FINDING BARGAINS IN THE STOCK MARKET
V S P Rao,
What are bargains?
Bargains are rare to find in a market, thoroughly scanned by millions of investors every minute. By nature, they are hated, discounted and neglected, or ignored completely. They do not fit in a ‘respectable’ portfolio. No one wants to own them. They are orphans and the very thought of putting them by the side of darlings of the market in your portfolio would be a big blunder. If the entire market is telling you a depressing, sad, and painfully long story of less-promising companies, why would anybody want to invite them into a party? Typically, they are like the uninvited guests in one’s portfolio. A healthy portfolio, by nature, must consist of the best candidates, leaving very little room for the lesser ones, and staying clear of the worst. Bargains, in short, are unappreciated, unpopular, and unloved candidates.
Why look at bargains at all?
Ultrasafe securities, usually, deliver uninteresting returns. There is always a mad rush to marry them in the marketplace. Because they are over-owned and over worshipped, there is very little chance of such securities giving mouth-watering returns. To outwit the market consisting of smart and intelligent souls, you need to take a contrarian path. This is where bargains matter. They are
• Unnoticed, ugly ducklings of the market
• Devoid of strong fundamentals
• Encircled by controversies of various kinds
• Apparently unworthy investment candidates
• Known for delivering consistently poor returns
• Perceived by all as useless investments
Why would anyone want to marry such an ugly candidate? As the saying goes, if everyone feels good about something and is happy to invest readily, it won’t be a bargain after all. Bargains have fallen out of favor and lost their sheen and value for valid reasons. If everyone thinks and feels bad about a company that was once the darling of the marketplace, then certainly one must take notice of such a company.
Where are those bargains?
Discerning investors look for good buys. They constantly chase stocks where there is a price-value mismatch, where the price is low relative to value, or the potential return is high relative to risk. Investors chase stocks that consistently deliver good results. When the demand for such stocks reaches maniac levels, prices peak out. The seemingly good quality stocks, turn into bad buys because of over-ownership. To make money, therefore, one must focus on stocks that have gone out of favor due to irrationality or incomplete understanding. Usually, bargains are found in situations where investors fail to assess an asset fairly or fail to look beneath the surface to understand it thoroughly or fail to look at the shining side of a scorned asset. Such bargains are not topics of discussion at cocktail parties. Usually, the price of such assets keeps on falling and falling. They grab news headlines for the wrong reasons. The market keeps on punishing the stock till it turns into a bottomless pit. Poor performance would sink the stock price to rock-bottom levels. Capital stays away from it or flees, and no one can think of a valid or solid reason to own it under any circumstances or at any price. In short, the perception about the stock has become worse than the reality. No one has a good word to say about any of such companies.
Investing in bargains
Bargains, as is clear from the discussion, offer deep value at unreasonably low prices. To make it big, therefore, bargains deserve a closer look. Cycle-fighting, contrarian investors have a golden opportunity to buy those distressed assets at irresistibly low prices. if you hang on to bargain buys till the market begins to assign a ‘fair value’ you would be laughing all the way to the Bank.
FINDING BARGAINS IN THE STOCK MARKET
It would be interesting to address capital allocation aspects on this as well. Assume you have 100 Rs to invest. And a 15 year window. This capital is all you have now, or will have in the foreseeable future and you need to maximize potential return over the given time frame.
Now should you invest in these bargains and hope and wait for the market to recognize these, which may never happen, or not happen within a reasonable timeframe - or should you go with tried and tested, relatively well known, growth and compounder portfolios. Or should you split? and if you split what percent would be advisable.
What is opportunity cost involved in tying up your capital and sitting on hope?
What is the risk level?
At which level of financial freedom do these bets make sense?
Would be interesting to know your thoughts around these points.
I can answer for myself, with 30 years of mistakes in the stock markets. Bargains are found at lowers levels, rarely in bull markets. Some are not bargains but have inherent problems which are not publically known. I split my investments between the known and unknown.
