Value investors will find enough bargains

Topics Coronavirus | stock market | NPAs

The latest round of economic projections remains gloomy. There will be a global recession for several quarters. It will be deep and it could turn into a full-scale depression. When it comes to recovery, different industries will have very different recovery times.

Manufacturing industries have supply chain issues due to global lockdowns. Industries, such as tourism and shipping, will also have to wait for demand, which has collapsed, to recover.  The global demand for industrial metals, energy, and industrial chemicals could remain muted for a long time.

The Society of Indian Automobile Manufacturers, the apex industry body, estimates plant closures by automakers and auto part manufacturers will lead to daily revenue losses of over Rs 230 crore. In March, auto sales shrank roughly 65 per cent year-on-year. Even adjusting for the shutdown from March 21, the drop was very steep. At least half of April will be wiped out, and sales aren’t likely to pick up after such an extended lockdown. The auto industry may be looking at a year-on-year (YoY) drop of 80 per cent in April sales, and that’s unprecedented.

Let’s assume the lockdown works and the disease doesn’t overwhelm India’s healthcare system. Even so, we are facing a grim situation. About 60 per cent of India’s GDP is contributed by private consumption. Demand will be hit very hard due to the loss of income suffered by millions.

Supplies of multiple types of goods and services will also be disrupted over the next few months. Food prices could swing all over the place. Moody’s has just issued an advisory that the outlook for the Indian banking sector is negative. The currency outlook is also dangerous, in part due to massive sales of rupee-assets by foreign portfolio investors (FPIs).

Under these circumstances, seeking fast growth in revenues or profits may be over-ambitious. Hoping for fast returns from a market recovery seems over-optimistic too. The economy will struggle to grow at all. While a few businesses may grow, most will struggle to not lose more ground.

Investors must look for a cushion of safety when they take long-term positions in this sort of situation. One way is to set very high standards in terms of leverage: Avoid any business that looks even mildly over-leveraged since defaults are inevitable in a recessionary situation. Low-debt companies are far more likely to survive several bad quarters in succession. So, a low debt-equity ratio is a must.

A second cushion of safety is low valuations. If a business is valued near, or below its net-worth, there’s a fair chance the share price has bottomed out. Under normal circumstances, profitable businesses trading below book-value (or close to book-value) usually have hidden problems. For example, most public-sector banks traded below book value before the extent of their non-performing assets (NPAs) was known to the investment community.

But these are not normal times, and stocks of solid, profitable businesses could get beaten down to near respective book values, or below that level. Low share price to book value could be a useful indicator. Instead of hunting for momentum stocks hitting new highs, investors must look for profitable concerns testing new lows.

Under normal circumstances, fund managers are focused on consumer discretionary stocks in the Indian market.  Those preferences may very well change if fund managers decide that this market segment will take longer to recover. For that matter, we could find a change in retail investor preferences if the bloodbath continues.

History tells us that even highly experienced investors display herd behaviour. Many of them hit the panic button and start selling as a market heads downwards. Given that many investors will also face a sudden loss of income, it’s possible that some will simply stop subscribing to SIPs as well. Therefore, watch SIP inflows carefully over the next few months. If funds are faced with redemption demands, the market will see renewed selling pressure.

That would be a good thing for the long-term investor. Value seekers will find bargains for sure in such a scenario. But it’s much too early to do any concrete analysis. We don’t yet have credible coronavirus data to make projections about how long the lockdowns will last. We also don’t have a clear picture of policy. A long period of economic pain is guaranteed. A low-debt, low-valuation strategy could be the safest bet under the circumstances.

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