The last nine months have been tough and grueling for equity investing. The ones who invested in 2007 have their nose under water the ones in 2006 are barely breaking even, the guys who got in 2005 are still in some profit, investors of 2004 are smiling and the ones of 2003 are still managing to laugh in spite of the carnage that stocks have taken.

The biggest problem that people face in such circumstances is the lack of confidence within themselves and their peer groups. That makes them do exactly what they shouldn’t be doing. For instance I have seen numerous people look at safe stocks. Well in the market nothing is safe but still if anyone were to look for safety why get into stocks. My sense is any kind of targeted return which is lesser then 20%CAGR is just not worth it. The Bank FD at 11% is far better – at least there is no risk of capital erosion there.

At this point investors should be able to decide whether they want to create returns from the market or look at mental peace. For instance trying to buy the fallen midcaps will never get mental peace but are the triggers of potential return. There are several midcaps which are trading at less then 10 times Fy10 and growing at 30% + CAGR. These are perfect cases of a potential multibagger. Caveat: We have to be sure of that 30%CAGR growth.

So a stock at Say A Ltd at  Rs 100 and a Fy10 EPS of Rs 10 trades at 10 times PE. Let us further assume that the 30% CAGR continues till Fy12 and that the EPS jumps to around Rs 17 for Fy 12. If ever there a bull market before that the consistent growers will be rewarded and we would get a PE expansion of 2- 2.5 times so a Rs 17 EPS stock with a 25 PE suddenly throws a number of Rs 450 which is almost 5 times the current price.

Question is how sure are you about the growth? Madcap cuts both ways and for the moment we have seen them cut in just one way.

So if you want less tension and a good night’s sleep we still have stocks like the HDFC brothers and the likes of Asian Paints to set the color of your life but if you are greedy like I am then there are the fallen midcaps strewn all over telling you “Buy me” but are we willing to listen?

Trying to make that five bagger attempt from here is a double edged sword. If companies do not deliver from here then investors could lose money so any attempt to create that additional return should be done with a view to take any losses if they so arise.

Additionally investors could have investments in 3-4 companies all potential return creators and position themselves in such a way that even if one of ideas go correct they recover their capital in the next 3-4 years whereas what they can make from the others is like an icing on the cake.

Personally I have followed that strategy.

Inflation is a statistical measure and is a year on year comparison. The higher base of 2008 could work out to the advantage of people who invest by looking at macro numbers. With crude and commodities falling as they did there is a very strong likelihood of inflation coming off by March 2009. Now the question is would the R.B.I wait for inflation to come off before cutting interest rates. Maybe they would. Cutting interest rates could be bad for the rupee and that is another headache for the Central Bankers but should it matter to an investor if interest rates are cut in October 2008 or in March 2009? I think not. Markets are smart and a fantastic discounting mechanism they would move in anticipation rather then in hindsight.

Once crude cools off it solves the Govt’s problems of current account deficit and that added with the Reliance’s gas find in the KG basin should add close to US $ 30 billion to the forex reserves. This should help stabilize exchange rates which is also affected by the foreigners selling. Further falling crude helps in reduced subsidy bills and that should help in improving the fiscal deficit.

But for that there are too many ifs and buts…

For the moment if we can get companies trading at 10 times Fy10 and growing at 30%-40% CAGR we will make enough money.

The low PE would help protect the downside and the growth help create upside out of a) EPS and b) possible PE expansion.

Clearly this report has a lot of red marks then the previous ones. But those reds will change into green – if earnings keep coming in and that is the biggest thing that investors need to work on.

*# Stocks in maroon are from The Equity Desk XI.

Regards,

Basant Maheshwari