"I
think being a woman is like being Irish. Everyone says you're important and
nice, but you take second place all the same."
—Iris
Murdoch (Irish, 1919-1999)
Word
for the day
Campestral (adj)
Of or
relating to fields or open country.
Malice
towards none
Why should
anybody be afraid of Donald Trump as US president?
or
Hillary
Clinton for that matter!
First random thought this morning
25years of economic reforms have certainly done a lot of good to
the country. It is therefore an occasion worth celebrating. The moot point is
how do we celebrate.
One thought could be to stop for a while, look back, feel proud,
gather more pace and begin journey on the same path with even more vigor.
The other thought might be to conclude this chapter as a happy
ending; and begin a new chapter with a different plot.
What's driving markets
The Indian benchmark equity indices are up ~8% YTD. Broader market
indices have performed even better. Most mutual funds and PMS schemes have
grown much faster than the indices.
Like most others, I am also happy to see the value of my portfolio
higher. However, being an absolute return investor, I cannot prevent the seed
of worry sprouting in a corner of my mind. I must know what is driving the
stock prices higher.
If the rise is sustainable, I do not mind a few percentage point
higher return. However, if it is just air that is causing formation of bubbles,
I cannot wait for someone to prick it.
In conventional sense, the return on the investment in publically
traded equity is a function of 3 factors (a) earnings growth; (b) changes in
price earnings (PE) ratio and (c) dividend.
The earnings growth is a function of multiple factors, e.g., (a)
capacity (production capability); (b) demand environment (market leadership);
(c) competitive landscape (pricing power, cost advantage); (d) innovation and
technology advantage; (e) resource availability (raw material, labor, capital,
managerial bandwidth etc.), etc.
The price earnings ratio (PER), one of the most popular equity
valuation criteria, is the ratio between the earnings of a company and its
market value. It broadly signifies that at the current rate of earnings how
many years it will take for the company to add the value which an investor is
paying today. Principally, an acceptable PER for a company's stock is defined
by (a) the return on equity (RoE) a company is able to generate on sustainable
basis and (b) the growth rate of earnings that could be achieved on sustainable
basis. A company that could generate higher RoE consistently and is likely to
grow faster, should be assigned a higher PER as compared to the ones which
generate lower RoE or has low or highly cyclical earnings growth.
A rise in PER, if not commensurate with the rise in earnings
profile needs deeper scrutiny.
Sometime the rise in PER occurs due to correction in anomalies
(undervaluation) of the past. This is a welcome move.
Sometime, PER changes (re-rates) due to relative forces, e.g.,
rise of PER in comparable foreign markets or change in return profile of
alternative assets like bonds, gold, real estate etc. This is usually
unsustainable and therefore a short term phenomenon.
Many times, demand-supply mismatch in publically traded equities
also drives re-rating of PER (excess liquidity chasing few stocks and vice
versa). This is again usually a short term phenomenon.
Sustainable rise in dividend yield is generally a sign of stable
profitability growth (P&L improvement) and strong financial position (B/S
improvement) and stronger cash flows. In some cases however it could reflect
stagnation in growth.....to continue next week.
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