Sitting on hope I do a lot and rarely catch the top and bottoms.
Hope it helps.
In general terms I agree with you, but the dilemma lies in the constraints - fixed amount of capital, fixed time window. And we are not talking about someone already financially independent. The goal of the capital available is to secure financial independence within the given time window. Given these constraints, how should one go about with the capital allocation is the main question.
I’ll just add my own thought process as well. Imo, if the above constraints exist, then bargain hunting is not advisable. Better to stick with fairly valued and well discovered growth and compounder names. However, I am ok with changing my opinion if someone can point out any key aspects I am missing out.
As an example, you can pick up Reliance Capital, where there is a serious mismatch between market capitalization and its intrinsic value. It has only the insurance business that can give 3X or 5X returns once the Promoter is out of the woods. When he would come out of the mess created for himself, only God knows. His other gem RelInfra is also languishing for reasons best known to everyone. Once the Promoter decides, enough is enough and he must outwit competition, by making bold moves, i think it can surge to levels that we have not seen before.
Bargains would test your patience since the wait is unending, unnerving, and exhausting. if you do not have that kind of patience, there is no use hunting for those hidden gems. Kedia saheb is known to dig deep into the market and find the gems before anyone can notice them. i think when it comes to capital allocation, you need to develop a style of your own and hang on to stocks where you have conviction. well-known companies are already over-researched, over-owned, and over worshipped. i do not think we can get mouthwatering returns if we hunt the same space that has already been exploited by FIIs and Funds.
Bargains, as a thumb rule, are not visible to the naked eye. You need a discerning, thinking mind–what they call the second-level thinking–to spot those Gems. For example, I do not see any reason why Godawari Power and Ispat should fall continuously, after declaring stellar results–that too, after becoming a debt-free company on a stan alone basis. The same is the case with NMDC which has fallen to miserable levels. If you find the financial health of these companies, using HDFC tools, they are at the top of the ladder scoring 80 plus out of 100. Are these real gems? Only time will tell.
Yep, that was sort of my thinking as well. Its is your circumstances that decide your choices. Just because a choice is available (bargains like GPIL etc as mentioned), does not make it the right choice for a specific person. So, as I understand it, capital allocation to bargains need to be determined individually based on your context. And in some contexts, it is wiser to skip it altogether, irrespective of prospective returns. Thanks much.
At the risk of being repetitive, a goal does not and should not change, financial or otherwise. There has to be reason, introspection and clarity before one can define a thought, idea or perspective as a goal.
So if my goal is financial independence, one that comes with a number and time horizon, I have to find the path to reach that goal, among the available choices. No place for thought experiments, let alone financial experiments.
My capital is limited, sacrosanct, has a purpose, and should deliver my expected return. I cannot simply afford deviating from the chosen path, and take unwarranted risks, irrespective of their size.
This affordability of not investing in any other kind of investing, be it value, bargain or otherwise is not psychological but real. I don’t have the capital or the time. I have a goal and I cannot afford any losses, monetary or time, so I would focus on optimizing my chosen plan, thereby maximizing the return, so that I could gain more than required, or gain early than envisaged.
These are subjective, not written in stone, thumb rules don’t apply here. One can search for new or better ideas, but as time passes, we should be able to discern what will work for us and what will not. For example, a 25 year old can take any kind of risks in the market, the worst that could happen is the erosion of capital, and time. He can afford the time lost. But for a 50 year old, the opportunity cost, even without the capital loss could be huge. Withe the benefit of hindsight, he thinks, he should have taken the guaranteed 7% for 5 or 10 years, than the inviting 20%, which he wanted when he invested.
My limited point is, it all boils down to personal state, there by personal choices. If I can afford to experiment, afford to take a chance, I will, as this is all learning to become a better investor. But if I cannot afford capital or time, I will not.
On a lighter note, if the problem of indecision persists, I guess the situation is alright, that person does not have to decide. It is raining but the rain is far away, he is not wet, so he is taking time thinking if he should move or stay. Is he wet, only he knows.
