A Brief summary of the Micro/Small/Midcap Carnage

Investment Learning
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I dont really think things have gotten weird - i rather think things are getting back to normalcy. I am more worried about the Nifty party though. Corrections have not yet happened there but i think its just a matter of time.

I looked at the Nifty data from 2006 till date. From 2006 to 2012, the Nifty earnings doubled while in the last 6 years, earnings have gone up by just 30%. At the same time though, while Nifty was trading at 17-18 PE in 2012, it is now at 27 PE. Unless earnings go up substantially in the next 2 quarters, we are talking about Nifty creating history even if it sustains current levels. I wouldn’t really bet on that happening.

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About the market situation its very difficult to predict where its going atleast in the short term. But if one correlates the large caps with small and midcaps universe often variable pictures emerge.

In January it happened that the small and midcaps suddenly had stopped moving up even as indices were going up. Post that there was the carnage in Feb-march. Most of small-midcaps have not recovered from that drubbing. Only those companies where fundamentals or future outlook have improved have managed to go up. All those frothy, shady companies have gone down and gone down a lot. That is actually a good sign.

In the relationship of large cap vs small-midcaps its often the dog that wags the tail and other times the tail manages to wag the dog. Currently I cant figure out much froth in the small mid cap space. In fact I can see a lot of fear. Investors are even scared to buy companies which have posted quite good results. Esp in small mid cap space. So I have a different view to @valuestudent regarding the market direction.

The only fly in ointment looks to be the macros with crude at 75-80 USD, fear about forthcoming elections, and so on.

Overall I would remain cautiously optimistic about good quality companies in the small-midcap space.

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A lot of earnings are in group companies of big companies. Hdfc Ltd, ICICI bank, SBI, Tata motors, many others … Have big subsidiaries with good earnings. However, nifty is measured on standalone numbers.
Also, stocks like SBI have reported loss or near zero earnings.
This pushes overall PE high artificially.
Nothing to be scared off.
Chill
Nifty and good stocks are on course to new highs within a couple of months

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Hi

Well I don’t know what carnage will be as @valuestudent defines as but a simple look at the stretched valuations will not give a comfort factor. On the Nifty PE thread enough has been said for the index. So nothing to add on that.

Now as @valuestudent says ‘bluest of blue chips’. Lets pick a small sample of today’s Nifty 50 compositions - HDFC Bank, Reliance, TCS, HUL & Maruti. I might be wrong in calling them bluest of blue. These 5 of different sectors contribute approximately 25% to the Nifty today. Look at the PE levels as reported on an annual basis. What value student says is true in 4 of them.

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I will come to HDFC Bank in a bit. For others the PE is mostly the highest in 2018 than the meltdown period - RIL (Highest 11 in 2008 to 16 in 2018), TCS (the exception with highest of 15 in 2006 to 11 in 2018, IT and pharma are today we know in what state), HUL (Highest 30 in 2005 to 55 in 2018), Maruti (Highest 27 in 2004 to 34 in 2018).

The better metric for HDFC Bank is to look at PB. And here too we will notice that we are approximately at the same book level as pre crisis time.

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Also intuitively we believe say a sector like FMCG will not fall much. Have a look at the two pictures below. I got this from a twitter handle. PE of NiftyFifty at the peak of the bubble in 1972 in US vs PE of consumer companies in India today.
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Personally I am not saying that we should shut our coffee cans or empty it right away. But as some trader said its better to be out of the market and hope you were in than to be in the market and wish you were out.

I know I said a trader :slight_smile:

Regards
Deepak

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Since I work in the industry, I was privy to this news:

The “Volcker Rule” was implemented under the Wall Street Reform and Consumer Protection Act, 2010 or famously called the Dodd-Frank Act, 2010. The one which Obama implemented post the 2008-09 crisis. In short, the rule prohibited banks from making risky investments, especially in derivatives, using their own money (Deposits from customers).

