The stock markets the world over have had a fabulous run over the last five years, with indices multiplying many times over. The domestic stock market has been at the forefront of this rally, and has been one of the best-performing markets and the darling of global investors. But all good things come to an end, and the dream run of stock markets worldwide has been no exception. This January was a rude shock that sent investors scurrying for cover. Traders have seen a year's profits get wiped out in a week, and most investors are also yet to recover from the bruises.
But, over the last few weeks, markets have seen a semblance of normalcy again. There has been a handsome rally, but doubts and worries still linger. Inflation, an economic slowdown, and the fiscal deficit are the three demons haunting the markets. But we have already had a steep correction. Valuations are not as high as a few months ago. Are we seeing the light at the end of the tunnel? Or is it an oncoming train?
The sooner we face it, the better - we are headed for uncertain times. The smooth and easy part of the rally is over and done with. The ride ahead is going to be tough and bumpy. Restructure your portfolio to survive, even thrive, in these challenging times. Keeping in mind the volatility and uncertainties, your portfolio should focus on downside protection. Take care of your capital and the upside will take care of itself.
We are already seeing stocks from the fast-moving consumer goods (FMCG) and pharmaceutical sectors hold firm. The formula of value investing is what will see us through. It offers safety in the face of the current volatility and uncertainty. Sounds like a good idea, but how do you construct a value portfolio?
Scale down expectations
Scale down your returns expectations. Returns of 40-50 percent are a thing of the past. And that is not a bad thing at all. Remember that Warren Buffett is where he is today because of compounded returns of 20 percent. Lower and realistic returns will also help us desist from taking unnecessary risks while chasing unattainable goals.
Focus on predictability
Focus on stocks which have high predictability of revenue and margins. Look at performances over a 3-5 year period to assess them, as one-year financials cannot give enough indication of whether a good performance can be repeated. Also, consider the protection that the margins enjoy. This could be due to a strong brand, distribution network, technology, and so on. A strong moat, as Buffett calls it, which helps the profits from coming under attack from competition.
Focus on price
Buy at the right price. Do not chase momentum or operator stocks. Ignore the hottest tips. Form your own opinion on intrinsic value, and stick by your norms through all types of markets. Do not loosen your norms to meet bull market requirements. And last but not the least, wait. All investing will take time (or else it is called speculation). This is the most difficult part, especially in this age of mass media and instant gratification.
Where to look for stocks?
Which sectors or companies will meet the criteria we set out above? FMCG and pharma are the obvious choices. But we will have to dig a little deeper, even in these sectors. HUL still fails to impress, but ITC and P&G meet our predictability and margin sustainability conditions. ITC has the strongest moat we know of, as new competition is not allowed and even existing rivals can't expand because advertising is restricted. P&G has strong brands and a commendable financial performance. It has invested in growing capacity and distribution recently, and should see sustainable growth going ahead.
In pharmaceuticals, the focus is on Ranbaxy and Dr Reddy's Labs, among others. But value investors will have to look beyond these companies, as they carry heavy balance sheets, capital requirements and constant margin pressures. An Aventis or Glaxo may be more fitting in the value investing theme with high ROIs and the promise of steady growth, with the product patent regime encouraging new launches by the parent.
Another sector which has the capacity to hold margins, especially in the face of current high inflation, is entertainment. But here, we need to look away from current favourites, distributors and exhibitors. These companies need considerable expansion and capital infusion to keep growth numbers healthy. Hence, Zee Entertainment and Sun TV are preferable, looking at the strong brands and consumer awareness. Moreover, the businesses are scalable, with lower investment and a strong ability to hold margins.
Many other stocks and sectors will meet our criteria. All of them will fulfil the basic condition set by a value investor - even a wrong stock at the right price, but never a right stock at the wrong price. Remember, price is what you pay and value is what you get.
Value investing
As Charlie Munger, vice chairman, Berkshire Hathaway, put it, "All intelligent investing is value investing." Value investing is the poor country cousin of growth investing, the city slicker that promises more spectacular returns.
Some features:
• Basic underlying value providing downside protection
• Strong performance record providing high predictability
• Strong business dynamics providing margin protection
• Conviction based on the right price, and not on momentum or the flavour of the day
• Patience. Too many investors lose it. The urge to do something - anything - gets stronger as we are bombarded with opinions and news.
Ignore the noise, focus on underlying value
