I have been follower of markets since 2017-28 and serious learning started only in last 2 years i.e. after 2021. I’d like to share my observation with data wherever possible which may help in avoiding some mistakes for retail investors like me.
I’d like to kickstart this topic with how entry valuations and market/sector cycle has a major impact on returns. In last 2 years this has been observed in IT cos, Chemicals etc. I’m mentioning some examples for better understanding
| Scrip |
Price on date |
Valuation on date |
Returns now |
| Wipro Ltd |
715 on 31 Dec 2021 |
PE of 31.5 |
CMP 380 (drawdown of 46% in 22 months) |
| Happiest Minds |
1500 in Jul 2021 |
PE of 135 |
CMP832 (DD of 45% in 27 months) |
| SRF Ltd |
2400 in Oct 2021 |
PE of 46 |
CMP ~2200 (no returns in 24 months) |
| Divis Labs |
5370 in Oct 2021 |
PE of ~70 |
CMP 3400 ( DD if 36% in 24 months) |
| Britannia |
3900 in Aug 2020 |
PE of 55 |
CMP 4500 (just 15% returns in 3 years) |
| TTK Prestige |
1400 in Nov 2021 |
PE of 54 |
CMP 792 ( DD of 44% in 1 Year) |
| Dmart |
5324 in Oct 2021 |
PE of 314 |
CMP 3665 (DD of 30% in 2 years) |
| Sona Comstar |
790 IN Dec 2021 |
PE of 200 |
CMP 550 (DD of 30% in 22 months) |
The above data indicates that if one is not concious of the valuation (specailly when margins are at peak) may result in drawdowns and years on no to negligible return. I tried to mention examples from different examples to consider the broader market.
Notes:
- At bottom of the cycle a co may look optically expensive in P/E terms. But that may not necessarily be over valuation
- Even if the PE is expensive for some cos, still the return may be good. There are many examples in India including Asian Paints, Titan, etc.
- The data is selected to make a point, so the inferences from this may not hold true for all the stocks or in all kind of market cycles
My lessons and key take aways:
- Respect valuation, especially in a cycle top
- Not all stocks may face time or price correction. But better safe than sorry
- Derating is a Beyotch. Better stay away where there is chance for derating
- In a market with 1000s of listed cos, why stick with a co with chance of derating, when there could be other opportunities with profit growth and rerating
Disclaimer: All the info is for knowledge purpose and not 100% backed up concrete data/research. The reader is advised to do their one due diligence.
I may be a shareholder of some of these cos in past, present or in future
Please feel free to share any examples that support or negate the info/data shared
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I have burnt fingers first hand in Divis labs, SRF, Dmart myself. But i kept on adding on the journey downwards.
Kindly elaborate on " optically high PE on downcycles"…Do u mean , since earnings are low, PE looks high as denominator has decreased , or some other viewpoint?
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I can add some more to your list
Laurus labs
LTI
Tata Elxsi
P.I industries
Alkyl Amines
Deepak Nitrate etc
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Exactly, this is what I meant. Few examples
- MCX with P/E aof 90x. Currently earnings are depressed with high software charges which would normalize starting Q3 FY24
- Fairchem organics, where P/E appears high at 64x, as the earnings took beatings in recent quarters
Broadly, cyclical cos may look optically expensive when earnings are depressed with very low profitability. Examples being commodity businesses like metals, etc.
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If the company is good, then it helps me to invest with the mindset of adding more should the prices fall. So, if I can invest 100% in say a company like Page Industries and then I would invest 50% of my available cash in it and then if it goes down add more or then move on to the next good company if the price goes up by a lot. I think investing in one go could be ok for those investors who have a huge corpus but for investors starting out, it’s safer to test the waters first.
So for some of the companies you have invested, maybe it’s a good time to average. Tricky decision though.
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It’s easy to say than execute. Let’s say someone bought Sona Comstar (which I think has very good growth prospects) at 790. Does someone average it when it falls to 650. Then what about when it fell to 550 and 450.
Does anyone keeps averaging until the price bottoms out? Let’s say one averages at all the said prices. Wouldn’t the weightage in PF be too high?
And the returns would be negligible if not negative.
Instead if someone has bought a beaten down stock with low valution at cyclical low, there are better chances of one of the two factors (valuation rerating and earnings growth) playing out.
Point to consider is in a PF of 20-25 stocks the odds matter and odds are in favor while buying at reasonable/cheaper valuation with decent growth prospects.
Note: in the first post of this topic I’ve mentioned some examples. One can see that the cos mentioned are one of the best in their industry and some are FII/DII favorite. One can imagine what would happen to other laggards
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Valuations are important for sure. However, human instinct is to avoid averaging down when the shares we bought are trading at a significant discount. But good companies (market leaders, high ROIC, low debt, good promoter share) are better value at x/2 than at x. If the company is good, I don’t see why I would not invest when the shares are falling in price. I am thinking if tomorrow companies like Colgate Palmolive, Hindustan Unilever, Nestle all fell by 25%-50%, I wouldn’t hesitate buying them and averaging down on them as my time horizon is 10-20 years. If my weightage doesn’t go above 5%-10% in a stock on average then adding another 5% doesn’t really affect portfolio balancing. I think at this point, I wouldn’t want to be thinking in a formulaic manner.
