Working through market pivots
It has been a frenetic start to the new FY. The headline NIFTY 50 is hovering around it’s highs while the BSE 500 is up ~10% FYTD. For the first time, we missed sending out the monthly newsletter last month; we just got busy researching new ideas and tweaking the portfolio.
When the market looks like it is breaking out of a range bound consolidation, investors should roll their sleeves up and work harder. If this turns out to be the cusp of a new cycle where the market heads higher, opportunity cost is likely to be high over the next few months. As we’ve been writing for almost a year now, leadership is likely to emerge from a new set of names. There is limited utility in loading up on the stalwarts of the previous run just because they have fallen 25-30% from the peak.
The importance of “buying force”
Outperformance tends to happen when buying force overwhelms sellers in a counter. Such buying force materializes when investors are pleasantly surprised by the improved prospects/numbers of a business and make a beeline to add exposure to the stock. That is when one sees large volumes in a counter out of the blue. So when you see stocks show a 5 year breakout supported by higher than usual volumes, time to get busy building a view on the business and the sector. Breakouts on a longer timeframe are to be taken even more seriously. Reliance surpassed its 2008 high only in 2017 and went on to triple from there in 4 years.
Fundamental investors need to have some mechanism in place that enables them to assess the supply demand dynamics in a stock. Be it technical analysis or tracking insider trades & institutional ownership, it is a very important element. If not for this, playing the cycle well will be difficult. One can’t get earnings estimates right all the time for all businesses. Even secular businesses have stock cycles, a casual look at the long term price trend will confirm this.
The industry for some reason goes out of its way to overemphasize BQ MQ but underplays this crucial element of alpha generation. Investing cannot and should not be reduced to writing retrospective case studies about BQ and MQ. Not every investor has a 10 year horizon for BQ MQ to eventually triumph over all other factors. Those case studies can never explain why the same damn business netted 5% p.a. over one period and 25% p.a. over another.
Human and social aspects of investing are always at work, ignore them at your own peril.
What are we focusing on right now?
Ground up work on enhancing sector coverage. Over the past 6 months we’ve added coverage on 4-5 sectors that were under represented in our coverage universe. Starting with Q1 FY24, we will also be dropping coverage on a few stocks. We made our share of mistakes in FY21, we did end up overestimating the quality and prospects of a few businesses. We want to unlearn & discard a few ideas every year.
There are some businesses that look optically expensive right now but aren’t. FY23 earnings were depressed for some businesses due to the effects of inflation on raw material & fuel costs. As this starts to mean revert in FY24, margin and earnings can expand meaningfully. We are on the lookout for businesses where the probability of an earnings breakout is high and the expected FY24 PE reasonable.
We are thinking about timely exits in a few businesses that are now trading well above our estimate of reasonable price. This is where we expect our recently acquired TA skills to come handy, today we have the ability to look at a chart and identify cases where the price momentum is likely to head much higher before the eventual cooldown. We aren’t trying to time the peak, just that we have a few more tools at hand to help us ride the crest higher before we pull the trigger. In technical parlance, we want to take exits in Stage 3 and not in Stage 2, given that we have a good understanding of the fundamentals of every business we buy.
Good performance over the medium term comes down to doing many things right when you run diversified portfolios. In concentrated portfolios two outlier stocks can cover up for many average performers, this is unlikely to happen in diversified portfolios. We sometimes feel that investing was much simpler and easier as a standalone investor. But when others look up to you to help them manager their equity portfolios, this responsibility makes risk management a much more important element of the process.
As India moves towards becoming a USD 5 trillion economy, the breadth and depth of the markets will only increase. Beating the index will only get tougher as more funds & investors jostle to latch onto the next big trends. Investing in 2013 was much easier than it is today, investing in 2033 will be much tougher than it is today.
The game won’t get any easier from here, we must progressively get better.