EQUITY investors are finding it difficult not to invest at present levels in the stock market. The key arguments that make a compelling story for investors include a booming economy, growing corporate earnings, increasing allocation to India by international investors and more importantly, a pro-reforms stable government. As more micro-cap stocks grab attention in a market where leading indices remain range-bound, it is all the more important to tread carefully with your equity investments.
While equity is the most volatile asset class, it is also the most performing one. Indian equities are seen as the best bet towards wealth creation in future. “Owning Indian assets is like buying a call option on global growth. Cost of entry in Indian equities is much less than the cost of not owning them,” says Sanjeev Patkar, director Research, Institutional Equity broking, Almondz Global Securities. However, in volatile markets, individual investors find it difficult to take a call on their equity investments. Hence, here are some points that one can visit:
Asset allocation: It may appear as a cliché, but it remains the foundation of all investment strategies. No matter what the market condition is, one should not overstep the boundaries outlined by the strategic asset allocation. This ensures that in bad markets, you end up buying some amount of equities and in euphoric times, you do not go overboard.
Dividend yield: It helps you decide the chances of you being a winner in equity market. Dividend represents the distributable profits of a company. It is a cash payout and seen as a real picture of a business. High-dividend yield stocks are relatively good in bad times and inclusion of such stocks in your portfolio helps. Mutual fund investors can refer to the portfolio dividend yield, if available. There are investors who prefer to invest keeping in mind the dividend yield of benchmark index. The higher the dividend yield, the higher is your chances of making money.
Price earning ratio and price to book ratio:
These two ratios are preferred by the analyst community while valuing stocks. The lower the ratio, the more attractive the stock, other things remaining the same. A point to note, consistency in business performance — read higher profits with better efficiency consistently — leads to premium attached by the markets.
Valuation of a stock need not remain constant. Depending on the business performance and the market sentiment, valuations change. A consistent performer at the lower end of the valuation bond is an ideal situation for a value investor. Investors can also refer to these ratios of the benchmark index. If you invest in equities when they quote low on valuation parameters, you stand to gain more than what you gain in times when everybody is interested in stocks.
Interest rates: Low interest rates are conducive to equity markets. As interest rates rise, the burden of interest goes up and the corporate earnings falter to that extent. Also, cheap money allows consumers to leverage and increase the economic activity leading to growth. Hence, rising equities are seen as an outright spoilsport by equity investors.
A thumb rule used by a section of equity investors to estimate earnings is to use the reciprocal of interest rates as expected earnings. For instance, if the yield on a 10-year government bond is 8%, investors would be looking at a price to earnings multiple – 1/8 X 100 or around 12.5 times. If interest rates jump up to 10%, the ideal earnings multiple would fall to 10 – (1/10 X100).
Buying growth: As we approach first quarter results, the valuations are already stretched. S&P CNX Nifty quotes at a P/E of 22.18, P/B of 3.77 and a dividend yield of 0.93. These numbers are readily available in index statistics on the National Stock Exchange website. Even if one factors in 20% growth in the first quarter, the valuations surely are far away from the attractive zone. “Markets have remained range bound for the past nine months and we have seen a time correction. Given the growth scenario, over the next 2-3 years investors should do well,” says Amit Nigam, senior portfolio manager- Equities, Fortis Investment Management. Investing decisions at this juncture is a difficult call for most investors as they witness domestic growth surrounded by uncertainties in overseas market in the short term.
Avoid extremes: Going gung-ho on India story is as dangerous as not investing in it. It is better to strike a balance when you take equity call. Anticipating a fall is one thing. But selling everything out of equities and moving into cash with the hope of buying at lower level is just not the solution. One should stick to his strategic asset allocation and instead play within the same asset class. Markets can remain irrational for a long period of time.
Also, high growth periods bring in better valuations for an extended period of time and not investing in markets due to such premium price tag cannot be justified. If you are worried about short-term risks in equities, better cut down your exposure to leveraged companies and small- and mid-cap stocks. Go with large-cap stocks or large cap-oriented mutual fund schemes.
In the long term, good quality businesses with consistent performance track record will do well and those who invest in them will do far better.
