A Brief summary of the Micro/Small/Midcap Carnage

(Dinesh Sairam) #447

I’d personally find no value in looking at Price Multiples or essentially singled out pieces of data. In my eyes, a bottom-up approach on specific companies is the most amicable. We make money investing against the market, not with it. That being said, the kind of work they’ve done to put this together is impressive. Kudos to the team.

Regarding looking at historical data for BFSI firms in general, once again I think it’s useless. The RBI under Mr. Rajan put the clamp down on almost every single player, so the entire space has been disrupted. Looking at today’s NPAs or NIMs next to their historical averages will make no sense because today is nothing like what it was for these firms before Mr. Rajan’s period. Maybe we can look back at today’s NPAs and NIMs a decade from now and hopefully heave a sigh of relief that the worst is behind.

(phreak) #448

Its not just the Price multiples but you will find the RoE/RoCE and leverage as well along with other earnings params and operating params like capacity utilisation and asset turns etc and more importantly how these have moved over last 17 years. It’s the RoE and leverage, along with the qualitative aspects of the sector that dictate price multiples (given RoE/RoCE, leverage and reinvestment/payout rates, growth and expected return (cost of equity), it’s easy to come up with rule-of-thumb multiples) and one must see this all in conjunction. Also, this says nothing against bottom-up stock-picking but just establishes base-rates and gives a lay of the land.

(Devaki Nandan Tripathy) #449

Well 12 years into the market has taught me otherwise. It’s not that your view is wrong; it’s just different than mine.

(Divyanshu Bagga) #451

It’s the unknowingly overpaid ones, but rarely knowingly overpaid ones, that cost you dearly. And it’s most likely during the correction that these unknown surprises emerge.

(paraa) #452

From the various data points one can infer,the froth in the midcap/small cap universe which existed a year before has vanished and things are in a normalized range.

But usually after such a steep fall like the recent one,the recovery is not V shaped,the market takes its own sweet time to find its bottom.

(Sarvesh Gupta) #453

I see a lot of unnecessary concerns being shared over what markets are doing and how are they expected to behave going forward looking at past data. While such an analysis looks neat, it may not still help much.

We need to come back to the first principles of investing. What investing at its core is laying out some cash today in expectation of a series or one-time cash flow in the future. I see that the present correction (or for that matter any other correction) has in no way impacted this series much except that it has lowered the first of the cash flow in this series (which is the only negative cashflow and where you need to pay upfront for getting the positive cash-flows later). So fundamentally, a lot of the universe is still working with approximately same set of numbers. In many businesses, much of the cash flows expected is going to be the same - in January 2018 and in October 2018. In cases where it has changed for the worse, frequently one would find that the although the positive cashflows have decreased a bit, the negative cashflow has seen more than adequate fall to compensate for the same.

The corollary of the first principle is also that we should never pay more than what we are going to get in the future (unless we are a shopoholic ;-)), so people who have overpaid in the past will always see some losses unless they were smart enough to sell to somebody else while the music was still on. However now that the music is not on, it makes sense to recalculate the equation of cash flows and decide accordingly. One should not shy away from booking losses if so be the demand of reality.

Charlie Munger has said repeatedly that investing is simple but not easy. Ups and downs in the stock market are part and parcel of the life of a long-term equity investor. While equity as an asset class has given the highest returns across geographies, the cost of this high return has been gut-wrenching volatility. And this is the reason the path of the creation of long-term wealth through equities is simple but not easy. Simple because one just needs to partner with businesses for the long term at unfair terms (which stock markets showers us with from time to time and especially during bear markets) but not easy because bringing knowledge to life is easier said than done (the difference between idea and execution of idea). In India, life is made more difficult through all-pervasive lack of ethics amongst promoters and many important market participants.

