Understanding the current market correction, the stocks and sectors to avoid now but more importantly where to look for next market leaders and multi-baggers
This is such time in the market that it will separate the men from the boys. The high flying stocks made sensible investors look like fools. The correction in those high flying stocks and people realize the importance of risk management and investing in good quality stocks.
As the market is correcting, though large indices don’t reflect the true value erosion in the portfolio of many investors. This is not the time when one should be holding some of the not so good companies but even if you happen to be holding it, it is time one should either move out of them completely or even if you believe in them, do not average them.
The investment shouldn’t be based on how much the stock has fallen from its peak.
The Reason I see for Correction
The current market correction is not only technical in nature but it also has some few fundamentals reasons for correction. The 3 most important reasons I see are:
- Higher Oil Price – Increasing oil price is never a good sign for an oil importing company like India. It means India has to spend more to import the oil.
- High-Interest Rates – RBI has made its stance clear it will work towards curbing the inflation. Higher oil price means high inflation and so RBI will have to increase interest rates even further to curb inflation and if they didn’t the inflation may shoot up.
- Falling Rupee – Though falling rupee is good for export-oriented companies, India still has a more import compared to its export. Because of such import to export trade deficit falling rupee hurts overall but the falling rupee is assumed to boost exports in the near term.
Where One Shouldn’t be Investing?
The above factors aren’t going to cool off any time soon, one should look at companies that can survive the tough times ahead.
So here the type of stocks that I will avoid investing:
High Debt
Debt has always been one of the major deciding factors for each of my investments. It has been mentioned in my investment checklist, fundamental analysis or in the business checklist and in the current scenario, it becomes even more of a factor to consider.
Companies take up debt assuming a certain level of interest rates but as the rate increase, the expense of interest increases for the companies and ultimately impact the profits and the bottom line.
Some companies may not be able to even survive the incremental increase in interest rates others may see an increase in interest expense as a dampening factor to their profitability.
Because the profits will be under pressure, the PE multiple for the companies may contract. One should avoid investing in companies where interest cost will impact profit margins.
Oil as Raw Material
Oil as one of the major raw material means the cost of the raw material will increase for the companies and so the profit margins may come under pressure.
One should be careful in analyzing such companies and consider only those companies that will be able to pass the increase in raw materials to its customer and don’t take a hit on the operating profit margins.
If companies aren’t able to pass the increase in raw material prices to its customer, again the price to earnings ratio needs to come down.
Majorly an Importer
With the falling rupee, the major impact will be on companies that are an importer.
Often the direct importers of any products or raw material see the impact but some companies where royalties are paid in USD may also see an impact.
I had few questions if Maruti is a good investment after the correction of almost 25% from its peak.
First one has to understand the reasons for the correction in the stock price of Maruti. It is a subsidiary of Suzuki corporation and so the payment of royalty for Maruti increases in rupee terms as the forex rates changes (there are news to make the royalty payments in INR only).
On top of that, an increase in interest rates means the cost of a loan for the customers of Maruti may rise creating a hit on the demand for its products.
The customers may also delay the purchase of vehicle seeing an increase in fuel prices.
All the above factors mean the price of the stock has to correct and this is the main reasons for the correction in the prices of Auto stocks especially Maruti.
Where to look for Next Multibaggers?
It is better to avoid bad companies but where one will find the next set of multibagger businesses?
So if one has to look for the next growth stories, where can one find such for the next few years down the line.
I think the answer lies in understanding the above scenario and looking for businesses that can not only survive the above conditions but thrive in them. So according to me, it is better to consider stocks that fall in these 3 areas.
Consumption (Rural and Staples)
No matter how bad the interest rate scenario be or how high the oil price be, the basic consumption growth story is likely to continue. One can delay the purchase of a car but one can’t delay the purchase of clothes, food items so on and so forth.
Such businesses are worth considering. I agree it is tough to find good business at discount valuations but the corrections can come to these stocks as well. Keep your shopping basket ready and see if you can add some good quality consumption stories in your portfolio.
Exporters
Falling rupee is an advantage for the export sectors. IT and Pharma are a couple of sectors that are predominantly export-oriented sectors.
Growth in the US and falling rupee can be a double trigger for growth in these sectors. If the scenario remains favorable for these export-oriented sectors, these sectors can be the next market leaders for sure.
Market Leaders
Any company that is a market leader in a space is bound to get more business because the bad business scenario can mean, small business either wind up or gets acquired by the major player in the market making it favorable for the market leaders.
So market leaders and companies that have better cash flow and balance sheet can do some acquisitions to fuel growth.
So one should look for such business as well for the better performance of the equity portfolio.
Final Thoughts
Like we saw commodity cycle improve in the year 2016 and 2017, oil and rupee also seem to be going through a similar cycle. So it is important to churn the portfolio to take advantage of the future growth areas.
Do you agree that it is better to churn the portfolio? Share your views in the comments below.
Do you think in the midst of trade wars, export as a sector can lead the next market upmove?
Yes there is some dillemma but I am still hopeful about export sectors.