The Price to Earnings or PE ratio is a widely used valuation ratio. You would quite often hear people saying for instance, that ABC stock is cheap because it is at 10 x PE or XYZ stock is expensive as it is quoting at 20 x PE. But can someone, by just looking at the PE ratio, determine whether a stock is cheap or expensive?
Similarly, in investing we believe valuation at the time of investing is an important variable that determines whether you are playing on a high-scoring ground (high average expected returns) or a low-scoring ground (low average expected returns).
The advantages of focusing on quality cannot be understated. By investing in quality you significantly reduce the probability of permanent loss of capital.
And since the business is strong, the long term returns are far superior to average quality businesses. Thus investing in quality is the perfect recipe to generate superior risk adjusted returns. But quality has become a generic term today when it comes to investing. No investor would tell you that they don’t invest in quality stocks. But the definition of quality is different for everyone and one might even say that quality is often in the eye of the beholder.
Rather than debating on the various definitions of quality we would like to discuss how we look at quality in Multi-Act.
Benjamin Graham had introduced the concept of a mythical “Mr Market” to describe how sentiment or emotions drive markets in the short term. His analogy cautioned us in getting swayed into making an incorrect decision because of Mr Market’s emotional make-up. Mr Market is prepared to make us an offer to buy or sell a piece of a fractional ownership in common equity every day. In doing so he indirectly informs us about the assumptions on growth (in sales or earnings) that are being built in the valuations. In a strong bull market these assumptions might be overly optimistic and vice versa in case of a bear market. The choice to transact at a particular price (and valuation), Mr Graham tells us, is ours.
There is a lot of literature out there on investing that mostly focuses on buying decision. However, you would find very limited discussion on what to do once you have bought i.e. when to sell. Possibly the reason for it could be there is no correct answer to this question. We would like to approach the sell decision through a different route. Thus rather than focusing on when to sell we would like to address this by answering the question – How long to stay invested? We believe if we try to bring in a disciplined approach to our sell decision in addition to the buy decision, we would avoid the behavioural pitfalls that most investors have to go through.
Back in 2001, Warren Buffett had talked about the Mcap to GDP ratio as probably being one of the best measures of valuation. On a top down basis this is one of the indicators that he tracked to identify extremes of market irrationality. Like all valuation indicators there certainly are limitations to the measure. And in pursuit of perfection one could make multiple adjustments to make the measure more robust. But as Buffett puts it “On a macro basis, quantification doesn’t have to be complicated at all”.
India’s corporate sector and its leaders were very impressed as the current government took reigns at the centre on the back of reforms it had set out to achieve. However, a review of the current scenario suggests that things haven’t changed much on the ground. Essentially, the rise in share prices of a majority of companies in the last year have been driven more by valuation re-rating than actual improvement in earnings. Likewise, there is an interesting set of data that is emerging in terms of the shareholding pattern across companies. Read More
In this opinion piece which was published in the Economic Times, the author is referring to “network effect”. Mr Sridhar has in a way suggested that companies like Flipkart and Amazon enjoy a network effect and has compared these businesses with that of Visa and Mastercard. Read More
Caught in the middle of political uncertainty, market volatility and fickle FII flows, investors in the Indian stock market could take their cues from the investment behavior of multi-national corporations (MNCs). More than two dozen MNCs operating in the country have ignored all political and the economic instability issues to increase the size of their domestic investments. This, more than any rhetoric, indicates a high degree of confidence in the India growth story.
A high level of Capital Expenditure (capex) in a country is believed to be a good indicator of economic growth since it indicates a high level of confidence in the growth story of a country. In India, the capex level has been falling for three years and is now the same as it was in the year 2001. Read More