I wish I could add several likes to this reply, but only one is allowed. Especially about the sacrosanct nature of the goal and the unaffordability of experiments - thought wise or finance wise.
Also the line about taking time to decide is superb.
Every new investor with a specific goal should take time out to read and absorb this entire response.
Nice note. But we could explore some specifics as well here.
Just to expand. There are 3 varieties of bargains that I usually see in market.
Short term headwinds - These are companies which has been valued lower and lower because most investors think the headwinds they face will continue for long time. Possible example is as someone put here - Reliance Capital. Finding these bargains would mean the investor has visibility for next 5 years when most others do not.
Exaggerated problems - These are companies facing real existential problems but the market is valuing them even below the value if the company succumbs to it. For e.g. companies trading below their liquidation value. Here even if company does not come out shining after it but comes out hurt - investor makes money.
Lack of short term tailwinds - These are companies that are realistic valued but market is completely discounting the future headwinds. IMHO - Any company in water purification, sewage treatment, irrigation are not valued correctly because India continues to depend on rainfall which will only be problematic in next 10 years
just wondering if you could expand on your approach or framework for finding bargains or even to understand bargain. i know its too basic question but still i would appreciate if you could explain your approach towards understanding bargains.
‘Bargain’ in my opinion is a transaction that’s favourable to the buyer. It may or may not be so to the seller. All else being equal, why would an item be sold for a price that sounds like a bargain to the buyer? Perhaps it is an element that’s not yet seen or experienced by the buyer, Of course, it could also be an element of value that the seller hasn’t factored in or isn’t relevant to him. The very shortage of buyers who see adequate value in the item is the cause of its “saleability”.being less than its peers. So to that extent, you, the buyer, will end up being in the situation that the seller was in. Implying thereby that you may end up selling it to a buyer who thinks it is a bargain for him!!! So, a transaction that’s not a win-win situation for both parties isn’t likely to occure outside the Greater Fool Theory. Just a first thought. Requires more analysis.
For occure, please read occur
I like Meghmani Finechem which is making all the right moves at the right time. Promoter holding is good and with an EPS of 25, it will certainly merit the attention of value investors. Bargains like RelInfra, Suzlon, HCC will test your patience and will keep you on the edge. a relatively safe bet could be Godawari Power which has delivered blockbuster results recently, but is still beaten down or rather crushed for reasons not known to me. With an EPS of 85 and P/E ratio of less than 4, your investment does not tank i feel, even if the market crashes. In the frontline category, National Fertilizers, RCF, Sail look very promising to me, since they have reduced their debt quite significantly in recent times. PSUs, of course, are hated by the Market due to excessive governmental intervention plus being in the frontline category, they become favorite whipping boys of the FIIs and DIIs whenever the market turns weak.
You are confusing bargains with commodities in some aspects. For example Sail and National fertilizers are commodity stocks. Commodity stocks are sold when their PE is low and when PE is low and results good they appear bargain.
Reliance Capital promoter has such reputation I will think 100 times before buying their stock.
This seems to be the case with SAIL and NMDC at the moment in January 2021.
With some high profits in 2-3 quarters back to back, these are trading at low P/E of < 10, but there will be uncertainty about commodity prices (steel prices), going forward.
Though dividend yield may look attractive, but the undervaluation could be mainly due to elevated earnings in past 2-3 quarters.
Disc : SAIL & NMDC are on my watchlist.
To add further to this discussion, I think there were substantial number of bargains in March-April 2020 period, which eventually moved up fast in line with broader markets.
Such bargains do come up from time to time, but you need to have lot of patience for it. I have seen such opportunities only in 2008-09, August 2013, November 2015 & 2016, April 2020.
I remember that, Large cap IT stock like TechM was available at P/E of < 5, during last few months of 2008 and went up to P/E > 15 by May-June 2009. I was able to capture that opportunity with some courage, but such cases are rare in Bull market.