The other day I was addressing a group of professionals on how our emotional and behavioural makeup decides our financial destinies. And during the course of the talk, I suggested that whenever a good business temporarily undergoes a problem and the stock price takes a major hit, it may be time to examine the reasons and buy the stock, ceteris paribus. “Ceteris Paribus” is a favorite term of economists. It means “everything else being equal.”
And I gave an example of Maruti Suzuki Ltd. The company had a labour problem at its Manesar Plant in Jul 2012. As a result the stock price had hit Rs 1090 or so. Maruti had halted production of its best seller car Swift and the markets had reacted by hammering the price. A quality business like Maruti would not let this problem fester for long and would resolve it. I thought it was a good time to buy the stock. By Jan 2013 the stock price was back at 1550 with analysts recommending a “Buy”. Somebody questioned again, does it mean that we should have bought the stock of Kingfisher Airlines also? And I said, “No. Before deciding to buy a stock look at the quality of business and balance sheet.”
As Howard Marks, the Chairman of Oaktree Capital once remarked, “Two principal factors determine whether an investment will be successful. The first is the intrinsic quality of the underlying entity being invested in. In short, how good is the venture you are buying a piece of or lending money to? It’s better to invest in a good company than a bad one, ceteris paribus. The second factor determining whether something will be a good investment is price. Ceteris paribus, given two assets of similar quality, it’s better to pay less than more.”
More than top quality, which will always be at a premium, look at Nestle, ITC, Asian Paints, Infosys, HDFC Bank, what is important is the right price. If I can summarise all the risk of stock markets, I will say it is the price of purchase. A CEO of a major mutual fund in USA once said, “every financial instrument is triple-A rating at the right price”. Buying any asset for less than it’s worth virtually assures success. Identifying top quality assets may or may not; the risk of overpaying for that quality still remains. A case in point is Infosys shares purchased at Rs 10000 per share in 1999-2000 dot com mania. Top quality stock but absurd price. Result: Loss to Investor even after a decade.
The stock markets have run up a bit. Nifty is trading at 18 times FY12 earnings. There are very few quality stocks available at the “right price” in this market. It may be time to stop investing in individual stock ideas as they are pretty expensive and look at debt funds or PPF/DSOPF for a few months or years and riding the rally with your investments so far. Accumulate a war chest for the next bear cycle as and when it comes. Very few cheap businesses are presently available to my mind. You can continue if one has the time, qualification and inclination to dig up some of those hidden gems.
I for one am fully invested and made my last lumpsum investment in direct equity yesterday. I intend to now only continue with my SIPs in MFs and take a longish break from investing in stocks for the time being.