Now coming to the question of what an investor should do in the present scenario, clearly there is no reason to get out at current levels except if you have been investing in stocks which trade at very expensive valuations or stocks where business doesn’t merit the valuations or portfolio strategies which only deal with ridiculous valued stocks in the name of quality (1 cr invested 2 months back in the PMS of a worshiper of only quality is worth only 73 lakhs as of yesterday - this paper loss is not a concern but the continued over-valuation of many of the stocks in the portfolio is). The other factor to consider is your overall equity allocation as a % of your family net-worth - if that’s too low (say 20% or lower), then it makes sense to increase it a bit now (unless you are nearing retirement or later). If that’s too high (say 45% or higher), then it makes sense to decrease it a bit by getting out of stocks which are still expensive. Else, you are advised to just stay put and not bother too much about paper losses.

One more thing - because small and mid caps have fallen much more than large caps, some supposed to be experts on TV and newspaper are now saying that it makes sense to move completely to large caps and highest quality stocks. This wrong advice is also being touted by all the brokers and other people who are supposed to be custodians of your wealth. This is behaving like a know-nothing investor. This is an advice best not paid any heed to. If at all, this was a useful advice till early this year. Being contrarian is the only way to create wealth through equities so whatever you do, please be mindful of whether you are following the herd mentality and consensus trade. And if you are not taking a bit different stance from the crowd, then why even bother, just start a SIP in NIFTY or give the money to a smart, trustworthy and high integrity manager and enjoy your life - this by the way is what is required by most investors - unfortunately 90% of the investors think they are above average investors.

(mahesh1980) #454

@8sarveshg sir, your posts are always insightful. Kudos to you.

Have one query. Read somewhere that equity part of one’s portfolio should be approximately 100 - one’s age, percentage wise. So for an investor in his thirties don’t you think 45% equity allocation is on the shorter side? Would be glad to hear your views.

(s) #455

Macros have changed and are casting a shadow on the market. Inflow in markets are sentiments every sell if has a buyer market will hold the market till a balance is reached. Business results are determinant of the value. If people start predicting downturn and recession it will create chaos but not a real downturn…Oil and election are key.Dollar value is not an issue for domestic market but for exim & cad it surely will make a difference. The broader Question is the economy contracting or world is falling in recession. Also is the business you are invested in recession proof…time and again quality companies have grown even in downturn

(Yogesh Sane) #456

current sell off in market is triggered by default by IL&FS and a secondary market sell of DHFL CP at a discount acted as a wake up call to investors who are pricing in a scenario where NBFCs will begin to default either as a result of asset liability mismatch or as real estate loans going bad.

IL&FS’s trouble stem from problem in infra sector especially road sector and not from real estate sector. So trouble at IL&FS is not a symptom of trouble in real estate sector. RE has been in a slowdown for a number of years and we haven’t seen NPA levels go up a lot over this period. So it looks like NBFCs that lend to RE sector have done their job of assessing credit quality well. Investors appear to be punishing the wrong sector here. There could be some cascading effect on the NBFCs in terms of funding drying up and fresh disbursements falling off a cliff. That could choke funding to real estate sector which could begin to come under stress. So a sudden risk aversion on Dalal street could lead to real trouble on main street which could further feed risk aversion on Dalal street in a kind of snowball effect.

Naturally, street will be looking at RBI and govt as a lender of last resort to step in and stop the snowball from getting too big. SBI buying NBFC loans is a starting point but it so hasn’t had its desired effect so they will have to step up the number.

Market is punishing HFCs for troubles that started in infra sector. A slowdown for a few quarters and rise in NPAs should not really cause a deep cut in their valuations as HFCs serve basic need of the economy and have long runways. When this is all over, I think biggest opportunities will come from NBFCs and by this time time in 2019, we could be counting profits in NBFCs.

Disc: Invested in Indiabulls Housing Finance.

(phreak) #457

Looking at this skeptically, are the NPA levels not going up because NBFC’s have kept on lending to this sector?

