Law of gravity in stock markets

Stock markets make us human beings behave in strange ways. When things are quiet and stocks are inexpensive, we do not enter the arena. Once things warm up and there is a lot of noise, including anecdotal evidences of fortunes being made by others, we start looking at it. Finally, we succumb. Either though a SIP route or a brave plunge in to the markets, all by ourselves. Most of us go through our lives without bothering to understand ‘valuation’. And given that over time, stock prices tend to rise, we attribute our investment performance to our skills and ‘information’ network. And when the performance of what we pick happens to be disastrous, we attribute it to lousy experts.

We all have different interpretations of “value”. To some, it is price. They look at historical highs or lows and seek their comfort. Some look at P/E multiples and buy it. Some look at P/E relative to growth. Some look at the overall market mood and are happy to look at ‘relative’ P/E multiples. Some are happy to chase what they read or hear that some ‘ace’ investor is buying. Sometimes it is ‘story’ based buying. Like we suddenly get bullish on ‘solar’ power or ‘electric fuel’ or ‘retail’ or ‘banking’ etc. Of course, there may be more theories and strategies. However, unle-ss one spends a lot of time in understanding business and financials, you are leaving your investment to chance and luck.

You should make attempts to improve your odds.  One thing we should understand is that we are buying in to future expectations on a company, stock, or economy. Buying the past is the most common thing that everyone does. Even when choosing a mutual fund to invest, we are happy to go by ‘independent’ ranking that is purely based on past performance. At each stage, when we buy a stock, we are buying in to ‘prospective’ returns. And that means one has to buy at valuations that give us a level of comfort. Stock prices never move according to our expectations. It rarely gives you the ‘speed’ of price movement that you want. Sometimes, even the direction can go wrong. After all, there are thousands of people out there forming a view on a stock, every moment. When you are buying or selling, you are in effect not just impacted by a price but also by expectations.

I would urge all of you to read or re-read the chapter on “Margin of Safety” in the book Intelligent Investor by Benjamin Graham. Essentially, it is buying a business at a price that is lower than what it is worth. Yes, we all think times have changed.

Everyone tells me that I will never be able to buy stocks, given my conservative approach. I will miss out on stocks and be stranded with bank deposits and liquid funds. There is so much money flowing in to the markets that downside is ruled out. Reforms are happening at rapid pace. We are growing rapidly. Banks are getting cleaned up. Trans-parency in governance. Aadhaar has helped eliminate so much of waste. Oil prices are low. Inflation is low. And GST will multiply the profitability. Low oil prices across the globe. Fastest growing economy in the world.

I prefer to not change my thinking or rules for valuation. Everything will obey the law of gravity. Excesses happen at both ends. I am happy at one end and unhappy at another. Why should I voluntarily choose unhappiness? I am not going just by the stock market indices. Given that we have a market with over 450 companies that deliver a RoCE of over 15 per cent on an annualised basis, there are enough companies to invest. However, when I scan each of them under a lens, I do not seem to find a ‘margin of safety’ anywhere.

One has to have an exaggerated view of future performance and also pray that nothing will go wrong, in order to make even a 15 per cent annualised return. Yes, there is tremendous volatility and there are huge price swings that will lure us to quick returns. However, given growth, interest rates, inflation and valuation, I will be happy to sit this one out. I will be happy to watch the action around me, keeping an eye on any opportunity that will come when the crowd becomes quiet. Sometimes, it pays to hunt alone.