April 2019 Newsletter – High PE Ratio

The markets made an all-time high in April 2019. The markets are consolidating close to these highs. The General Election of 2019 is going on and as we write this newsletter, most of the constituencies have already voted. By the time we write to you the next month’s newsletter, the election results would have been out. While the Bharatiya Janata Party is most likely to be the single largest party, the markets will be having a keen eye on the number of seats the BJP wins on its own. Anything above 220 will keep the sentiment positive on Dalal Street. However, if the single largest party fails to win 200+ seats, then the markets could react adversely. In 2009, the markets were locked in upper circuit after the Congress won 200+ seats on its own and the UPA retained power with an even more powerful majority.

Talking about the elections might be fancy, but the real issue is the missing earnings growth. The Q4FY19 earnings have been disappointing. The Nifty’s EPS has shrunk to ~ 400 per share and the PE Ratio is at a bubble territory of ~29+. These valuations are not sustainable, and we need to be very selective of the stocks that we buy now.

HIGH PE Ratios – The new normal?

In the late 90s, the dot-com boom created bubble valuations, in 2007 the economy grew at such fast pace and the markets rose up to bubble valuations. People justified those valuations citing some or the other factor behind a sustainable long-term growth in earnings. However, the valuations cooled off as the markets crashed. This time, the investor community is citing the low interest rates that are keeping the valuation levels elevated. Interest rates globally are near zero and this has created immense liquidity, a lot of which has flowed into emerging markets. Rs 67,122.07 Crores has been pumped into the Indian equity markets in 2019 by the FIIs. In 2018, FIIs had withdrawn Rs 53,020.87 Crores.

Analysts are expecting the Nifty EPS to increase by nearly 60% in FY20 because of positive earnings from banks. The NPA crisis has eroded the profitability of banks and this depressed earnings. If indeed the Nifty EPS grew by 60%, the PE ratio would cool down to ~ 20. Such expectations of a bump in earnings growth have been there for the last 3 years, but in vain.

Low interest rates mean low returns from safe assets like Government bonds, term deposits, etc. When the returns from risk free assets go down, the expected returns from equities also go down.

Risk free Equities Remarks
10% 18% When the risk-free return is 10%, I expect atleast 18% from equities
6% 12% The risk-free return is down to 6%, I am happy with 12% from equities

 

When an investor expects 18% returns from equities, he will want to pay lower valuations (Maybe a PE of 15). But if his expected returns from equities go down to 12%, then he will be ready to pay higher valuations (Maybe a PE of 22-25). This is a very generalized example. The financial theory behind this is an entire subject.

What makes up the returns?

Particulars 1-Jan-2018 31-Dec-2019
EPS 10 20
PE Ratio 15 20
Share Price 150 400

In the above scenario, the earnings have grown by 100% while the share price has grown by 266%. This is because of the expansion in valuation multiple that the investors were paying for the shares.

Particulars 1-Jan-2020 31-Dec-2021
EPS 20 30
PE Ratio 20 18
Share Price 400 540

In the above scenario, the earnings have grown by 50% but the price has risen by only 35%. This is because of the contraction in the PE multiple that investors were paying. In the dull market phase of 2011-2013, many good companies were available for a PE ratio of < 10. Today, very few good companies are available for a PE ratio of < 25. If we pay such valuations today and the earnings do not grow over the next 3-5 years, then the valuations will cool off and we wouldn’t be able to make such returns.

We are not saying that one should only buy stocks that are trading at cheap PE rations. Infact that is one way to load up cheap quality companies. We should pay high valuations only when we are sure that the earnings growth will continue long enough. Now, in the stock markets the ‘sure’ term doesn’t exist. So, our research is focused on determining the longevity of earnings growth, high ROCE, etc.

Very few companies can sustain such valuations for a long period of time. Most companies see sharp cool down in valuations eventually and leave behind a lot of retail investors stuck at higher prices. When the valuations are elevated, we prefer to maintain a decent cash allocation in the portfolio.


