion


(Dinesh Sairam) #382

Ok. Here you go.

Market Cap = DCF of All Future Dividends

Discount Date used in a DCF (The Denominator) = Risk Free Rate + (Beta * Risk Premium)

Essentially,

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Risk Free Rate: This is mostly market-defined, but can also be controlled by the Central Bank. The problem we’re discussing is that an increase in this directly leads to a decrease in stock prices.

Beta: Completely controlled by the market. We can’t even attempt to explain this. This is the ‘noise’ part of the market.

Risk Premium: Essentially, this is (Market Returns - Risk free Rate). Since Risk free Rate increases (As per our discussion), Risk Premium will fall. There is also a cascading effect as the Market Returns adjusts itself. But the standing proof that this figure is more or less stable is to look at the historical returns of either NIFTY or SENSEX. So coming back to the drop in Risk Premium, this will lead to an overall stabilization of the CAMP Cost of Equity for any stock or even an index as a whole.

The general idea to note is that that Risk free Rate is both positive and negative in the CAPM equation. Therefore, it has a self-adjusting tendency.

Hence it is not far fetched to say that an increase in interest rates does not directly impact stock prices.

If the interest rates go on to affect the Sales, Margins or Reinvestments of a company, then yes, its value is bound to drop. However, this would be a ‘fundamental’ issue and not so much a ‘macro’ issue that we’re discussing right now.


(Krishnendu) #383

Hi Dinesh,

Thanks for the formula.But I am not very good at these things so can you please brief using this formula at what lever SENSEX or NIFTY should be as on date?


(Dinesh Sairam) #385

I did value SENSEX a while ago in my blog. I pegged it at around 32k. But since then many of the metrics I used have changed. I might do a recap of that post again. Let’s see.

In any case, like I said, massive sell offs are fuelled by fear. No amount of fundamentals will explain the anamoly.


(EL) #386

Why do you think markets all over are so fixated on yield curve, the difference between 10 year bond and 3 month bond. What is the historic yield curve and current yield curve on Indian 10 year and 3 months bond ?

Every recession since the 1950s has been preceded by a curve inversion.

Anyway I don’t wish to add more into this. You have made up your mind on interest rates having negligible or zero effect on value of assets


(Dinesh Sairam) #387

Once again you haven’t completely read what I’ve written. You are attempting to explain the drop this way:

  1. Interest Rate Increases
  2. Discounting Rate Increases
  3. Asset Values fall

I’m trying to explain it this way:

  1. Interest Rate Increases
  2. Discounting Rate doesn’t change a lot
  3. RBI demands more from banks
  4. Banks demand more from Industry
  5. Industry borrows lesser
  6. Industry’s growth plans halted
  7. Revenues, Margins and Capital Creation affected
  8. Lesser Profits leads to lesser Implied Dividends
  9. So, the numerator, not the denominator, gets affected (Shrinks)
  10. Asset Values fall

(EL) #388

Thats ok , I dont with to add anything more as it wont benefit me in any way actually coming to think of it other than costing time. I am sure you are of the same opinion


(phreak) #389

Very true. All sort of expensive stocks are losing their flab. It’s high time.

Last year bulk of the activity was in the Investing as a full-time career thread. This year bulk of the activity is in the carnage thread. How quickly things change.

I think it’s time we get back to micro and post in individual companies’ threads about business fundamentals and valuations and see which good businesses are going to be available for bargains. I envied people who claimed to have bought some good micro/small caps at 10 P/E in 2013 because everything I wanted to buy then, that I thought were good businesses (last year and early this year) was insanely overpriced. Now most have come to very interesting levels to nibble on. Some midcaps and largecaps are not yet there but am certain will be there in the next few weeks. This time probably a portfolio can be built without any compromise on business quality because valuations are going to be much better.


(atul1082) #390

It’s a good suggestion. A


(Krishnendu) #391

Yeah that’s a very good suggestion. Please also enlighten us if you find any. I will also start searching for the same.


#392

yeah,may be equity is only for wannabe Buffets and Mungers. Rest should just do FDs.

BTW, it was my own macro call that I went 40% into cash during Jan - March period. I am kicking myself for not selling some others too. This is the second time I have saved a part of my PF. India is not a mature economy like US. We have volatile movements in different parts of economy and if somebody wants to own other than 10-15 evergreen stocks, one has to be aware of macro. WB makes 40-50% in few years but their followers here lose the same in few months here.


