Markets: Of expectations, sentiments and more...
Source: Equitymaster.com
The Indian stockmarkets are in the midst of a 'dream' bull run. Since January 2003, the BSE Sensex has gained around 175%, a CAGR return of an impressive 40%. (To put this into perspective, please note that the entire index has given this CAGR. BHEL, one of the main Sensex stocks, has given a stunning CAGR of over 104%, around 753% point-to-point!) Thus, it follows that if the entire index itself has performed so well, certain individual stocks would have undoubtedly outperformed it.
However, one index that has lagged the performance of the Sensex has been the BSE IT index. In fact, it has given only 28.5% CAGR compared to 40% for the Sensex since January 2003. This has been the case despite the good financial performances of Infosys, Wipro, Satyam and TCS (added after its listing). These stocks, in fact, collectively account for over 85% of the weightage of this index. As a matter of fact, Infosys (up 132% point-to-point), Satyam (160%) and Wipro (just 67%) have each under-performed the benchmark index, the BSE Sensex.
What does this mean? Is it that software stocks are, therefore, more attractively valued compared to the Sensex? Or has it been due to financial performance not being upto mark?
Well, one of the reasons that could be attributed to this relative under-performance could be 'market expectations'. But as far as we are concerned, these companies have done well in terms of their fundamental performance. To put the latter in numbers, Infosys has grown revenues and profits at a CAGR of 40% and 41% respectively from FY03 to FY05 and is expected to clock a 30%+ growth in FY06. Corresponding figures for Satyam are 26% and 43%, and for Wipro, 38% and 41%.
The key point we are trying to make here is that often, certain characteristics of the stockmarket ('market expectations' for one) result in stock prices fluctuating wildly at times. As an investor, one has to steer clear of such fluctuations by keeping one's emotions at bay.
It is pertinent here to bring out an extract from the book, "The Intelligent Investor" by the legendary Benjamin Graham, guru of Warren Buffett. He says, "The market is a pendulum that forever swings between unsustainable optimism (which makes stocks look expensive) and unjustified pessimism (which makes them too cheap). The intelligent investor is a realist who sells to optimists and buys from pessimists." The emotional discipline that Graham talks about is vital, if one is to remain unscathed by the mood swings of the markets.
Our main focus in this write-up is not on any stock, the above was merely an illustration. But in general, an investor must understand that any business has an inherent 'value' that is de-linked from the company's stock price. In fact, over the longer term, the stock price will actually reflect this inherent value. For example, Reliance would be having huge and very valuable tangible assets, such as its Jamnagar refinery, retail gas stations and oil and gas fields. All of these have a certain value and will surely be reflected in the stock price, in tandem with fundamentals.
The important point for investors to note here is that they should develop an intellectual framework for investing and have the necessary emotional discipline to ride out any bear or bull market and emerge unscathed. Of course, this is easier said than done and emotions and market hysteria have, at some point, carried away any number of investors and lured them to their doom.
Therefore, in conclusion, we would say that if you want to invest in equities, ensure that you have the risk appetite, have a long-term horizon in mind, develop a framework for investing and most importantly, have the emotional discipline to not get carried away by market mood swings. This advice has the potential to work wonders for your financial future.