However, the Trump administration has loosened the regulatory and reporting requirements under the Dodd-Frank to allow for riskier trades using depositor’s money. You can find articles online stating that the banks have already started doling out riskier loans (The same kind of NINJA loans that caused the 2008-09 crisis) and started dealing with derivatives in conjunction with the loans.

I’m not suggesting that this could cause another crisis. For one, the biggest banks are more mindful of risk now than they were in 2008-09, thanks to the Basel-III norms: https://www.clarusft.com/capital-ratios-and-risk-weighted-assets-for-tier-1-us-banks/

But the training wheels on Risk Management are off. Can the banks take care of themselves this time around? I hope they do.

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Why settle for in or out when there are so many states in-between? A game of probability should be played with allocations driven by odds. At most times I have to ask myself if I am in or out of the market and when I realise that I am not able to answer that question in a jiffy, my allocations are optimal - it could be anywhere between 20-80 to 80-20 (of the equity portion that is) at most times. We must learn to think fuzzy. Even that 20-80 could have been 21-79 but unfortunately our brain takes lot of shortcuts.

Even this nomenclature of investor/trader I find irksome. All these labels tend to restrict what we do. Thinking like a trader helps in avoiding endowment effects and is quite useful. We even set prices we sell or buy as round numbers when its absolutely alright to buy in decimals, to pyramid them, scatter them and just be free in thought and action. The point being, trying to predict doomsday and staying out or going all in in euphoria are both equally harmful, one by omission and another by commission. Maintaining a healthy cognitive dissonance is difficult but very fruitful.

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Dear @pradip.

Someone’s gut feeling. No Sir, I have tried last year to say many times this is not the valuations to buy small and micro caps. I learnt that not many pay heed, because, most don’t want to hear the truth, they just want to hear positive words of hope, and words that stocks will work out for them irrespective of at what price they are bought. The truth is uncomfortable, so lets bury our head in the sand is the general approach.

So, what I have been trying to learn from last nearly two years is the “fact” of how stock markets work and not my “wish” of how stock markets should work. I am sure I do not know what it is exactly, but that is my quest. I have no interest in prophecy but it is in me trying to become more and more rational.

I am looking at data points and then trying to come to a conclusion on a. where we are and b. where are we likely to go if we know where we are.

Thanks to @deevee for having posted much of the sensible data so I do not need to mention it.

To add to it, I will attach an an excel by the brilliant Anil Kumar Tulsiram. He has done tremendous work. It has a world of knowledge in one excel, but one could use it to simply compare the earning ratios to 2007 to 2018. The file is dated April 2018 so some stock prices have changed. Have a look at Dec 2007 PE and Latest PE.

EDIT: Please treat the attached excel with a pinch of salt. Mod has pointed out that some data has probably not been entered properly and is standalone instead of consolidated. Kindly update before you use the excel.

If you want the full file please go to https://t.co/qjAnpP7Z1z

Also, Lets try a sensible thinking approach which does not need excel. Colgate Palmolive is the example. Apply this logic to most stocks. Net Profit: 673.37 Cr. Market Cap: 33,900 Crore. So, you pay 33000 Crore today, to buy a profit of 673 Crore. If you put 33,000 Crore in the bank FD, you will get 2310 Crore as interest in 12 months. Does it make sense to buy at such market caps? But it seems that it does to a whole bunch of people :slight_smile:

Anyhow, there is no point in explaining further to those who will chose to pay any price for a good stock so to them, I wish them good luck. They will need it.

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Thanks for the detailed response. I know understand your comments were driven by actual numbers.

I beg to differ. Higher PE in the present does not necessarily translate to an eminent crash looming. (I infact wish it was so because making money in the market would had been so easy :slight_smile: ).