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Also, let’s say we invest in 25 stocks. No one can know that the company you invest 1% would become 15% of your portfolio while the company you invest 5% of your portfolio will not budge. Also, your multi-bagger stock could be a company that was being sold at 50 p/e at the time of purchase rather than a low p/e stock. All one can do is try to be rational by buying when the opportunity arises in the form of a market correction or a correction n that particular stock or some capacity expansion that is ignored by the market.
While it would be good to have all stock purchases at market lows, this is harder than averaging down on a good company! This way I am not missing out on some growth. A good example is 3M. It has always been an expensive stock. We would miss out on say 200% return because we are going after 1000% returns which are rarer.
In the end, I guess each investor has their own style of investing. As long as it is as rational as possible, we should be fine!
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Depends on the time horizon for investors. That helps in making decision. For long term, draw down of 50% in a quality stock is an opportunity. Otherwise if investor is looking to make use of business cycles for short term may be 3-5 years, then yes above analysis makes perfect sense to take care of valuation and avoid waiting for years.
I agree that may be true in somecases. But it’s not applicable for all cases (infact not applicable for most of the cases)
Take example of pidilite
One can see that the profit growth in last 10 years is in teens and the returns are higher because of the rerating. Basic common sense tells that the chances of profit growth will be only in teens for next decade as well. So, the returns would also be in teens (as valuation rerating from here onwards is quite difficult).
So what I mean to say is, If we pay high valuation like (50-100x) for a co growing <20% in sales and profits be ready for derating.
Short response to your above point is, “In Indian market with 2000+ listed stocks why buy a low growth, high PE stock that may fall 50% ?”
I’d rather wait and buy the stock at historically low valuations
Take example of Saregama Ltd
It’s a co that can grow profits at 20-25% CAGR. If someone paid 67x P/E for it, he/she should be ready for derating. But at Current P/E of 33x It’s not a bad decision to buy.
Cases where I’d pay high valuation:
- MTAR current P/E of 70x. But FY24 P/E would be 53x and I’d happily pay that for a co that can grow 30-35% in sales and profits for next 4-5 years (Why would I pay the same P/E for Pidilite growing in lower teens)
- I’ll pay 30-35x for SRF, Gujarat Fulorochem that can grow 15-20% , but not 45-50x
- Will pay 30x P/E for Dodla dairy growing at 15% CAGR but not 45-50x P/E for Britannia growing at 13-15% CAGR
Finally If someone is experienced enough to have vision on a co. for 10 years time frame, they should very well be aware and consider the entry valuation and drawdown potential
@CreateBetterVersion If the comments you’ve made are coming from experience of holding a stock for few years with drawdown, please share with examples. This would be a good case study to oppose the point I made and would help other participants
Thank you
Praveen
Disc: No recommendation by any means. Holding some of the cos discussed
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You have got apoint , , i have entered all above companies at today’s valuation , specially it sector , as i see reversal definite and risk/reward better here onwards
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P/E re/derating is a double edged sword
I want to put down my thoughts on some point that I think will effect an investors returns a lot. That is P/E rerating and derating.
Let’s take a stock at 100rs and 20x P/E in Fy23 end with EPS of 5. Let’s assume we expect profit growth of 20% and the P/E to rerate downwards or upwards in FY24. The following scenario may occur
| Scenario |
EPS |
P/E at FY24 |
Stock Price in FY24 |
Return |
| same P/E |
60 |
20 |
1200 |
20% |
| P/E rerating |
60 |
25 |
1500 |
50% |
| P/E derating |
60 |
15 |
900 |
-10% |
| Slight rerating |
60 |
22 |
1320 |
32% |
| Slight derating |
60 |
18 |
1080 |
8% |
What does this tell me:
- Try to be in a scenario of rerating as far as possible
- Even though there doesn’t seem to be much difference in 20 P/E and 25 P/E, the returns are huge if we have a short term view. So, try to take advantage of P/E rerating whenever possible
- One may achieve point 2 by following the trend (technicals) define the exit from a stock rather than exiting once it reaches the P/E you think is fair (there’s not much difference between 20 and 25 P/E as per me). So, hold it and take extra returns
Note:
One may note that the rerating or derating effect is bigger, as I considered a 1 year time frame. But, the difference may not be as big if we consider a view of 4-5 years. But market has lot of cycles, and the rerating and derating can happen in just a few weeks to few months
Example: I’d like to explain one of my current dilemma as an example for this. You may know that MCX is recently gowing through a low earning phase because of high software charges which would normalize from Q4 FY24 onwards. So, I made a calculation of how much return I can expect from MCX by FY25 end. Let’s look at the following scenarios
I consider P/E to be in the range of 35-45x, as this is peers CAMS, CDSL trade at 40,50x P/E and the growth rates are better for MCX
| Market cap in FY23 |
Profit in FY25 |
P/E |
Market cap |
CAGR return in next 1.5 years |
| 13000 |
425 |
35 |
14875 |
9.4% |
| 13000 |
425 |
40 |
17000 |
19.6% |
| 13000 |
425 |
45 |
19125 |
29.4% |
The data says the estimated returns can vary from 9.4% to 29.4% based on what P/E i think is fair. And 9% is very poor return and 29.4% is top notch and the the difference is just P/E change from 35x to 45x
KTA:
- Don’t exit a stock just because it’s reached a P/E that you estimated. After all there is not fair value but there’s a fair band
- Book partial profits or take help of technicals to make exit (for that matter even entry) decisions
- If you have few stocks in P/F you returns may vary highly because of P/E rerating/derating, but if you have 15-25 stock PF, the effect of P/E on the total PF returns may not be significant
Disc: May have postion in the cos discussed
Please feel free to share your experiences of how P/E rerating and derating effected your returns or missed out on high returns as you thought the P/E has reached a fair band
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Your thread is very insightful…thanks for the same. I tend to read the whole thread, every time you put a new post. The example of MCX …watching it closely.
