Riding the Bull and Handling the Bear

Contributed by: Aditya Jadhav, CFA & Shreenivas Kunte, CFA

IAIP’s Mumbai chapter hosted Basant Maheshwari for his session on ‘Riding the Bull and Handling the Bear’ on 19^th Feb. The session was very well received with a full capacity audience of fellow charterholders and CFA candidates at the National Stock Exchange auditorium in Bandra. Among others, Basant has a history of identifying several multi-baggers like Pantaloon Retail, TV18, Titan, Page Industries and Hawkins Cooker. In this forum, he brought to the audience over two decades of equity investing experience and shared his insights on investment thoughts.

The session started by reviewing and summarizing world capital market’s history over the last 200-300 years and looking at the historical patterns that bull markets have traversed. Basant observed that whenever an index broke out after consolidating for 2-3 years, it tended to appreciate by 3x to 4x over a 20-30% rally. Historical patterns, according to him, suggest that large index rallies are likely to be led by new emerging sector accompanied by dominant themes that will tangibly benefit the human race. For example, around the 1850s it was the Railway network companies in the UK and during the early 1920s it was consumer durables companies such as Radio, Telephone etc. in the US that led the rally. Japan led the cheaper, better auto and manufacturing themes and bull market around the 1970s. At the end of 20^th century it was internet or dotcom companies and in the Indian context in the early 2000s it was Infrastructure, real estate companies that led markets to newer highs. However during these bull rallies leading sectors tended to appreciate by 8x-10x. Companies in such sectors are among the candidates to become multi-baggers – growing 30x-40x times of their original size.

One of the investment screening insight that the speaker offered for getting mega sector calls right or for identifying dominant sector bull themes, is to locate complete packs of companies from a sector that are making new highs (every day) or to look at sectors growing at about 30%. Sectors growing at more than 30% for example could be among the leading sectors. However, such sectors could attract the limelight only after doubling or tripling. Companies in these sectors are seen likely to be expensive on valuation metrics with trailing P/Es of 30-40x and forward P/Es of 20-30x. But the accompanying sector bull rallies have been seen to sustain for over 20 years – investors would therefore need to develop sufficient insight and conviction to remain long over an extended period. He highlighted a few other characteristics for identifying emerging leading sectors. Companies in these sectors are likely to be relatively illiquid and unpopular. Big companies of today for example Infosys followed this pattern. Illiquidity signifies that the stock may be undiscovered and yet investors could be reluctant to invest in illiquid stocks.

Companies offering more than 30% growth with positive Free Cash Flow (FCF), dividend payout could provide enough cushioning to investors wary of price corrections. Historically sector leaders such as Infosys, L&T have continued to return the capital to investors post correction. Conversely, companies that do not bring with them dividends and or free cash flow would be vulnerable to corrections of more than 50%, if a growth story punctures. Free cash flow/ dividend protected companies on the other hand are likely to correct to less than 50% if the underlying thematic ran out of steam.  Another price-based indicator for a vanishing growth story is that the associated stocks are less likely to sustain new highs for more than a couple of days. One is reminded that very few in the market are able to sell at the top as the window is likely to be short – a couple of days, bottoms on the other hand could sustain for more than a few months.

The initial growth hypothesis in such sector bull rallies is susceptible to corrections. Whatsoever may be the management justification for a changed slower growth profile, nine out of ten times companies would not be able grow again at the same pace. Unfortunately, it is that most of the times, managements tend to window dress and wash all the dirty linen in the bear phase or price correction phase. Thus one may want to look for opportunities to bring a portfolio shift towards high quality stocks, when a sector bull rally is about to end. It may not be that easy to find high quality stocks. In order to qualify to a higher quality benchmark, a company would need to be in a good business (sector) and simultaneously run by a talented management team. Good corporate governance companies in addition to giving better dividend payouts are ones that have not diluted their equity in the last 5 years despite doubling sales.

Basant disclosed that among the sectors that may lead India’s bull rally could be housing finance companies. Currently most of these companies are growing at 20-30%. Turnaround of India’s interest rate cycle is likely to increase the affordability of buying houses boosting the growth rate for housing finance companies. The 7% GDP growth hypothesis could face challenges but the current government offered the best chance for growth. The need for housing for example in India is real. “Roti, Kapda, Makan” is a thematic and has tail winds supportive of two sectors – housing finance and consumer companies. While intra sector bullishness may not be globally synchronized, bullishness across equities in generally is likely to be around the same time. He cautioned against turn-around stories and relying on chat sites for market insights. With respect to investment exits, a better strategy would be to focus on the growth theme (or main thematic on a stock) fading away instead of the percentage return made on an investment.

– AJ & SK