Hopeless in hysteria

GUEST COLUMN

feels that the next big stock market opportunity could well be an all-out crash.

Friends, welcome to what is going to be my most unpopular column.
I am about to argue that the market is extravagant, exuberant and excessive. I am going to argue that people who wouldn't trust their neighbour with their scooter key are willing to trust hazy stocks with high discounting. I am going to argue that this edition of the bull run is being driven by the greed of collecting more paper at the expense of reason.

First a psychological take on the market. Bust is when robust retrospective performance and positive outlook are dismissed on account of a deep investing fear; excess is when we look for investing themes, NAV-led discounting that may not translate into earnings, we discount stocks for their 2009-10 earnings, borrow to play the market and queue up to pay 40 times face value for projects that will only completely materialise in 2016.

I will argue my case selectively with some numbers.

ABG Shipyard

(selection based on the fact that the company was among the first to announce quarterly results, no other reason) reported a 30 per cent top line growth and 58 per cent bottom line growth in the third quarter of 2007-08 over its immediately preceding quarter. Sound performance. If you annualise the bottom line for this third quarter (Rs 47 crore), you have an EPS of Rs 37 and a P/E of around 25 based on its existing market capitalisation.

My questions: A P/E of 25 indicates that if you buy into the company today, you would be able to recover the full proceeds out of the earnings in a quarter of a century. For the company to deserve this, it would need to grow at least 30 per cent a year "� as per a yardstick often used by market analysts of growth equals P/E less 25 per cent "� annually across 25 years. Let me give the company the benefit of the argument: it might actually be able to do so.

However, it would also mean that the company is fully discounted for that prospective growth, creating either a hold argument at best or a sell argument at worst, which is really the state of the broad market today.

Gujarat Industries Power Company (GIPCL) reported a bottom line of Rs 21 crore for the second quarter on an equity of Rs 151 crore. A few months ago if one had annualised (not necessarily a recommended practice but used in this case for building an argument) this earning and checked for its affordability around a market capitalisation of Rs 900 crore, there could have been a reasonable buyable case for the stock. In three months thereafter, the stock trebled.

My question: What happened in that one quarter that investors like you and me re-rated GIPCL at three times of what its management slogged years and years to achieve?

PART TWO

Now "� to make the argument curiouser - let me justify this boom. That's right, justify.

It is unprecedented because some of its drivers are unprecedented. Simple.

India has never seen such an appreciation across almost all asset classes so what is happening on the markets is only a natural extension.

India has never seen GDP growth being sustained at close to double digit for such an extended period.

India has never seen foreign investment into services, industry and capital markets of the quantum that we are now seeing.

India has never seen such a sustained strengthening of its currency against the US dollar resulting in low inflation even with record oil prices.

India has never seen disposable income growth coupled with the extent of aspiration growth we are now seeing.

India has never seen investments in industry and infrastructure of such a scale and speed that could potentially correct decades of under-penetration.

Points conceded. However, the speed in building a new India has perhaps been exceeded by only one thing: our speed in discounting that such an India "� bigger, richer, stronger - will indeed become a reality.

Consider this. The BSE Sensitive Index was 14,000 in the third week of August 2007 and around 21,000 in the first week of January. This implies that half of what it took this index nearly 30 years to achieve was replicated in only four months thereafter. Has India changed so significantly in the last few months? Have the poor disappeared off the roads? Have the rivers started flowing in milk and honey?

So what is the reality? That in our obsession to link performance with potential we have priced the market to a point where there is absolutely no provision for the Black Swan (the one word for something unpredictable that may pop out of the corner shocking the market into a meltdown).

No major industrial counters on the market represent a screaming buy, very simply because most have already factored the growth of 2008-09 into their existing pricing.

The quality of stocks at single-digit P/Es is declining with every passing quarter, almost prompting the argument that if it is still cheap then there must be something wrong with the company. Most IPOs are overpriced because there is always some sucker who wants to invest his full cash into corporate paper first and worry about whether it was right later.

Most stocks are being justified for purchase not necessarily on the basis of their earnings capability but because, when compared to some other stock in its genre, it appears to be 'relatively cheap'.

Most seasoned value-seekers are convinced that the market is 'aggressively priced' (which is their polite way of saying get the hell out) but who is listening to them anyway. Most who do want to take a call and exit (for what could be more frustrating than seeing the market rise thereafter) are now retaining their presence sheepishly under a different nomenclature called 'long-term investors'.

PART THREE

If one asked me, "Where do you see the biggest opportunity in the market?" my answer would probably be "In a crash."

Because if such a thing were to happen "� markets are most vulnerable when there is absolutely no provision for something going wrong "� almost everything on the market would be considerably cheaper with the fundamental India growth story still intact.

This reality "� weak present, secure future - could combine to present a significant capital appreciation opportunity with a relatively low risk. In my words that is heaven from a value-seeker's perspective.

Will it and when?
Two questions I won't answer "� as if I knew "� but permit me to end with two extracts.

Venerable American economist Professor Irving Fisher made his immortal estimate of "Stock prices have reached what looks like a permanently high plateau" just before the Wall Street crash of 1929. Charles Mackay wrote in his classic Extraordinary Popular Delusions and the Madness of Crowds that "Money, again, has often been a cause of the delusion of multitudes.

Sober nations have all at once become desperate gamblers, and risked almost their existence upon the turn of a piece of paper... Men, it has been well said, think in herds; it has been seen that they go mad in herds, while they only recover their sense slowly, and one by one.'

It is time to stop looking at the market and start looking inward.

Mudar heads Trisys, India's largest annual reports consultancy. Hate mail for this column is welcome at mudar@trisyscom.com. Disclosures: does not own ABG Shipyard or GIPCL