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Thanks Neeraj for your kind words.
Burnt my hands a lot of times over last 6 years of my investing journey. Idea is to not repeat mistakes and on the way I’d be glad if my lessons can help other VPers like us
Thanks to the community
Praveen
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I hope you mean Medium/Large cap IT sector. That is in low valuation due to slowed economical growth in the US, from where most of it’s profits are generated.
SmallCap IT Sector is already reasonably valued
Do Quarterly Results Matter ?
Most of us know that the Financial resutls of a co matter. But it may not always be the case depending on the investment frame. I’d like to summarize my recent experiences in this regard:
| Company |
What happened |
My assessment |
| MCX |
Quarterly Profit is depressed because of high Software Charges |
These higher charges won’t be there (most probably) after Q3 FY24. I ignored the net profit and looked just at the revenue growth |
| XPRO India |
Resutls are down YOY |
My thesis is 2-3 years down the lline when the Capacitor film capex starts ramping up. Current quarter financial resutls doesn’t matter. But If there’s any challenges in commercializing the capex, it’s a problem |
| SRF |
Revenue and profit down both QOQ and YOY |
Inventory rationalization lead to degrowth. Once the inventory at the customer/distributor level is consumed, orders should come in |
| Kernex Micro systems |
Resutls not announced yet |
My thesis is the huge order inflow for TCAS players (only 3 players currently) which would happen in next 1 year. But execution needs to be seen, so I want to see that co convert orders (550 cr worth to be executed by Sep-2024) to revenues and show profits |
My Key Take aways:
- While financial results are important, the level of importance depends on the timeframe of your investment thesis
- One time hit to a co’s P&L may lead to fall in stock price. It might be an opportunity for an investor if the thesis is still intact in his time frame
- But if the recent events (hit to P&L) reveal new permanent risks, and reveal that the quality of the co. is poorer than we considered, then it may change my expectations from the co. and re-evaluate the investment decision
Disc: No reco by any means. Just for educational purpose
Any points, examples supporting or opposing the above views are most welcome
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To add a point to your thesis, I guess market’s reaction to quarterly results can also be considered. The rise or fall as per the participants’ view, the strength of such or fall can mean something. Price may react in accordance with the results or may react in a opposite way too. So I guess, along with the thesis we have, including the reaction of the market will help more. Not to mention observing charts, which presents the same picture in a different but helpful way. There could be an element of short term traders too, but not to the extent of speculation without any basis.
Just some thoughts.
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Absolutely. Charts really help us, and the market irrationality may give us opportunities. But we don’t know how long the market starts irrational.
One recent case where I got benefited.
- On 28 Sept 2023, MCX closed at 2096. But it fell to 1916 next day low, as there’s an objection raised for the technical robustness of their Platform.
- If someone had view of 1 year, it’s a good opportunity (as the porblem would most probably have been solved in a year)
- at ~1926 rs, my expected returna over next 1.5 years time frame was too good and bought.
But yeah, since I did not know how long the market stays irrational, I couldn’t buy as much as I’d like. And it didn’t go below 1900, and instead it went up gradually from there.
Using technical and Funda view would be a great combo.
Technicals would help avoid downside risk (avoiding catching falling knife) and Funda would tell us if there’s value in a stock at a certain price
Yes, when we have a long term view, sometimes we get good opportunities, and these sometimes may not available for much time, so I guess psychologically, it is better to take advantage of such opportunity and add some to the existing position, so as to not feel about losing such an opportunity if the price moves up later. And of course, the fall may extend for long time, and if the bet is based on fundamentals, then I guess buying more for a lesser price than before makes sense. Positions can be built this way too.
For short term though, such falls could make a big dent in the profits, or can even be termed as stop losses.
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to the readers. This Diwali 