Every time market volatility rises and prices move sharply,
a valuation debate gets automatically triggered. While it is universally
acknowledged that the current market price (CMP) of equity stock is based on
future outlook, it is not uncommon to hear buy-sell arguments based on
historical data.
In our view, CMP as determined by the collective wisdom of
all the market participants is mostly true and fair value of a particular stock
under the given circumstances.
However, there are brief periods of extreme market momentum
(as the one we are witnessing currently), where CMP may not reflect the
collective wisdom of market participants due to some technical factors like
involuntary forced supply due to liquidity issues or absence of execution of
demand due to non-financial non-economic reasons like some rumors, political
uncertainty etc. These deviations from the true and fair value however do not
last long and usually get corrected in short periods of time.
The valuation debate therefore is mostly irrelevant inasmuch
as it hardly provides any actionable theme.
Insofar as the actionable at current juncture is concerned,
we believe that the return on investment in publically traded equity is a
function of 3 factors (a) earnings growth; (b) changes in price earnings (PE)
ratio and (c) dividend.
(a) 1QFY14 has
seen first earning contraction since 2QFY10. Post results FY14 consensus Sensex
earnings have been downgraded by ~4%. In our view, 2QFY14 results will likely
be much worse than 1QFY14 and therefore earnings will be downgraded further.
(b) In next
8months India shall hold general elections for Lok Sabha or the lower house of
the Parliament. Given the current fluid political scenario, the perceived
political and policy risk in the country is high.
Therefore, given the low growth, stressed balance sheets,
policy risk, uncertainty over continuation of global flows and fragile global
economic conditions, there is little probability of any noteworthy re-rating of
Indian markets in next 9months at the least.
(c) Given rising
cost of capital, tight liquidity, slowing growth, and margin compression, the
dividend payouts are more likely to contract.
Under these circumstances, the most optimistic equity return
that could be expected in next 12months is 5-12%, with equal chance of similar
losses. The most likely scenario is single digit return with high risk.
With risk free debt returns running close to 9% and bank
deposit rates on the rise, any investment strategy has to consider this matrix
to be practical.
A lame duck government at the helm, prospects of tighter
global liquidity, inflation bottoming, currency in doldrums, we suggest wait
till this period of indecision is over and the market arrives at true and fair
value for making any fresh investment in Indian equities. We expect to go out
for shopping closer to Diwali by when 2QFY14 macro and corporate performance
data would be known and true and fair value discovered.
Thought for the day
“I am the wisest man alive, for I know one thing, and that is that I know nothing.”
- Socrates (469-399BC)
Word of the day
Lacerate (v):
To tear roughly; mangle.
(Source: Dictionary.com)
Shri Nārada Uvāca
All denials notwithstanding, the government on Monday disallowed import of flat screen televisions as part of free baggage allowance! An instance of penny foolish and pound foolish.
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