(Yogesh Sane) #458

Possible and even probable in a sort of evergreening of loans in anticipation of an eventual upturn in RE. But it would not enable them to disburse fresh loans and grow their portfolio. NBFCs were generously funded by mutual funds hungry to beat FDs so it might have fueled their growth which could have lead to bad behavior like this one. However, this behavior is like cheating yourself and given that most NBFCs are tightly controlled and they are indeed worried about going bankrupt with lower chances of bailout (vs PSU banks), I wouldn’t expect such behavior across the board from large to small NBFCs.

(phreak) #459

Could be bandwagon-effect and incentive-caused bias. I could be totally wrong though.

(Shailesh) #460

These businesses are cyclical … High Interest Rate & Liquidity has huge impact on Financial stocks .

  1. Liquidity issues - are typically short term but has cascading impact across system . Best example in recent history is what happened to Lehman , Bear Stearns , AIG etc in 2008 . But often these problems get sorted out in 6 to 8 months and companies that survive tend to do well in long term . But who will survive is big question … But price damage in these markets can be as much 90% like the way CITI fell from $80s to below $1 . One should have courage to hold the stocks in such deep correction if it happens

  2. NPA : This issue is second part … Imagine last 4 years Real estate sectors is reporting lack of sales and low profits while companies lending to RE sector are Gr @ 30% + and reporting great profits – Something is a miss … ++ Lot of NBFC were lending to against stocks whose prices have crashed . Classic story of 8K miles promoter calling fraud as his pledged shares were sold . When one gives loan and the underlying asset decreases in value ( real estate or stocks ) it is sign of emerging NPAs … Once NPA starts couple of things happen – This is long term problem takes 4 - 6 years to resolve …

a) Velocity of loan rotation declines - that crushes ROA and increases cost to income ratio - Both this reduces earning and hence leads to derating of financial stocks

b) Inabiility to raise equity finance at fair price … The basic success of NBFC and YES bank was they were able to raise equity capital ( QIP / rights ) etc at increasing price level . so they could lever more and Gr could hide all bad things could be covered unlike PSU banks who were facing issue of equity capital inspite of having good amount of CASA funds even in Demon days .

So what should one do … In any debt loaded cyclicals it is better for bad days to be absorbed for some time . Increase allocation slowly after 6 / 7 months after first fall … Typically you may lose small upside but it will be much higher than downside …

(pradip) #461

Thanks for sharing your thoughts. I can relate this two great quotes

Peter Lynch - Market is full of people who know the price of everything but value of nothing

Howard Marks - There are two kind of predictors in the market. Predictors who dont know. And predictors who dont know that they dont know.

(Shailesh) #462

Enclosed is Price Graph of ICICI Bank - Jan 2004 - March 2009 .

ICICI Bank was darling of stock market with reported Gr in excess of 30 CAGR , great marketing , great CEO ( Mr Kamath ) and great second line management , excellent hyper growh subsidiaries – yet when Liquidity crunch hit the business in 2008 - its growth engine stalled , Retail NPAs meant it had to focus on corporate loans - HDFC bank , Bajaj Finance and others captured its retail market and ICICI just lost the MOJO …

STock Price moved from Rs 40 + in 2004 to back to Rs 40 odd in 2009

(Hitesh Patel) #463

The stocks of financials specifically NBFCs have corrected a lot in recent crash. Many of them earlier touted as having strong business models and long runway for growth are being hit hard. The issues that are plaguing or likely to affect the sector are coming out only now after most stocks have corrected 30-40-50% from the recent tops. And my guess is things will get a lot worse before they get better.

When a sector which is market favorite suffers from correction, the extent of correction is often more than anticipated. We have seen things similar to these happen in the tech crash of 2000, real estate and infra crash of 2008, pharma crash of 2016 and so on. One just needs to look at the time lines as to when these sectoral stocks were able to make some kind of a comeback. Usually by the time these sectors make a comeback other sectors attract market fancy and stocks from that sector start running hard. That should be the place to be rather than bottom fishing in a sector where we are yet not aware of the full risks that exist.

Ibulls Housing which is from a group which is always viewed by markets with a jaundiced eye has corrected from a high of 1440 to current levels of 660 odd. Now stocks dont correct to such extents without any reason and only due to panics. Sometimes stocks correct first and reasons come out later.

