Sensex@2010 – Thoughts and Strategies

I wanted to caption this topic as Sensex@35k but then I thought who am I to decide whether the sensex will  be at 35,000 in 2010 or at 53,000 by that time. We can only debate whether the market is bullish or bearish the extent and magnitute is decided by the invisible hand  individuals and institutions that collectively make Mr. Market.

In the last four and a half years we have made money like bandits in this market. People who were able to hold on to their stocks made big multibaggers in their portfolio not just in stocks. The ride has been tremendous and maybe in our life time we will never get a chance to see something like this again. Who knows?

I am a cricket buff and while watching the recently concluded Twenty- 20 series I tried connecting the analogy into our investing startegies.Suppose Team A scores 150 in their alloted 20 overs and Team B is put into bat manages to get to 100 for 1 in the first ten overs. What would the strategy be for Team B? They would need to play sensibly without talking risks and also try to protect the good start.The anchors would drop and the batsmen would play with more caution and with more ground strokes, the sixes would evaporate and the singles would be the order of the day.

Even in investing when we started in 2000 - 01 we started with a  nothing to lose type of a feeling and that initiated a lot of high risk high reward strategy but now we need to play safely with caution because:

a)      There are no such sure shot bargains (multibaggers) available

b)      If at all there are these multibagers come with associated risk because something that could not have performed for 5 years will find it extremely difficult to justify its market cap expansion in the next 12-24 months.

c)       We know that the biggest money is made in  PE re-rating.and from what it seems all stocks are discounting a couple of years ahead so PE expansion is out of question. In that event it is the EPS growth that will have to help us in market cap expansion.

d)      We do discuss that 90% of the EPS growth is influenced by the RoE and RoCE. and that no company can grow at more then its RoE (some exceptions here) and no company indicates an RoE of more then 40% consistently(very few exceptions here).

e)      For a company to keep growing at a RoE of more then 40% is almost impossible. At some stage size becomes its enemy or competitors sill never leave a business that shows such growth. We need monopolies or brands to generate that kind of growth.

f)        But the brands are already discounting 2 years ahead of their time.

Over the number of years I have never seen a big multibagger emerge from a company that trades at a PE of 30 times and above current year. 60% of the multibaggers evolutes from PE expansion and only about 40% of that market cap expansion is a derivative of an EPS expansion. So if a Pantaloon has become a 65 bagger today its PE ratio has gone up 10 times and the EPS has expanded 6.5 times. Ditto for all the big multibaggers across the board.

So while we are fairly sure that the any gains that investors make will be out of EPS expansion only (in case of high PE stocks) what we need to see is the risk reward trade off that we encounter in the constant pursuit for that ultimate multibagger.

It is not fashionable to tell someone that you are looking at a 35-45% CAGR for the next two and a half years but it is not wise to destroy all the wealth that we have created over the years. Time to visit this thread again – every day

I am prepared to hold a high PE stocks in some special situatins when the company is undergoing a spin off/restructuring etc but even then we need to watch the stocks very closely.

Sensex at 53,000 looks a great deal in 3 years but that comes to a CAGR of 45% only!!!

To my cricketing analogy someone mentioned that investing is not a Twenty – 20 but a Test Match. To that my argument is that we can always play a second innings as long as we do not “retire hurt” in the first innings.

“Have you become fearful?”  Is a question that I face each day and my answer is “Yes, I have. I am extremely fearful to stocks that do not have a favorable risk reward” and if we can find one there is no one that stops us from selling our stable stocks into the more adventurous ones.

In this fierce bull market investors should end their greed themselves because otherwise Mr. Market will end both the investor and his greed – together.