Below is a quote from PF -
"If the company is deliberately and consistently developing new sources of earning power, and if the industry is one promising to afford equal growth spurts in the future, the price-earnings ratio five or ten years in the future is rather sure to be as much above that of the average stock as it is today…This is why some of the stocks that at first glance appear highest priced may, upon analysis, be the biggest bargains. "

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Dear @valuestudent

The strategy you’ve proposed to develop an intuition for the overvaluation of certain stocks is interesting.
I had a look at Colgate’s performance in the year ending March, 2006. The company generated Rs. 137 crores in profits and was trading at a market capitalisation of around Rs. 5200 crores.
Depositing the amount in a bank would have yielded around Rs. 420 crores in annual interest- 3 times the annual profit. Very similar to the case you’ve highlighted.
Even from those elevated levels the stock has generated a very impressive 17% CAGR for the past 12 years. The return generated is irrelevant to my query.
What levels would you consider attractive for such consumer oriented stocks? At what multiples do you see ‘value’ in these stocks? They’ve seldom traded at low multiples. Probably because there’s visibility in revenue generation.
Would appreciate your comments.

I may be completely wrong, but I feel, that looking at the past and projecting the future isn’t always such a good idea. My rationale being that in every bull market, the leaders of the upward movement are different. In 2000, it was one sector, in 2008, some other, in 2017 some other.
Hence, it’d be a comparison of apples and oranges. Just my thoughts.

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Deepak, please tell where are the historic PE, PB values of Indian stocks found.

Thanks.

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In the screenshot, I observed that Piramal Enterprises had PE of 39 in 2007 and latest PE of 167. Isn’t it wrong ?

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Just updated. Please check.

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Hi @shreys/@valuestudent

Bonds and equity share similar characteristics. If the economics of a company are such that it has to plough back 100% of its profits into the business indefinitely to produce an earnings growth rate equal to the FD rate then it should trade like an FD.

But some cos are not like that. Some cos need to plough back say 40% of their profits to produce an earnings growth > than a standard FD rate. This creates that difference in the valuations between a bond and an equity.

Many of the FMCG stalwarts have these characteristics and thus trade at elevated valuations. People have made fortunes buying shares of large FMCG cos and holding on to them for more than 20-30 years.

As far as small caps and mid caps go, my experience in the last 4-5 months has been that its ok to have one in your portfolio provided that you have purchased it at throwaway valuations or if not it is exhibiting growth rates of more than 50% for the past few qtrs due to multiple triggers. The 20%-25% growth stories in the small and midcap space have not been convincing and run ahead of their valuations far more than they should have.

Also just eyeballing the absolute value of sales and comparing it with different cos in different industries has given me a food for thought and a perspective. For e.g - Jubilant foods sells about 3000 crores worth of pizzas after being in the business for such a long time and going through a turbulent time while Vakrangee did a whopping 5800 crores of topline. Even Colgate does 4000 crores. Avanti and KRBL both do about 3000-3500 cr of topline. Comparing sales numbers like this gives a qualitative “feel” and triggers questions about size & scale and sometimes you just know something is amiss without having to put a number on it.

All in all, its been a good learning experience for me as well and i keep learning new things all the time

Best and keep sharing your views
Bheeshma

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At the outset, I’d like to mention that my understanding of capital markets is primitive. Please excuse me if I err.
We, as investors, often tend to look at the past and extrapolate. But, I think, only in hindsight, do we know the true cause of an event. Perfect explanations can be made about the past, never for the present state.
I’d like to share verbatim an extract of Peter Lynch’s monumental work- One Up on Wall Street on the ineffectiveness of preparing for meltdowns.
Extract-
In Mayan mythology the universe was destroyed four times, and every time the Mayans learned a sad lesson and vowed to be better protected- but it was for the previous menace.
First there was a flood, and the survivors remembered it and moved to higher ground into the woods, built dikes and retaining walls, and out their houses in the trees. Their efforts went for naught because the next time around the world was destroyed by fire.

After that, the survivors of the fire came down out of the trees and ran as far away from woods as possible. They built new houses out of stone, particularly along a craggy fissure. Soon enough, the world was destroyed by an earthquake. I don’t remember the fourth bad thing that happened- maybe a recession- but whatever it was, the Mayans were going to miss it. They were too busy building shelters for the next earthquake.

