Can you trust Nifty index?
Nifty 50 fell from high of 12,000 to 7,500 in a matter of two weeks in March 2020. In just three months since then, it has reached back to ~11,000.
This swing has brought back the confidence of a lot of investors.
“In the short run, a market is a voting machine but in the long run, it is a weighing machine” – Benjamin Graham
You can gauge short run by looking at the share price but over the long run, the share price has to catch up or go down based on the fundamental performance (sales growth, profit growth, capital allocation etc.) of the company.
Over the years, I have observed that quality companies fall less in comparison with the index and the same set of companies catch up when the index climbs up.
We can see this with the help of an example. Let’s look at a quality company, Nestle India. The share price declined in March but not as much as the market (-20% Nestle India vs -37% Nifty 50). Nestle India also recovered very quickly and maintained its level ever since.
However, Nestle India and other high-quality companies have not been marching the Nifty 50 rally in the last 6 weeks.
If these high quality, high growth companies have not led to a rocking Nifty, what has?
Here are four columns i.e. Average 5-year RoE, Average 5 years profit growth, 3 month’s share price return and 1 month’s share price return.
At a sectoral level, consumer durables have the highest RoE at 38% but in the last 3 month’s share price performance has been only 8%. This sector comprises of companies such as Nestle, Asian Paints, Britannia etc. This is one example that indicates high return and high growth over the short-term has not translated into the high share price.
Now, look at Telecom sector, known for low RoE and low growth with a highly regulated environment, delivering as high as 30% return. As per NSE, Reliance Industries is classified as Oil and Gas, if you were to assume RIL as Telecom, this return will improve further.
Even a company-specific analysis indicates that high-quality has not been a differentiator in the current market environment.
Note that all companies have a value, market maybe correcting to that value. Quality companies catch up soon and low quality catches up later. We are at the later stage of correction.
Do you invest now or wait?
There is a whole lot of money being pumped in the economies all over the world. Equities are bound to gain from that fund flow. There will be a lot of companies that will surpass their true worth in time to come.
Here is a checklist to ensure that you are walking on the right path.
Rule no. 1: Skill and luck
Often people attribute good outcome to a skill and a bad outcome to luck. In the current environment, I have seen amateur millennials giving stock tips and how they made money in one or two stocks.
These stocks are in the likes of RIL, Airtel, Eicher etc. The rationale is usually half baked and driven by the share price movement.
You need to distinguish between skill and luck. If you are skilful, you will be able to generate favourable outcomes more often.
Rule no. 2: Fundamental focus
In the long run, the share price will chase the intrinsic worth of the company. A sense of a broad range of intrinsic worth is good enough to take action.
There are a lot of methods to arrive at the intrinsic value. However, you can develop your own method by combining various valuation techniques. Again, you are not trying to get to an exact value but a broad range.
You may be a value investor, growth investor or a cyclical investor. Your way of arriving at the broad range may vary depending upon your investing style.
Rule no. 3: Patience
Current market maybe just catching up with an extreme reaction shown in the past. Once this stabilizes (who knows when), fundamentals will become more important.
A short-term price movement should not modify your style of investing.
If you cannot afford to spend time doing your own due diligence, index investing is better. As per John Bogle, Founder of Vanguard Group, you should invest in an index that includes as many companies as possible.
Ideally, the index should be Nifty 500 but that’s not available as yet. As of now, your options are restricted to Nifty 50 and Next Nifty.
However, if you take exposure in high-quality high growth companies, the basket will beat the Nifty index by a huge margin.
My advice would be to flirt with the index for fun but marry quality companies for stability and growth :)
Our job is to buy something for less than it is at least worth and generally hold on till we can sell at a price above its fair value.