Thread by @kabhilash02

Hello everyone,
Initially, I had no intention of writing this note.
Before we continue...I hope everyone understands that we do not provide any advisory
services. All information is only for educational
purpose and not investment advice.
(1)

2) Nifty from its all-time high of around 12000 has only come down to somewhere around 10800,
correction of only about 10%.
I strongly believe market movements of less than 20% do not even deserve a comment.

3) When people say, “ There is blood on the streets, why don’t you comment on the market ?”
All I can think of replying is, “There is no blood on the street, there might be blood only in your
portfolio :p ”. Because you might have bought a lot of small-cap at a PE ratio of 100.

4) Nifty is down ONLY by 10% from its peak. No Big deal.
Present Scenario-
Frankly, our view has not changed much from last year’s refresher session (September 2018)
We had no clue how significantly small-caps and mid-caps would correct but in past

5) we had pointed out that PE Ratios of 100 for
small-cap index and a high of 54 for midcap funds seemed unreasonable.
Since the peak in January 2018, this is how the indices have fared.

6) We could not have foreseen the sizeable corrections seen in the Mid-cap and small-cap
universe but we can and did see very clearly that the valuations were very very high and
therefore not sustainable.

7) From this whole episode, which will repeat again and again in different forms in the future too,
what we should learn is this :
During good times, things often appear to look like they would continue indefinitely.

8) Many believed that Mid-caps and small-caps would continue to rise no matter what. After all Investors
had “past data” to validate their convictions.
How could anything go wrong?

9) It is during times like these that you had to remember God's (Warren Buffett) words " Be fearful
when others are greedy and be greedy when others are fearful"

10) At PE Ratio of 100, people were being greedy, we simply had to act with caution.
At PE 100, even if earnings doubled and PE comes down you don’t gain anything.
For Example, if an index has an earning of 300 and pe of 100.
( Remember , price = earning * pe ratio ?)

11) Price (Index Value) would be 300*100 = 30,000.
Now, even if the earnings double from here in one year but PE comes down to 50.
price still remains = 600*50 = 30,000.

12) And even if earnings grow by 15% CAGR for the next 10 years but PE comes down to 50
(down 50%) in 10 years you would not gain much in price.
Price in 10 years would be : 1500*50 = 75,000
From 30,000 to 75,000 in 10 years is a CAGR of 9.59%.

13) Hardly a satisfying result for an asset
whose earnings increased by 15% CAGR over 10 years.
There are two lessons to be learned here :
1. No matter how great an asset, how fast it is growing, if you pay the wrong price you
basically don’t make any money.

14) 2. We buy whn PE (Sentiment) and Earnings, both are low.
Let’s tak about the markets in general.
Is it time to go all-in? (or the jaan laga denge wala situation😀?)
Well, the best time to go all-in would be when everybody is selling. Now, how do you know
everyone is selling?

15) Ask people in your business (or other Investors), how’s it going?
If they say things are very bad, the next question should be, “You think there is any hope of
recovery anytime soon?”
If they say NO, then the case is built to go aggressive.

16) Right now the situation might be bad for the economy but there is still hope. (but yes investors
have started to lose hope though, which is reflected in low MCAP/GDP Ratio.

17) How do I conclude there is still hope? Well, the Nifty PE Ratio is around 26. (Though even this
is not high considering you have negative yields in some parts of the world. Remember, Warren
Buffett’s quote :
“ Interest rates are to Stock Markets, what gravity is to objects”

18) If Investing community as a whole felt there was no hope, the pe ratio today would be close to
15-16 ( 100 divided by 10 yr Govt. bond yield OR FD Rate for simplification ).

19) The 10-year govt bond yield today is 6.33%. Therefore, PE Bank (Lower Range) = 100/6.33= 16
approx.

20) So this is definitely not the time to go all-in, but do we know whether PE will even come down to
that level in the near future? Absolutely not.
“We cannot anticipate, we can only observe”

21) Now the question is - should I sell today?
There is so much pessimism. Auto sales have fallen drastically, there are talks on WhatsApp
and in the media about a fast-approaching recession in India and globally etc.

22) Agreed. But since when did we decide we will sell in times of pessimism?. Haven’t we been
discussing that we sell only when “others are buying” or when there is too much optimism in the
market.