Two thousand years later, we’re still looking backwards for signs of the upcoming menace, but that’s only if we can decide what the upcoming menace is.

How beautifully Mr. Lynch has explained our tendency and its futility to look back and try to predict the future and gain control.

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Just came across these golden words… & it can’t be an apt time than this…

" There is no shame in losing on a stock. Everybody does it. What is shameful is to hold on to a stock, or worse, to buy more of it when the fundamentals are deteriorating "

~ Peter Lynch

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Why l t foods is going down ?I agree,Q4 results are not good .But stock is falling much more as compared to result.After QIP, d/e ratio has also improved from 2.4 to around 1.3

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Since I have not seen a correction like this before ,It would be immature to make any comments on why midcaps and small caps have corrected to this extent,however we as investors learn a lot from reading.I have read all the wealth creation studies by motilal oswal.
Excerpts from the mid to mega category study and 100 bagger study-
There are two type of investments,transitory multibaggers and enduring multibaggers!
Transitory multibaggers are hard to define,since they rise and fall due to various reasons!
However there’s one thing common about enduring multibaggers.You can hold such stocks for decades without worrying.One of the main characteristics is that all of them are consumer facing companies,they don’t just create products they create brands,they are leaders in the respective category,and they focus on customers.
Some Examples of consumer facing companies - Hdfc Bank,Titan,Vip industries,astral,page industries,finolex cables,symphony,maruti suzuki.
These are industry leaders with major focus on consumer needs.These are secular stories.
We should take this correction as a lesson and try to stay invested with companies that are consumer facing and avoid companies that are driving their eps due to underlying commodity prices
Views invited
Regards,
Jay jain

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What I’ve been observing over the past 2-3 weeks is -

  1. No of bids vs no of sells in most small cap counters I own are overwhelming in favor of bids
  2. However bid - ask spread is widening, opposite to what we have seen in 2017

We are seeing some value buying coming in even though people expect prices to fall further, we haven’t seen real panic yet.

My take is that the 20% correction from peak levels is a pretty important psychological mark because every time a sector /index has fallen more than 10%, people have always made money buying into that over the past several years in India. The real fun will be when this naive concept gets taken to the cleaners, another 5% fall in small cap from here and people will learn their lessons. The downside beta in small cap vs index since Jan has been 4 times, i.e NIFTY 50 has fallen approx 5% while NIFTY SML100 is down 20%

Another 5% fall from here and things will get very interesting, good time to start buying into stories which you understand well and can take long term bets on. One should not expect to make too much money anytime soon though

Please note - I am not predicting further fall from here, all I am saying is that if another bout of selling comes, there is a pretty good chance that the small cap index will be down 30% from the peak (it is currently down approx 20% from the peak).

The bottom in any market is caused by the absence of sellers and a market top is formed by the absence of buyers. Anthony Bolton said this more than 20 years ago

Keep watching the traded volumes and bid ask volumes carefully.When we have a steep fall in traded volumes and you have volume of bids > 2X volume of sells in quality small cap counters is when I will start getting greedy, till then I will keep nibbling

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https://m.economictimes.com/markets/stocks/news/whats-cooking-at-manpasand-vakrangee-atlanta-how-to-spot-red-flags-early/amp_articleshow/64410977.cms?utm_source=AMPusers&utm_medium=twittershare&utm_campaign=socialsharebutton&__twitter_impression=true

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Many analyst have missed out on one big news flow.Bankimg NPAs covered from every other industry or rather all the industries except Real Estate.
I fail to understand that an industry which has huge supply & when there is huge demand deficit from investors & even to some extent even from end users.
Pre & Post demonetisation builders have actually sold out their project in all the demon adjustments. Yet there is not a single NPA in the public domain. How is this possiible. ?is there something huge wave of bad loan coming.from this sector ??