August 21, 2011

Time to open up the wallet?

26-Aug : A clarification
In the post below, i spoke about investing in the index either via a systematic investment plan or through some simple rule set ( such as buy below a PE of 12 and sell above 20).
I did not imply that one should be investing in the index now !. I am surely not investing in the index now as it is not as cheap as i would like it to be. 

However if you want to avoid all this mumbo jumbo, the best option is to use a systematic investment plan and invest in a mutual fund or index fund on a regular basis. 

Finally, remember to switch off the finance channels on TV to avoid derailing a sensible long term plan.
I have a little extra spring in my steps these days!
Let me share a small personal story. As a kid growing up, diwali was a great time for me. Being a north Indian, sweets are a big part of diwali. We would visit our grandparents during diwali, and I had complete freedom to eat as much sweets or mithai as I wanted to. I have always had a sweet tooth and I still recall a month of pure bliss during diwali. Barfi, gulab jamun, pedas …mmmmm!
I feel like it is diwali or almost diwali these days. I don’t mean in the literal sense, but everyday  I look at the market and find my favorite barfis and pedas available for less and less J
But it is such a bad time!
I think all of us know the million reasons why one should not invest money and stay away from market. US is in a mess, Europe is a disaster waiting to happen, India is overheating …blah blah blah.
One cannot open the papers or watch a channel without someone trying to predict a disaster sometime soon. Where were these idiots in the beginning of the year when the index was at 20000 levels? If they could not see six months out then, how are they able to see six months out now?
The truth is that, it is never a good time to invest. There always is some problem somewhere. It could be macro problems such as now or industry/ company specific issues such as in the infrastructure or IT industry. By the way, the right time to sell would be before the market realizes that there is a problem in the industry and not after it has been priced in.
If risk avoidance is the goal, then the only way to invest is in bank deposits. Even in the case of bank deposits, one faces the inflation risk. So in effect, one cannot escape risk. The only thing an investor can do is take intelligent risks for which one is compensated (much like an insurance company)
What is an intelligent risk?
An intelligent risk is one for which one gets the appropriate return adjusted for the risk. The main component for intelligent risk taking is diversification and pricing. You do not overpay for it and you diversify. This is much like an insurance company.
The unsaid part in the above is that one knows what one is doing. No amount of diversification or price can save you from ignorance.
Why not wait till it all clears up
Unless you have some crystal ball to look into the future, it is futile to try to predict the turning point (if you do have a crystal ball, why waste it on the stock market anyway).
Majority of the investors are typically late in knowing when the tide has turned and then there is a mad rush into stocks (remember April 2009 when the index jumped by 10%+ in a day !)
If like me you cannot predict the turning or don’t care to, then a good time to buy is when the prices are low. It is quite possible that things could turn worse before they get better and you may get a better opportunity. However trying to pick the bottom or the top is a fool’s game and I would prefer to pick up stocks which are cheap enough and then just stick with them.
So what to buy?
The first question to ask yourself is this – Do I have the stomach to withstand large swings in the stock prices and considerable paper losses for sometime? It is quite possible that all this may take some time to clear up and could test your patience.
The second critical point is whether you need the money in the medium term. If you need the money in the next five years, then don’t put that money into the stock market. A large drop will scare you and you may exit the market at the wrong time.
The perceived risk in the stock market is high during bear markets, but the actual risk is lower. Everyone was scared in March 2009 – so the perceived risk was high. But if you invested during that period, you made good returns.
If you are short on time and cannot do the research, then you can do what I have done in the past – Invest in an index fund. As I have said in the past, investing in an index is a good option for a lot of investors, especially if you not have the time and interest in analyzing stocks. You can use a simple rule set like mine or do some fancy math to figure the right time to buy.
I was short on time during the first quarter of 2009 and felt the market was fairly cheap. To take advantage of the undervaluation, I invested quite a bit in index funds to take advantage of the low valuations.
If however you have the time and inclination to analyze stocks, then beaten up sectors which do not have a structural issue is a good place to start. I think infrastructure and capital good is a place to search for bargains. The IT industry on the other hand has structural issue and I will not invest in any company unless it is really really cheap.
My mouth has started watering these days and if the market continues to drop, it would be an early diwali feast for me J


Pradeep said...

Great post Rohit - as usual.

For most of us, indexes is the best way to go until the point one is very advanced where you know what you are doing - in terms of understanding all the variables (not merely playing a guessing game). Very convincing when you cover these issues in such a methodical way. Thanks.

I hope everyone reading heeds to this advise.

mkd said...


That is exactly the feeling that I am having right now. Aptly compared and very well described :-)

Anonymous said...

cn u comment mre abt d issues in IT industry

Anonymous said...

HI Rohit..!! i couldnt agree with you more, these gloom and doom predictions provides mouth watering opportunities to invest for long term.!
i regularly follow your blog, Keep up the good work.!
P.S attempting to write one too.. :)

Babu Kalyanam said...

