Why do retail investors need to hold their horses?

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It has been a crazy run-up for the equity markets over the last year as the economy tries to find its way back to normalcy.

It’s like whatever you bought in the last 6-12 months has fetched you enough returns to make you believe that equity markets can make money for retail investors. But that’s not the purpose of this article, the purpose is to caution investors.

Why do we feel this way?

In our little experience of the markets over the years, we have realized that earlier an investment tip was enough to convince a retail investor to buy into a particular stock.

Well, now times have changed as investors have become wiser thanks to more information available at their disposal on companies and sectors, etc.

They want reasons on why a particular stock will go up or down. So, now they sell us stories instead to convince us to buy/sell.

Some of the stories are worth reading

Currently, there are endless stories that are running in the markets. To name a few, the copper story where everyone is gung-ho that the demand for copper is going to increase substantially due to EV adoption and supply not picking up pace as expected leading to run up in Copper and Copper Stocks.

The Adani Story, it’s great that the company is receiving all these orders of airports, renewables, infra projects, etc.

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But has anyone looked at the debt and the valuation it trades at? Looking at these prices it looks like every infra, port, road, renewable energy project will go to Adani and Adani only.

The Chemical Story, China plus one policy of global MNCs and Make in India sops for chemical manufacturers has led to a strong rally in a highly cyclical chemical sector.

And this one is the best, recently due to extreme shortage of oxygen cylinders, investors went crazy behind oxygen stocks, out of which one was Bombay Oxygen (up ~1.5x in one month), but as it turns out the company had discontinued its industrial gas business 2 years ago and is now registered as an NBFC company. Limits this is!

Bombay Oxygen

The stories are endless Make in India stocks (Dixon, Amber, etc – Domestic Manufacturing), Digitization stocks (Everything digital – likes of Info Edge, Just Dial, etc), Diagnostics, Insurance, Sugar, etc.

The story of FAANG stocks (Add Tesla to it) is also a hit not only in the US but has gained huge popularity in India as well.

If equities weren’t enough, we have an altogether different story for cryptocurrencies (they are the future, the next gold, the dollar will lose value, etc.) as well and the returns here are just AWW! Worthy in the last 6-12 months.

In short, you name stock and there will be 5 people selling you a story that will be a multi-bagger in months, year, etc.

So investors should just sell everything and sit on cash?

Well, NO, some of these stories are great in the long run and has great potential to be outperformers but the biggest concern is that we are seeing some of the lesser-known or, as Mr. Vijay Kedia calls it the “bhangaar caps” which are seeing unprecedented moves and investors in expectations of high returns are falling for this trap.

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Therefore, in our view, there are two things investors must know:

  • Are we paying the right price (valuations)
  • Is the company having dodgy fundamentals?

Let’s come to valuations.

We must not forget that equity as an asset class has got re-rated over the last year as interest rates globally have practically crashed leading to lower risk-free rates and higher terminal value.

Low-interest rates coupled with continuous liquidity (bond-buying) inflow by central banks is like the best combination one could have for a risky asset like equities.

This is because when interest rates are low, investors turn to riskier asset classes like equities.

The liquidity flows into equities typically start with quality names and flows downwards (usually when valuations for quality turns expensive) to lesser quality names and even to the “Bhangaar caps”.

There could be other reasons as well, on why a company is trading at higher valuations. Read more on this here.

This brings us to the 2nd point which is dodgy fundamentals – This is where investors need to be extremely careful before investing because right now excess liquidity and expensive quality stocks have led the investors to turn to fewer quality names for returns.

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But we need to be careful because if tides turn (liquidity squeezes and interest are headed upwards) they are the ones that will be dragged down the most.

To sum it up, we are not saying this party may end soon but the prudent approach would be to do your due diligence on the sector (cyclicality, growth prospects) and the company (management, moats, etc) and most importantly its valuations (why is it trading at a premium or discount? Can it sustain or improve?).

Buying a quality company at an expensive valuation is still better than buying a Bhangaar cap at a decent/cheap valuation. But if you wish to ride the optimism on fewer quality names, invest with strict stop losses and do not overexpose yourself to one stock or sector.

Remember as Benjamin Graham once said, “The intelligent investor is a realist who sells to optimists and buys from pessimists”.

For investors who have held these (Bhangaar cap stocks) for years remember that Bull Markets are the best time to sell your mistakes.

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