23) Having said that, it does not mean that the markets cannot go down from here. Markets can
very well Tank..but the price has not gone down below the recent significant bottom (around
10,030)

24) The problem is that Earnings are horribly low and pe is high. If PE keeps decreasing, the
markets will go lower for sure, but remember we take big decisions only when :
PE and earnings are both low or both high.

25) If these extreme events do not happen, we hold for a long period of time, because we believe
earnings will go up in the future with the growth in the economy and as Warren Buffett says “ If the
earnings do well, the price will eventually follow”

26)
Currently, markets have horribly low earnings but high PE.
Remember Benjamin Graham said, " Mr. Market is a very rational man, but sometimes it
behaves like a drunken man"?

27)
We would say that markets are in a drunken state only when both PE and Earnings are both
high or both low.

28)
At All other times, we should practice charlie Mungers’ assiduity (read: ass-e-dity) -
assiduity is the ability to sit on your ass and do nothing until the great opportunity
presents itself "

29)
Also, do you think Mukesh Ambani or Azim Premji or any other business person would be
thinking, “Hmm, economic situation does not look good, the future looks uncertain? So I think I
should sell my business for now. I’ll buy again when economic scenario improves”?

30)
Think like an owner and not a speculator.
And always remember this Quote from Warren Buffett,
" Stock markets are profitable only because they are uncertain."

31)
Warren Buffett’s portfolio has been down by more than 50%, about 4 times (If I’m not wrong).
You will have to tolerate this huge uncertainty or price volatility to get higher returns.

32)
It’s true that stagnant earnings growth has plagued the top 50 companies for the last couple
years, and yet dumb people like me keep repeating the earnings growth are just around the
corner.
...but this kind of faith is a basic requirement to becoming a good investor.

33)
I believe that the later the earnings growth will come, the stronger the growth in earnings we will
see.

34)
But yes anything that you require in next 5 years, start planning for it by saving a part of your
capital into something safe such as a liquid or ultrashort term fund (though even they don't seem
to be safe today 😊)

35)
Things that we talked about in last year's refresher session hold true even today
1) P/e looks expensive
2) Earnings are low
3) P/B for nifty is avg or below avg
4) M.cap/GDP is below average

36)
Understanding P/B
Markets are definitely look expensive when you look at P/E of Nifty but are reasonable if you
look at the assets (book value)

37)
To elaborate, let’s assume I have a factory that can produce 100 cars. If I can produce and sell
100 cars I would make a lot of money, but right now the problem is the demand is only for 70
cars.

38)
The infrastructure (net assets) available can produce 100 cars but currently the demand is only
for 70 cars. Now should I value a company based on its assets (infrastructure/buildings factory
etc) that can produce 100 cars or on the profit that I make by selling the 70 cars..

39) currently?
If you believe the demand for 100 cars is going to come, I think the better way would be to value
a company based on its assets (infrastructure /book value)

40)
So, right now if you look at P/B for nifty, it would be around 3.3. P/B for nifty in 2008 January
(Peak) was about 6.5 and the 2008 October (Low) was about 2.2. So today’s P/B of 3.3 seems
reasonable.

41)
Not horribly cheap but reasonable.
The Million-Dollar-Question now is : How and When will the demand increase?
For that, understanding the slowdown and understanding what other countries that are now in
High-income group did to deal with such slowdowns in the past is importnt

42)
May be I will make some youtube videos on the slowdown and what governments have or can
do to deal with it. The challenges that the Indian economy faces are huge, but that is not true

43)
only for current environment, the challenges have been huge since 1979 when sensex was at
100.
But Remember , either the industrialist will innovate and increase earnings, ...

44)
or RBI will reduce
interest rates to increase earnings and at the same time increase demand as a result of low
interest rates or government will start giving big orders to increase demand and improve
capacity utilization rates.
MCAP/GDP Ratio

45)
Today MCAP of listed companies on BSE is about 142.42 lakh crore and GDP would be around
US$ 2.8 trillion i.e. 200 lakh crore INR.
So MCAP/GDP ratio is about 0.71.

2008 October Low: MCAP/GDP was about 0.5
2007-2008 Peak: MCAP/GDP was about 1.46

credit - VARUN MALHOTRA
entire post is written by my Guru Varun Malhotra for Eifs course participants.
#investing