Good one Rohit.
However, have this doubt in mind: Isn't the market P/E still bit too high even according to your own thresholds, (In July as per BSE website, it was some around 19+, may be some 17 now, nt sure ) to start investing even in index funds?

Anonymous said...


Gaurav said...

Hi Rohit,

Great post as usual. I am convinced. When you talk of structural issues in IT industry, do you mean the significant exposure of IT companies on export revenues? Personally i am not very comfortable to invest in IT stocks, because:
1) Significant exposure to western economies
2) Forex risks
3) Lack of any long term value offering (i dont consider cost advantage as a sustainable value offering esp. in weak dollar situation)
What do you think about this approach?

Thanks & Regards,

Gaurav said...

Hi Rohit,

Great post as usual. I am convinced. When you talk of structural issues in IT industry, do you mean the significant exposure of IT companies on export revenues? Personally i am not very comfortable to invest in IT stocks, because:
1) Significant exposure to western economies
2) Forex risks
3) Lack of any long term value offering (i dont consider cost advantage as a sustainable value offering esp. in weak dollar situation)
What do you think about this approach?

Thanks & Regards,

Lucky said...

Reassuring post. Clears some doubts in my mind (was wondering if I pulled too many triggers too early).

One word of caution. Although certain sectors are selling extremely cheap, overall market PE is still 18. This is in the third quartile at best.

Long term investors may get good returns but do not expect to double your money in 3 years or less if you invest in the index.

Just ask yourself when you expect the Sensex to reach 30-32K. 2014 sounds a bit early (to me) for that.

rajesh sankar said...

Hi Rohit

Relevant post at the right time. I am also in the same dilemma of where to invest in this falling market as more stocks touching 52 week lows. as we do not know all the companies / industries. At this Juncture to invest in ETFs (broad Index) seems to be good idea.

Yes we cannot predict where the markets are headed, but ignoring analyst and media's we should use our common sense to read the facts instead of hearing biased opinions.

since Jan the markets are sluggish after 2 years of bull run. The present market crash is also similar 2008 predominantly due to global conditions and yes of course there are domestic concerns wrt Inflation and interest rates but the fundamentals never change. i feel the high volatility in markets are due to large participation by FIIs as they are pulling out money from developing countries and i believe these money should return soon, as no developed countries will not these kind of returns.

I feel FII activity is more relevent at this juncture and also relating this to Index would be more appropriate. presented below the NIFTY (index) Monthly average and sum of FII activity on the corresponding month for both 2009 & 2011.

Month Avg of NIFTY Net FII Act
Jan 2,854.36 (5,172.82)
Feb 2,819.21 (2,833.43)
Mar 2,802.27 (683.57)
Apr 3,359.83 5,560.10
May 3,957.96 13,886.09
Jun 4,436.37 (85.14)
Jul 4,343.10 (1,364.60)
Aug 4,528.51 (4,839.96)


Month Avg of NIFTY Net FII Act
Jan 5,782.71 (8,903.60)
Feb 5,400.92 (7,422.90)
Mar 5,538.42 8,395.39
Apr 5,839.09 4.40
May 5,492.20 (3,705.38)
Jun 5,472.64 2,662.76
Jul 5,596.59 3,930.12
Aug 5,169.07 (8,956.48)


Unknown said...

Good post, Rohit.

#1: South Indians too love Sweets on Diwali day - no different than North Indians :-)
#2: "... if the market continues to drop, it would be an early diwali feast for me.." That's different for different people and causes many to miss - waiting too long. When does one bite is the question.

Keep up the good work!

BEst Regards,

Anonymous said...

Hi Rohit,

Excellent post as always.

I have just started analysing businesses in stock marker and learned a lot from your blog. I wish to make few comments.

If we take consolidated EPS of sensex, then sensex PE is around 15.7 at present.

Buying individual stock is a dilemma as quality stocks with predictable free cash flow, high ROE and good management like FMCG counters are not cheap.

In capital goods, L&T, Areva T&D still trades at 24-26 PE and doesn't appear obviously cheap. L&T went to historic low PE of 10-12 in 2008-09.

At some stage, India story is probably oversold as it appears from valuation gap from US bluechips.

company PE div yield
Johnson 15.44 3.6
Microsoft 9.14 2.7
Intel 8.98 4.4
Pepsico 16.05 3.3
Shell 7.2 5.4
GE 12.07 4.0
S&P 500 12.5 2.3

These valuations are in context of US 10 year treasury yield of 2.1%

IF one compares above with Indian bluechips- hard to buy Indian companies over to US.

Obviously cheap valuations appears in PSU banks which might not after all cheap considering NPA's, pension provisions etc.

I am eager to buy but still not able to find anything with high conviction.



Anonymous said...

BTW, the Sensex is still at a PE in excess of 18 as BSE website.


Sachin Purohit said...