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Alphamultiple Advisors – A new avatar

Dear Reader,

We have changed our firm’s name from DalalStreetBulls to Alphamultiple Advisors. Subsequently, our domain has also changed from www.dalalstreetbulls.com to www.alphamultiple.com

VISION:

  • To be the most ethical, transparent and the best advisory firm
  • To deliver high returns for our investors consistently
  • To eliminate human bias from investing

MISSION:

  • Select the best companies to invest and participate in their growth story
  • Be part of India’s transition from a $1,600 GDP per capita to a $8,000 GDP per capita economy
  • Invest in a blend of growth and value stocks & double the portfolio every 4 years

 


Please note a change in our communication details:

Email Id: info@alphamultiple.comraghav@alphamultiple.com


 

The change is with an eye on the future. We strive to move forward in the wealth creation journey for our investors and this reflects in our new logo.

Our Logo:

alpha – It stands for the returns in excess of market’s return. We are here to generate alpha for the investors.

multiple – We have a multi-strategy approach towards the portfolio with both medium and long term investment strategies being deployed. We do not want to be a firm which is heavily dependent on a single strategy or fund manager. We believe that the future of investing lies in the elimination of human bias and the deployment of rule-based and disciplined strategies.

the greater-than sign > – The red greater than sign indicates returns in excess of the market and the placement of the sign signifies the exponential power of equities. 2 + 2 + 2 is 6 but 2^3 is 8. We are looking out for investment opportunities that can compound wealth in the long run. It also shows our intent to keep moving forward.

Best Regards,

Raghav Behani

Founder, Alphamultiple Advisors

2017: The death of debt funds

Debt funds are seen as a safe avenue for investing. Marketing debt funds is a common way for advisors to boost up their AUM. Portfolio advisors talk of debt-equity split in the portfolio as a safe-risky asset class split. After a stellar year (2016), debt funds faced a terrible year. At a time when equity markets are in a strong bull run and investors are grinning at their 20% p.a. and higher CAGR, a few are sweating over their debt fund returns even if their equity gains are pushing up the over all returns.
2017 bursts a famous myth – Debt funds are safe to invest in.
Most investors and advisors fail to deep dive into the facets of investing in debt securities. It is not simple as investing in a fixed deposit AND neither is it an alternate to fixed deposits for the layman investor. When you invest in debt, your focus is on protecting capital and not growing it – So is it worth investing in a much riskier asset for an extra 0.8% to 1% p.a.?

What went wrong?

Bond prices fell and thus yields went up. The prices of debt assets held by medium and long term debt funds slipped thereby resulting in lower NAVs. In the last quarter of 2017, the 10 year G-Sec yield rallied from 6.4 to 7.2 and this sent bond prices spiralling lower. There is still immense volatility in the yields due to different reasons and this is expected to continue into 2018, which we foresee as another tough year for debt fund investors. Bulls might be ruling the roost on Dalal Street but bears have taken complete charge of bond street.
Which funds did we advice?
We advised our clients to invest in 4 debt funds. We also shared a detailed report (available at the end of this post) highlighting WHY we chose these 4 debt funds.

Read our report for clients on debt funds: Debt Funds Outlook

What does this mean for debt fund investors?

Every debt fund investor should understand the risk factors associated with investing in debt instruments. These instruments are not as simple as a bank fixed deposit and though they offer better liquidity, higher returns and lower tax on interest, the risk is much higher than a bank fixed deposit. 2018 is going to be another tough year for debt fund investors and a careful analysis is needed before any investments are made in debt funds.
Invest in debt funds only if you are well aware of movement in bond prices or if your advisor has the knowledge of these instruments. Our research desk focuses not only on equity assets but also on debt instruments. We got the debt funds right in 2015 and 2016 and then we again got it right in 2017. Our research and advisory services for investors focuses heavily on debt-equity allocation based on valuations, thus it is very important for us to get the debt funds right. Choosing the right debt fund involves the study of many factors: interest rate movement, macro economic data, duration, sensitivity to interest rates and quality of paper.