Why Jaspal Bhatti could have been an Ace Investor !!!

Apart from the technical aspects of Company and Security analysis, the more important aspect of investing is observing and understanding human psychology. Bhatti sir’s portrayal of Investor psychology in his satire “Full Tension” (PP Waterballs episode) in 1994 is spot-on. It captures harsh reality of small time investors getting caught in penny stocks of borderline fraud companies which mushroom during an IPO boom. 30 years hence the story is as relevant with the (in) famous cases of a) A two dealership Company raising funds and b) the case of Gensol where promoters took investors & Bankers for a ride while splurging siphoned money for personal use. Various celebrity investors and industry insiders were caught on the wrong foot in the investment as well.  

These incidents give good qualitative indication as to where we are in the Investment cycle. Market participants have thrown caution to wind, Liquidity is abundant for one and all, Diligence seems to be non-existent. A more quantitative drilling into Economic cycle, Capital market cycle, Credit Cycle and Real estate cycle will provide further empirical evidence on the state of things.

Economic & RE cycle – Post a temporary plunge during COVID, the last 4 years have seen a huge run up in the earnings of Nifty 50 Companies. Similar run up has been seen in Nifty Realty index and SBI stock (which can be considered a shadow of Credit cycle for Indian Economy).  The stock generally goes through euphoria when outlook is cheerful and languishes when economy is ailing and bad loans are rising. We were in a strong expansionary phase in last 4 years possibly due to liquidity infused by markets world over to fight covid. Whether this strength will continue going forward or there will be a slowdown in earnings as is visible in Corporate profits over the last few quarters needs to be seen.

* Data represented against a nominal index of 100

Capital market cycle - The number of IPOs and listing gains which are a good indicator of investor interest/greed are at an all time high. Owners/Private Equity funds have offloaded significant ownership during the last few years and retail investors have hiked their stake in public Companies.

Market valuations

Absolute earnings (EPS) and ROE have been at record and decadal high respectively. However, margin pressures are expected to remain/increase despite a robust revenue growth leading to lower profit outlook. Nifty 50 P/E has moderated from highs in 2018 and is just slightly above historical average. Adjusted for possible impending earnings downgrade the valuations seem to be optimally priced. 

* Covid period - Earnings dropped, security prices held given temporary nature of earnings downgrade

** Calendar year end data points, may be slightly different compared to Fiscal Year end data points typically reported. 

Conclusion

Given a combination of all time high Earnings and decadal high ROE’s, euphoric capital markets with record IPOs and not so cheap valuations in context of slowing earnings/profit growth, it might be prudent to be slightly cautious & defensive in the portfolio build up. This may be more relevant given the markets are not discounting any risk on growth due to geopolitical trade/war fallouts and continue to trudge along taking every bad news in stride. Accordingly, smarter active Fund managers who believe in holding back deployment when valuations are not attractive have positioned themselves defensively. An increase in exposure to quality fixed income in the last couple of years was a good individual investment idea given the above and I believe still continues to be so.