This is the crux of investment:
The question is whether I will be able to hold and buy if such times come.
One research showed that investors, in general, “fold” at around 30% DD of PF. This is general human behaviour, I assume I too fall in that bracket. Assuming otherwise would have BIG consequences.
Wealth Managers suggest keeping midcaps as 30% of ones PF, because they collapse 50% in every bear market cycle. An aam-investor is not used to seeing so much money, 50% of his invested wealth, vanished in matter of months. And the only hope he has is that the company is reputed, this hope is like a “bujta diya” going off silently into the night. Each passing day this hope becomes fainter, heart becomes heavy, and with enough days in the bear market, most investors are bound to fold, while citing variety of reasons, like:
a) They’ve found a better investment.
b) Indian politicians are terrible, they cannot handle the economy.
c) Oh there is a war, now this will fall more 50%.
Well, you get the drift.
So, I for one don’t want to start out thinking that I will be able to withstand a 30% DD, and I play accordingly. But, in the time of need, I will try to muster the courage.
PS: This applies mainly to people making investment which is a significant portion of ones all available liquid capital (or his networth).
Well if you are assuming bank FD are safe from 30% drawdown, then you are mistaken. Yes, in nominal terms, the value of FD can never go down. But what about its value in real terms? With the way central banks around the world are printing money, can you guarantee that next bubble to burst won’t be in the form of debasement of fiat currencies? Maybe that future possibility is already discounted by stock market. If rupee devalues, the nominal earnings can rise, and without any change in stock prices, your favourite P/E ratio can correct to historical average.
Devaluation of rupee is not new. In the past, there has been slow wealth transfer from those holding their savings in bank deposits to those holding property or gold instead. Are you taking that possibility into account?
Why?
I am only pointing out that your PF should have 70% Large Caps, 30% Mid Caps for have some semblance of stability, which Real Estate provided.
FD and liquid funds fetches nothing, 7.5% less tax.
The current environment is beating stocks, which are out of favour, to deep lows.
Energy and Mining Cos are at all time lows.
Some good MidCaps too are being hit.
Instead of making a PF of expensive stocks, I would opt for good stocks that have corrected. I expect to beat the Index by atleast 5% doing so.
How can you be certain that my stocks are expensive?
The true measure of stock valuation is not given by multiple to its present earnings or near future earnings. It is given by the discounted sum of future earnings. If the underlying business can stay relevant for long time and has a long competitive advantage period then it can achieve a truly unimaginable figure as future earnings. This is because compounding is exponential, even if its lead over discount rate is small, when compounded long enough, it can do wonders. What I have tried is to find business with possibility of long competitive advantage period and large growth potential, so they can compound their earnings for a long time. Judgement of competitive advantage is qualitative, and hence my approach.
Do refer to the following example of Walmart’s valuation in 1974 which illustrates my theory.
Walmart returned 23% over 12% return by index. It was selling at twice the pe of index. Even more interesting, its fair pe was around 600, at any lower multiple it was actually cheap. This is because it was able to compound earnings over a long period.
It is possible for there to be different successful strategies, but if everyone started following a same strategy, they can’t beat market because they make the market. A large number of participants try to beat the market by buying recently corrected stocks, so it is not easy to succeed in this approach. Nevertheless if you feel confident in your picks, then you should give it a try. You don’t necessarily have to commit money to it, but you can track its performance against market, maybe even share the portfolio here for discussion.
An Indian investor has a muted expectation of around 12% CAGR, with commensurate risk. Meaning, if PF has a tendency to fall by 50%, then surely it is just insane to expect 12% from it.
I assumed, you are shifting from Real Estate to Equities for something similar. I didn’t think that your objective is to explore the whole potential of a stock.
Well. Good Luck. Fly safe.
Amit, since you seem to chime in most of the discussions of the so called high P/E stocks, why don’t you start your own portfolio thread. Would be very interesting to follow your thought process and your stocks in your own thread.
There is not much to make a thread about. My stock selection is boring and simple. I have the usual suspects on my shortlist.
After the first quarter results, the buy price is now closer to CMP; hope is restored 
With a few more quarters in I should have some material to post about.
So is my portfolio - boring and simple. The business models of my stocks is well appreciated. They are also capable of investing profits back into the business at high returns, so I don’t have to make much of buy/sell decisions. Yet creating a thread, writing down my thoughts and getting feedback has been immensely helpful.