Talking about index funds, there's a question I have got about it. What happens to an Index Fund when one or more of Index stocks are replaced by some other stocks in the index? Does the fund immediately sell off the outgoing stock and buy the incoming ones in that proportion?

Anonymous said...

Hi Rohit,
What is Ur take on the US debt position & thus on the Dollar as reserve currency & its probable impact on global markets (equity, commodities, forex etc.)?

Secondly, what are Ur views on commodities (agricultural, oil etc) and gold/silver specifically?


Ranajit said...

Hi Rohit,
Good points and I am also waiting for the market to drop further to find some more bargains.

Just a note about P/E ratios though. I think using PE ratio to judge market level (or probability of profit in this case) may be a little risky if one doesn't have long investment horizon. The reason is because earnings can drop very fast even when the PE ratio is low and then the price eventually follows.

I had done some data mining a while back ( using data for NIFTY50 and S&P500) just to see if I can use PE ratio to automatically allocate funds in an index ETF or MF (based on degree of "cheapness").

What I concluded was that PE ratio is probably a good indicator in emerging economies like India which have had high GDP growth for more than a decade ( at least for now and in the absence of a black swan event) and will probably continue to be so for some more time. The PE ratio data on NSE website for NIFTY50 only goes back 11-12 years which is too short a period to create a rule, since India's economy has been growing at a rapid pace during this time. But that same rule may not apply to developed countries.

I used S&P 500 data from the US for the last 50 years and found that sometimes the market may tank severely (during a recession) even when the PE ratio is low to moderate. For example ( if I remember correctly), sometime in late 2007-early 2008 the S&P 500 had a PE ratio ~ 16-17 but from there the market went down about 50% within a year. This is because during the recession the earnings fell severely ( much faster than the market) causing the PE ratio to jump to 60+ at one point. Now if one had bought based on a moderate PE ratio they would have bought when the market was high (PE of 17) and sold when market was low (PE of 60). I am guessing this could have happened even if the PE ratio had been <12.

This data point cautioned me against blindly trusting PE ratios as a measure of cheapness of the market. Frankly I prefer to use P/B ratio more ( again, this is not without limitations either), as book values don't change so fast and shows the equity in the business/market rather than earnings which are more volatile and may change drastically from one quarter to next.

Jatin said...

Hi Rohit,

Sesa Goa is below 200 now, your bargain price. Would you buy now??
Views plz..

Rohit Chauhan said...

Hi pradeep
It is simple to understand ..but very few people follow it. a lot of people want to get rich quick. luckily most of the readers on this blog are not of that type

hi mkd
agree with you. lots of opportunities these days

hi anon
i have written about my views on the IT industry several times on the blog. will put a follow on post soon


Rohit Chauhan said...

Hi rohan
thanks for the comment and best of luck on your blog

Hi babu
at the current point the index is not cheap to invest. i just gave an option to do so if the market drops further

not sure what you mean by liquidity. extra cash ? if that is the case, for most there is a regular inflow via salary. if not, then makes sense to keep a little bit around in case something very attractive comes up


Rohit Chauhan said...

Hi gaurav
yes i agree with your point on IT companies. other than labor arbitrage i dont see a big competitive advantage for these companies to maintain such high margins in the long run.

they will continue to be good businesses - no doubt about that, but i will not pay current valuations for that.

on mid cap IT companies, i am even more pessimistic


Rohit Chauhan said...

Hi lucky
yes one has to pick the stock in this market ..if you blindly pick the current favorites ..i think the future returns are not going to be great


Rohit Chauhan said...

Hi rajesh
the volatility is quite high and agree that we are facing a slowdown.

at the same time, i generally dont analyse the reasons for the volatility. i follow the hindi saying
- aam khane se matlab hain ...ped ginne se nahin

i dont analyse the cause of the volatility - though TV channels like to - i just try to take advantage when the market throws up good opportunities


Rohit Chauhan said...

Hi arun
agree 100% on your comment :) all indians like sweets :)

i am not trying for the perfect time into the market good opportunities keep coming ..i keep commiting capital


Rohit Chauhan said...

Hi ashok
i think it boils down to your conviction. US blue chips are very cheap for sure ..but they will also give moderate returns at very low risk

In contrast indian companies have high volatility , but should give higher returns. companies like L&T are not cheap ..but there are several others in the same space

in addition, FMCG companies which have been my favorite are pricey


Rohit Chauhan said...

Hi sachin
yes thats true the US thats call the index effect. a stock going into the index sees a jump in the price and one going out sees a drop due to the rebalancing


Rohit Chauhan said...

Hi mohan
sorry no views ...i just read the papers on these topics but do not base my decisions on it. in the long term the dollar should drop long that will take ..have no idea

on commodities same thing clue
i never buy commodities for investing


Sajith said...

Hi rohit,

I was looking at a company called Geodesic. I looked at the AR for past 3 years. Low debt flows everything is in place. What could be the reason for this underperformance. Stock is trading at 2 PE and below the cash value level.