The market has been in correction mode since January 2018. While the Sensex is still up 4.67 per cent over the past year, the S&P BSE Midcap is down 15.6 per cent and the S&P BSE Smallcap, 26.29 per cent. The carnage is worse outside the indices (see table). Among midcaps (101-150th stock by market cap), 41 per cent have suffered a price erosion of more than 30 per cent from their 52-week highs. The pain is even greater in small caps (251 and beyond by market cap), where 66 per cent have seen more than 30 per cent correction. Some small-caps are down by as much as 85 per cent.
Entering near peak, chasing momentum: The key mistake many first-time investors made was to enter the markets close to the peak and invest in stocks at exorbitant valuations. They also chased stocks displaying strong momentum. Prices of many mid- and small-caps rose two-three times, and some even 5-10 times in 2017-18. As prices soared, the number of shareholders in them also rose. “Investors were purchasing these stocks as their prices were going up,” says Jatin Khemani, founder and CEO, Stalwart Advisors, a Sebi-registered independent equity research firm.
Once prices began to correct, many compounded their errors by buying the same stocks on their way down. If a stock had touched a high of Rs 4,800, investors bought more when it fell to Rs 4,000, and further more when it fell to Rs 3,000. They tried to average down their purchase price, believing it would rise to Rs 4,800 again. “Investors became anchored to the 52-week high price. Their entire focus, both when prices were moving up and were on their way down, was on the price and not on the stock’s intrinsic value,” says Khemani.
Unlike Sayeed, many first-time investors have now gone from being excessively optimistic about equities to being excessively pessimistic about them. “Have patience and put up with the pain, especially if you hold quality stocks. If you sell and exit now, your notional loss will become an actual one,” says S G Raja Sekharan, who teaches Wealth Management at Christ University and is an avid equity investor.
Tweak your portfolio: If you entered equities without much planning, a downturn provides the perfect opportunity to carry out the necessary course correction. First, define your goals. Then based on the time left to your goal and your risk appetite, decide on your asset allocation (equity-debt split). A higher risk appetite and a longer investment horizon mean you can take higher exposure to equities. “A long investment horizon is a must in equities. They do not give linear returns, but usually do better than other asset classes over a three-five-year period,” says Gaurav Dua, head of research, Sharekhan by BNP Paribas.
Next, decide on your category (large, mid and small-cap) allocation. “Large caps lend stability to the portfolio and should form its core. As you move down the market cap ladder, volatility increases. But if you have the ability to tolerate a few bad years, mid and small caps have the ability to generate higher alpha over 5-10 years,” says Ankur Maheshwari, chief executive officer, Equirus Wealth Management. Raja Sekharan suggests that first-time investors should have the bulk (70-80 per cent) of their portfolio in large-caps.
Reassess your stocks: While temporary drawdowns are a part of equity investing, the problem arises if investors have picked poor-quality stocks or have overpaid for them. Many of the stocks falling currently will not bounce back, as has been the fate of many in the infrastructure pack that have never gone back to their 2007 price levels. “Ask if you would buy each of these stocks at their current prices. If the answer is yes for some, keep them and stay the course. But if the answer is no, get rid of them right away,” says Khemani. The company behind the stock should have a sound business with a sustainable competitive advantage. Maheshwari emphasises the importance of earnings. “Over the longer term, earnings growth drives the performance of equities. Check if the company has a good track record of earnings growth and whether this will continue,” he says. The management should be competent and there should be no corporate governance issues. “Avoid highly-leveraged companies and those with a high level of pledged promoter holding,” says Dua. Ratios like return on equity (RoE) and return on capital employed (RoCE) should be attractive over the past five years, and valuations should not be much higher than historic averages.