Furthermore we both believe in value investing philosophy. The difference is I look for value among high PE stocks, where most people don’t. But I don’t endorse investing in high PE stocks, they can be overvalued if the underlying business doesn’t have moat and there is no certainty of them compounding earnings for a long period of time. A good case example is Shankara building products. For some reason they were being touted as Dmart of real estate industry. What people missed is that they didn’t have a strong moat like Dmart. Investing in high PE stocks requires you to differentiate between those stocks buoyed by hype from those with truly excellent economics.
On the other hand you want to find value among low PE stocks. Just like how not all high PE stocks are overvalued, not all low PE stocks are undervalued, especially with so many bargain hunters. There are no ‘usual’ suspects for value among low PE stocks. Maybe by starting a thread you can get some constructive criticism of your picks.
In India quality companies always trade at a premium because there are so few of them (“scarcity premium”). See the HDFC group companies. This I have learnt from my stock market investing journey and still learning. Of course they can be stuck in time correction mode for few years like HUL did before it’s open offer. But chances of permanent capital erosion is close to nil unless and until there is a major fraud. So for a good night’s sleep, having a portfolio of high quality companies is necessary. Of course we can have a few dark horses kind of bets but majority of capital preservation will come from these quality companies. Now buying valuation obviously also matters, like in recent case of Page industries people overpaid a lot and now are facing the slowdown and stock has corrected a lot.
Also I strongly believe that the rules of the game have changed. With the world awash with negative interest rates, P/E can go as high as possible. In India too interest rates are on a much much downward trend. So just comparing P/E without considering the interest rates at the two point in time is not correct. Also Nifty is majority comprised of financials which should not be valued at P/E.
Also in my experience markets give low P/E to companies because of some reason - most likely because of the promoter quality. Things might change with GST but in my experience a chor will always remain a chor, he will only change his method. So spending time searching for the one jewel in low P/E stocks might not be a good use of time unless and until you are a full time investor and have good channel checks regarding the company/promoter/industry. Generally building a big position in such stocks is difficult because of the low liquidity. For people like me who have only access to public information, sticking with established quality companies at fair valuation is enough.
The term “Fair Valuation” is a million dollar one. There are many PFs on VP that have all purchased great stocks, and at their perceived “fair value”. The very fact that they have selected those good stocks show that they are above average thinking-investors. Yet, it appears that they are not entirely comfortable. One more downmove, say Nifty reaching 10500, and a lot of these PFs will be wound up. (Sorry, for making such a generalized statement, obviously it is not true, I am just making a point).
I think, stock selection is important, along with that one must do everything to ensure that he is psychologically well balanced to see the stock through thick and thin.
Yes, it appears large quantity of shares were dumped today. Many short term traders would have grabbed the shares in hope for a quick profit, their selling in coming days will create upward resistance. Besides with the economy not doing well, the margin will contract from near all time high. There is a good possibility of negative growth in coming quarters. So I am expecting downtrend to continue.
Nevertheless my portfolio is holding steady, thanks to positive movement from other stocks.
Why am I not selling if I am expecting downtrend to continue?
That is because I don’t know where it will bottom or how to distinguish a bear market bounce from change in trend. If I sold the share now and did not buy back in time when the trend changes, I might lose my position.
As for my actively managed portfolio, it is heavily concentrated in Dmart (greater than 20%) while 3M is just 3%. So despite the 10% fall, my portfolio ended the day in positive. I plan to use this opportunity to book some profit in D-Mart and increase the weight of 3M.
While i understand and agree that many coffee can companies are highly valued and there are valued so more for pedigree and market leadership and might not show that much growth but 3m is a different company operating across many sectors and growth has a much higher chance to recover . They are highly innovative and heard that 20% percent of their sales is always for new products . No one can predict the future and i might well be wrong but as of now , companies like 3m India cant be compared to other high pe companies as they have a unique business model and dna . Similarly high pe companies with a relatively higher growth are much better than high pe with lower growth (where only reason is pedigree and hope )and hence all high pe companies cant be painted with the same brush . It wouldnt be an apple to apple comparison. So within high pe ratios , there are some companies that might be still worth investing and some that wouldnt be . If pe ratio would have been the sole valuation matrix, investing would never be an art and would have been just a function of excel calculations . All high pe stocks are not to be invested is what i agree with your viewpoint . However some high pe stocks are better than others due to various other factors and pe ratio couldnt be the only indicators . I am an amateur and still learning . Even i believe that many stocks are overvalued basis past performance or pedigree , however many stocks still churn high quality secular growth and i believe if the stocks are still performing then these stocks should be separated from the ones valued highly based on hope .
