After rallying 55 percent from its March 24 lows, equity markets have now taken a pause. The benchmark National Stock Exchange Nifty is down 4.5 percent during September so far though the index is still up 48 percent from the March 24 dip. So broadly speaking the rally is alive and kicking.
The pause in rally, however, provides a window of opportunity for investors who prefer to accumulate stocks when prices are relatively stable and not jumping up and down every other day. From the face of it, the correction so far has been shallow but the index is now at the same level as it was in the last week of July. The broader market is witnessing what may be described as a time correction wherein the stock prices remain range-bound for an extended period of time, making them attractive.
So should take out your cheque book and start buying stocks now especially if you missed the April-July 20 rally? Here are some points to consider before you take the plunge:
1. The benchmark index has corrected a bit in the last 10 days but the index remains expensive that limits the upside potential. So expect most of the action only in specific stocks rather than the Nifty. At the close on Wednesday, the Nifty 50 was trading at 32.3 times its underlying earnings per share on trailing 12-months basis. This is because the COVID-19 lockdown has lopped off 22 percent of the index earnings.
This is 60 percent higher than its historical average price to earnings (P/E) multiple. In fact the index valuation has almost doubled from its March lows. The Nifty 50 trailing price to earnings multiple had fallen to a six-year low of 17x on March 24 this year, which was a juicy opportunity for value investors and many jumped in.
In contrast the broader market is currently miles away from the value zone. There is a lot of good news baked into the current valuation of the index and investors expect a swift recovery in corporate earnings in the last six months of FY21. If the recovery turns out to be poor, correction could get deeper.
2. The pause in the rally makes it easier for investors to look for value picks in the current market. A cursory look at the broad based BSE 500 index suggests that nearly a quarter of the stocks have seen a decline in their stock price since the end of July while the index itself is still in the green. This provides a good opportunity to accumulate good quality stocks if the market remains range bound.
3. The rally has now shifted from bigger and large cap companies to small and mid-cap stocks. For example, Nifty 50 is up just two percent since the end of July but NSE mid-cap index is up 7.4 percent while NSE Small-Cap index is up 11 per cent during the period. Historically the rally follows a cycle where the stock price of large companies starts moving-up first followed by second and third tier companies and so. When the cycle starts unwinding, smaller companies take the first hit while large cap stocks are the last to correct.
So if you are a value investor, it is time to go and book some profits on mid and small cap stocks in your portfolio and raise your exposure to large companies which are underperforming the broader market.
4. Given this you should look for stocks that not only provide upside potential due to the expected growth in their earnings in the next few years, but also offer downside protection in case of a further correction from the current level. A further 5-10 percent correction is not ruled in the benchmark indices given the combination of record high valuation, index shrinking earnings, India’s GDP contraction and growing tensions on the India-China border.
5. There are quite a few quality stocks which hardly participated in this V-shaped rally from March to July. Many of these stocks will provide safe harbour to value investors and also provide upside potential when the growth returns in the economy and their sector (SEE TABLE).
As a thumb rule investors should look for companies with credible promoters, little or no debt on their books and a dividend paying record. Good promoters don’t care about the stock price or market capitalisation of their companies and as such are invisible from market media. So avoid stocks if the promoter or the company management are often seen talking-up their company and its stock price.
These understated companies are largely those owned by multinationals, government or old conservative business groups. And may be evaluated for investment in the current market scenario.
(Karan Deo Sharma is a Mumbai-based finance and equity markets specialist).