(KunalKothari) #393

If you can predict macro with reasonable success, you may soon surpass Buffett & Munger in fame. Please don’t forget us mortals on the way up!


#395

There is lot to learn from WB and CM but I don’t idolize them since most of it is not applicable in India yet. The idea was not to show off my skills but to tell you that a small guy like me can use macros to save PF.


(KunalKothari) #396

I have never mentioned anything about WB/CM (except in response to your post mentioning them), my only point was that if one might need the money in 3-4 years, they probably shouldn’t invest it in equities. Anyway, the conversation is going off-track, so all the best!


(Mridul) #397

My 2 cents on current market carnage…

This is what p/e de-rating does. 30 p/e at 20% growth suddenly becomes 15-20 p/e at 20% growth.

As per Fisher, p/e is a blend of three separate appraisals…

  1. Current financial community appraisal of attractiveness of overall mkt situation
  2. Attractiveness of industry
  3. Attractiveness of company itself

Even with growth prospects of industry and company remaining unchanged, given stock might correct due to change in perception of the overall market and macros…i.e. part of p/e owing to attractiveness of mkt as whole might disappear…this is more or less owing to sentiments…

In my opinion -

  1. cut junk (companies which you won’t buy more on correction)
  2. try building a good pf without going down the quality curve. (Which you can down average without second thought).
  3. Deploy cash gradually.
  4. Try thinking which sector can lead the next bull run. This is crucial as financials despite being ‘undervalued’ might not lead to quick recovery n lead the next bull run, whenever that happens.
  5. Think hard before buying…second level thinking.
  6. Think long term
  7. See if you can find companies which don’t get impacted too badly by macros…
  8. High roce, reasonable growth, longevity to deploy internally generated capital is the key things to focus on!
  9. Focus on earnings growth.

We all commit mistakes. Key is indentifying them early, learning from them, and moving ahead. Try minimizing number of errors as you move forward in your investment journey. Everything gets hit in carnage but quality with sectoral tailwinds would be the first to rise again. Being invested in quality in wrong sector could be bad unless one has very long term investment horizon (subjective, i know).


(Krishnendu) #398

This is the most crucial thing I guess if anyone wants to ride on the next bull run. So can we have a seperate discussion thread on this ?


(manivannan.g) #399

To name a few:

  • Logistics
  • Aviation
  • Cement
  • Pharma
  • Textile
  • Many of Oilg & Gas companies

PS: Pls feel free remove this, if its off-topic.


(manivannan.g) #400

50% of stocks traded on NSE are down 50% or more from their 52 week highs


ref: https://twitter.com/Prashanth_Krish/status/1047872045021892610

The index is not exactly reflecting the pain. I remember the article from nooreshtech, “in 2013, the indices were bullish, but the broader market, smallcap & midcap were bearish.”


Bull & Bear Markets in US:


Ref: https://twitter.com/Prashanth_Krish/status/1047882832109096960


(vaedermacher) #401

Sorry, Dinesh, just to comment on this - fully onboard that CAPM / DCF is not the way to explain market caps but it is incorrect to say interest rates have no impact on stock prices, they have a massive impact due to the way in which they skew the risk reward trade off when large institutional investors think of portfolio allocations. The entire market move yesterday was prompted by a spike in US 10Y yields. Risk premium do not contract when the risk free rate increases - risk premiums are fixed spreads above the risk free rate that capture the quantum of risk relative to what is considered the safest risk (not risk free, just the safest risk to take) - since the safest risk is the benchmark by which other risks are measured, it follows that an increase in baseline risk cannot decrease risks benchmarked to it. What happens if the risk free rate rises is that the overall spread needs to increase to the previous level to justify the investment - if it doesn’t, it implies capital needs to be reallocated towards the risk free asset, which causes a collapse in risky asset prices which then causes the spread to widen again. So yes, the spread adjusts to its old level, but this is via reallocation of portfolios which has a huge impact on flows. Also the relevant risk free rate imo here is US T bill rates, and not Indian gsecs, which are themselves benchmarked to US treasury bills. Indian government and RBI actions have to be seen relative to the true reserve currency of the world.