Pe ratio itself is not the only metric which should be used for valuation. Even I was wrongly overfixed on pe ratio initially. Below video by Bharat bhai of ASK is highly recommended .
First of all, many, including me have not purchased great companies. We have purchased Good companies. Yes, some may turn out Great. Imagine if we all purchase Great companies then we don’t need a forum for us to learn 
Second, you need to embrace the fall of these good companies the same way as you embrace the rise. The fall, and the struggle is the learning or tuition fees we must be ready to give to understand what is a great company.
Imagine a coffee can where all or majority companies are Great. Even the most astute and learned investor will dream of it.
Lastly, do you think valuation has made the companies, which you call great, fall? If valuation was only reason then many others would not be standing strong where they are and still rising.
It is the assessment of growth which goes wrong, and hence the valuation. Valuation is a by product. It means nothing.
If you can assess growth, the longevity of growth, its sustainability in tough times, and management/promoter integrity to enable it, ride it and give back to shareholders - you have then found a great company. And believe me, if you find such a company, then valuation means nothing.
Lastly, Value traps are more disastrous than valuation traps. This is from personal experience.
Just my thoughts, I maybe wrong. Thanks
On why I believe Asian Paints has a strong moat with robust demand which can allow compounding earnings for many years to come.
Today truly is a black swan event. In a single day my portfolio jumped from around -3% to over 3%! Had I been trying to time the market, I would have missed today’s gain, and staying out of market on such exceptional days can be really disastrous to our long term gains.
The move to reduce corporate taxes is a good one. It will encourage investments and leave more money in the hands of profitable business to allocate. Finally the government seems to be taking the right measures. However just cutting taxes will raise fiscal deficit, government needs to balance the act by cutting expenses, for example it can start with divesting loss making PSU like Air India, BSNL, etc.
Edit: ended the day over 6%, a gain of 9% in a single day!
Tax cuts will not impact all businesses equally. Yes, it will raise profit margins, but that is also true of your competition, and if the company does not have competitive advantages, competition will eventually lead to passing the benefits to customers.
One can argue that more money in the hands of consumers will boost demand, but that is only if the government also takes measures to control expenses, and hence, fiscal deficit. Otherwise we are just replacing corporate tax with inflation tax and that is even worse for demand. It does not seem government is interested in cutting expenditure, rather it is banking on increased foreign investments, attracted by lower taxes, to fund its deficit. We will have to see how that plays out.
On the other hand businesses with a strong moat can protect the margin gain. That leaves them with more profit in hand which they can invest back for an even better returns. Indeed the market reaction so far supports this thesis.
Luckily, my portfolio is already optimised for taking advantage of this move, except for replacing Drreddy with Bajaj Finance. I have been intending this change (move Drreddy’s allocation to Bajaj Finance) for a long time, and now the timing seems right.
The word on the street is that, there had been short positions sitting on profits, which got covered as a result of the announcement. Short coverings are usually rushed, like panic moves.
The premise for shorting the market is still unchanged. For ex. Ashok Leyland and Maruti are still going to shut production, and Havells is still going to have lapped up inventory, for sure at least in the near term. Therefore, the premise for making fresh shorts before the second quarter results is still unchanged.
For all we know, since we are in a phase of dull demand, with profits from earlier trades and bad quaterly results, the shorting this time around could be sharper.
What do you think?
Yes, that is also a possible narrative which explains Friday’s move. In stock market, it doesn’t help to be too sure of the narrative that fits your position, so I am also open to the possibility you have suggested. Only time will tell whether we get a rally or the downtrend resumes. So I am thinking of positioning myself by buying call options in business with moats, where possible, as the IV isn’t very high. If we do get a strong rally in these stocks, I will make some profit; If on the other hand there is a sharp reversal, my loss is limited.
As for my cash positions, my portfolio picks, they are held with long term considerations which now seem even better with taking tax cuts into account. Stock market is a forward discounting machine. A stock price isn’t only about next quarter’s earning, but about the earning from the next forty years, and even after that. The market can bottom if it sees improved future earning, even if the near quarter results are expected to be bad.
Interesting to know that you were intending this change. I read that even top business house promoters and MD were also caught with surprise by this move from gov. What pointers enabled you to intend this move in advance?
