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Monthly Digest – July 2021

By Avatar photoKedar B | Edited By Kedar B | Updated on September 22, 2023

Investors who invest for the medium to long term should spend the bulk of their time reading and forming views about various businesses and sectors. This holds good across all market periods – good, average and bad. The bulk of my alpha generation over the past decade has happened during periods when the market return wasn’t great. Good times anyway lift all boats, they don’t call for superior skills. 

In a bull market one needs to be clear about what not to buy, in a bad market one needs to be very clear about what to buy. A subtle but very important distinction. 

Given where the market is, it is very easy to let go of discipline and to hop onto stocks that are decent businesses with strong price momentum. This category is one of the more dangerous ones in India, the market view can change very swiftly in a very short period of time. Many specialty chemicals businesses fall into this category in my assessment, these trade at 30x FY23 earnings as if they are all high quality, free cash flow generating compounders with pricing power. These were good investments till 18 months ago and do have healthy representation in the current portfolio. But when the risk reward equation changes, such businesses cease to become a buy even if they don’t become an immediate sell. 

Over the next few months I expect to see myself spending time researching sectors I have stayed away from for many years. Many economy facing sectors have order book driven businesses that can offer revenue visibility for years to come. They will obviously have more execution challenges compared to a consumer business but in a good cycle they can deliver 20% earnings growth at healthy capital efficiency. 

My sense is that the market has become myopic in some aspects through the 2015-21 period. When market leaders in sectors that are currently out of favor start delivering 20% earnings growth while the businesses that are currently in favor grow at 12%, the weight of numbers eventually tells on valuations. What we take for granted today need not be so a few years down the line. 

When the narrative changes, so does the investment philosophy for the majority of investors. The incumbent investing philosophy can go for a toss in the face of hard numbers barring a limited set of investors who have been through many such cycles. These limited set of seasoned investors go through long periods of self doubt even if they manage to stay the course across cycles. We should not let anyone fool us into believing that it is going to be easy just because it sounds simple. 

As this market runs extends further, it is important to calibrate based on where one sees better rewards given the risks involved. Not all risk emerges from business quality, management quality, capital efficiency & corporate governance; valuation risk is a big one to track too. Just that the past few years have trained investors to think otherwise, but this too is likely to change with time. 

Some suboptimality in the portfolio can set it up for more resilience when the cycle turns. It is imperative that we proactively start thinking today; unless we do so, we will not be able to act decisively when it matters. 

For the time being we should happily take what the market gives with both hands. Such phases of the market can reward us more than we expect and much more than we deserve.

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