Whenever such corrections happen the reaction of market participants is of surprise in first phase of correction, , denial in next phase and disgust in last phase(which is when people throw in the towel and ditch the stocks near the bottom.)

Instead of getting into such falling knives its always better to buy some really solid businesses which also have corrected albeit to lesser extent. Of course the ideal thing is to sit on the sidelines and watch the horror show and allow it to finish before venturing out a buy but still if one has itchy fingers one should focus on solid businesses where wealth destruction possibilities are minimal.

(sincyvarghese) #464

It seems like none of the sectors and stocks are immune from the correction that is going on. At INR 74 to the USD it looked like IT sector will provide some cushion. Now IT is also correcting. It looks like a fire sale for people who are very leveraged. Basically sell anything for which there is a buyer at a reasonable price.

This in my view is a tricky market. We saw the Index going to 34000 odd. Then it gained 1000 odd points in a few sessions. Now it is close to the previous lows. It is difficult to sit on the sidelines when after a fall the index gains 1000 points. You fear you will miss the bus. You deploy some money and lo and behold it goes down further. It looks like people are waiting for a bounce to sell more.

This is one reason I like markets which remain at their lows for a longer period of time - probably 1-2 years. You can see there is some bottom. For NBFCs to start outperforming RE has to fall further, much more than the paltry 5%-10% corrections. I personally feel more than the ticket size the number of loans actually matter more for the NBFC.

I’m right now not doing any purchases. When most speculators exit the market and short sellers will have nothing to short, it might be the time for long term investors to start their buying.

(phreak) #465

Materials are doing alright in the recent carnage - Specifically Commodity Chemicals - both organic and inorganic, typically, more harmful the process/byproducts, the better they seem to be doing - check Aarti Inds, Valiant Organics, Guj Alkali, Manorg, Tanfac to see what I mean. Same with Paper - IPAPPM is still trading above 20/50/100/200 DMA. IT/Pharma I think will be the first major sector to bounceback but not before they reach and consolidate at historic/fair valuations, along with the usual previously overvalued quality stocks with a long, proven record of wealth creation.

Disc: Holding the stocks listed by name except Aarti Inds


For me hunting ground would not include commodities. Slowing China is a bigger force than anything else and I would like to go with exporters which can maintain pricing power to benefit from Fx tailwind. China has already started loosening regulation. Just check coal production which is bouncing and they have to support their own currency.

Select Pharma - No holding as of now but looking at few API players
Domestic stories - continue to own Delta, Saregama, Repro unaffected by macro and not leveraged either. Waiting for Dmart to fall further
Select IT - yet to find one which can maintain pricing power. Bias toward Midcap
Other exports - own Sterlite Tech. and still looking for others.
Fast growing/recovering banks – Still evaluating. May be Bandhan and AU small Fin banks on correction
NBFCs - Continue to own Edel, Manappuram and added Muthoot Capital in correction. All these will gain marketshare and thrive in the medium term. I am very confident that they can maintain 20% RoE and investors will return eventually. Banks can’t encroach most of their businesses.
SMEs - evaluated few but won’t add as of now.

Raised cash during Jan- March upto 40% of PF. Have started deploying slowly.
As usual, I will stay away from pure commodity HFCs, highly valued domestic consumption and other leveraged businesses.
One thing I am sure that I will not go down the quality ladder irrespective of valuation.
Also, stay away from theme stocks i.e. business that have yet to prove though I have one too (i.e. Repro)

(HIMSHAH) #467

What I think is problem was plenty of money of sip and all chasing few good scripts. Problem is excess. I had seen few years back where all portfolio in the world had Infosys . And hence a time came where after certain stretched valuation their was no new apatite for Infosys. Same has happened this time. Everyone where running after only few good scripts. So they were going up like anything.
Now it’s reversing. So when selling comes even by one or two players all are scared as their are no new buyers and no apatite in lower price as all have the sscripts already in their portfolio.