Markets are at an all-time high. Shouldn't we book some profits instead of adding fresh capital? Should we wait for the markets to correct a bit?
Can we, as asset managers, really time the markets and do market timing yield better returns?
Well, history and our experience have proved it otherwise. No one can really predict the market movement in advance. When COVID struck, Nifty went to a low of 7500 levels and investors were worried about the impact the pandemic had. No one ever expected such a sharp V-shaped recovery, surpassing 1.4x increase to 17500 levels in this short span of time. It is, not only, difficult but, impossible to correctly predict for how long this run will continue before we see a meaningful correction. Please note we are not talking about a market fall driven by major events like COVID-19, demon, subprime, etc.
Investing in markets is not about index levels or stock prices. While the stock price determines our entry cost and future returns, it is not the deciding factor for equity investing. The stock price is a function of earnings and multiples (Price= EPS*P/E). The parameters that determine earnings and multiples are quite different and have little in common. The company's earnings are a function of its business model, economy and sector dynamics, government policies, demand & supply scenarios along with quality management, business leadership, etc.
On the other hand, multiples depend on macro-economic outlook, liquidity in the system, geo-political situation, currency fluctuations, market sentiments among other things. It is relatively easy to predict earnings and their parameters compared to multiples. What investors don't realize is that even if earnings double in 3 years and multiples half, the investor will not lose their money. As earnings growth leads to multiple growth and hence where earnings growth is right, multiple also grows; yielding better returns. We can discuss many case studies where earnings growth was visible and yet market multiples contracted; however, still the stock gave quality returns to the investor over a period eg. HUL (earnings visibility) witnessed marginal fall of less than 5 percent during the sub-prime crisis.
Similarly, Asian Paints gave almost 2x returns over FY07-10 when Nifty returns were marginal over the same period. Similarly, in today's markets, Maruti, a fundamentally strong company, has missed the recent rally and underperformed the broader markets (Stock up 64 percent vs Nifty up 137 percent) purely as the company has recorded a negative 5 percent earnings CAGR over FY18-21, owing to multiple factors.
We should understand that fundamentally strong companies with good management, sound modus operandi, healthy balance sheet, robust earnings growth potential etc. will generate good returns for investors in the long term irrespective of any knee jerk interjections. Hence, we, as asset managers, try to explain to our clients that equity investing should focus on earnings growth and not market levels for long term wealth creation.
The authors, Mridul Jalan and Sweta Jain, are co-founders at Senora Advisors. Jalan is an alumni of IIM Calcutta (2005 batch) with 2 decades of experience in equity markets. The views expressed are personal
(Edited by : Priyanka Deshpande)
First Published: IST