Stock Market Crash: Best investment opportunities come at the point of maximum pessimism

Investors who stay the course over a long run and remain invested will witness the power of equity.

These are indeed very tough times for Indian stock market investors. Especially for those that invested in mid- and small-cap stocks.

It is very easy to lose perspective in such an environment. Investors tend to lose sight of medium- and long-term possibilities when there is too much negativity all around. Investors must not forget that the best opportunities are born during such points of maximum pessimism. Are we there at the point of maximum pessimism yet? Tough to say. But looking at the stock valuations in certain pockets, we may already be in the bottom quartile.

Declining prices or wrong investment hypothesis?

In the investment world, things do go wrong and we must remain open to changing our mind when the hypothesis goes wrong.

As full-time investors and investment advisors, we ask one simple question to ourselves while re-evaluating portfolios. Has our investment hypothesis gone wrong or has the stock price moved in a direction opposite to what we had anticipated?

We think you should do the same. If you have bought a certain share at fair valuation and only the price has gone down, while the hypothesis remains the same, should you be worried? If investors start reacting just because the price has gone down, then what’s left in any equity investments approach?
Of course, in many cases, a major fall in the stock price is a sign of things to come. And one must act irrespective of the price if the data suggests so.

When should you start worrying?

We are more worried about the fundamentals of our portfolio companies than anything else. We think you should worry about the falling price of a stock only if any of the below symptoms occur;

  • Liquidity risk: the business does not have enough capital to run day-to-day operations
  • Solvency risk: the business may go bankrupt
  • Business risk: the business model itself is under threat due to change in technology, regulations etc.
  • Fraud risk: the reported numbers are fudged and the management is questionable
  • Valuation risk – astronomical valuations getting de-rated

Since the time liquidity issues in the financial system came to the fore, every company with debt is being considered poor. Every capital-intensive business has become untouchable. Can the economy function and grow without debt, without asset-heavy industries? Do all companies with debt on their balance sheets go bankrupt? Right now, markets are not differentiating between solvency, lack of liquidity and bankruptcy. It cannot continue for long and this phase too shall pass.

On the contrary, we find a great deal of value in the old economy and asset-heavy industries. Capacities are getting filled up and capital is scarce. It is very difficult to put a new asset on ground. Companies with existing installed capacities are in a position to have a good multi-year profitable run.

We must be counter-intuitive if we have to succeed in the long run. In a lot of cases, the untouchability of an investment idea in the early phases is the source of alpha generation.

Investors must check if their investee companies have business strength and a strong balance sheet that would give them enough staying power to get through this period of economic difficulty. That shall help in figuring out whether the drawdowns we are seeing in portfolios is temporary or if they are irreversible.

Things are not really as bad as they seem to be. India is going through a period of big re-adjustment due to new regulatory frameworks such as GST and NCLT, coupled with increased tax compliance. Short-term concerns such as slowdown in a certain parts of the economy and taxation issues are not going to kill the $5 trillion story overnight.

This period must be used to sharpen the skills and build a portfolio that will perform in the long run. This is certainly not the time to panic and run away from equity investments amidst all the gloom and doom.

Investors who stay the course over a long run and remain invested will witness the power of equity. People who invested over the last three years or so are witnessing the horror of equity at this point. However, as these investors spend more time in Indian share market, they too shall witness the power of equity.

The article was part of the Personal Finance section of MoneyControl  and it was published on 12th Sep 2019

Link: Market crash: Best investment opportunities come at the point of maximum pessimism

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