The last one year has been a value investor’s dream. Analyze and find an undervalued stock, buy decent quantities of it and voila!, in a few months time the market has recognized the undervaluation and corrected it. As a result most of the stocks in my portfolio have corrected substantially and I am looking at decent gains.

This has been the experience across the board and I don’t think it is proof of my or anyone else’s special genius or abilities. Now, before we start considering this as a normal state of affairs, let me point out an experience I have had for the last few years. This experience is not unique and has happened to me several times, but I am giving this example as it is recent and ongoing.

I read and analyzed Merck in Aug-Sept 2006 and found it to be substantially undervalued. The company had a growth problem, where due to the limited portfolio of products, its topline was more or less stagnant. However the company was able to improve its bottom line by 50% during the same period by cutting costs. In addition the company had almost 350 Crs in excess cash and was thus selling at 4-5 times its earnings.

So here was a company, with great ROE, moderate growth and high cash balance selling for a song. I decided to start building a position and started buying the stock slowly. I eventually built my position for 2 years with the stock dropping during that period. The net result of the position was a loss of around 15% by the end of 2008 including dividends.

Was it a bad pick?
Now a valid argument could be that the stock was bad pick in the first place. In investing, it is important to remember that decision need to be made looking forwards and not backwards. My approach to investing is to compute intrinsic value with conservative assumptions and buy at a discount to this number. This approach may not work everytime, but works surprisingly well most of the time.

The company had a decent performance in the past, was reasonably well managed and had quite a bit of cash. During the period 2006-2008, the company was able to grow the topline by 30% and the bottom line by 10%. Not exactly a blowout performance, but pretty decent. In addition, there were a few things happening below the surface. The company started investing heavily in sales and marketing during this period due to which the topline started accelerating at the cost of the net margins.

The turnaround
The turnaround in the price finally came in Q2-Q3 2009 as the topline growth started flowing through to the net profit in terms of growth. At the same, the market was also in a mood to correct undervaluations and price most stocks closer to their fair value.

Whats the point?
The point is that undervaluation and fundamental performance alone are not sufficient triggers. A lot of times it is the market mood which decides when the undervaluation will correct and you will make your returns.

Now, one can say that if it all depends on the moods, then one should wait for the mood to turn and buy the stock before the turn happens. Well, on that please leave me a comment if you know some logical approach of figuring that out without getting into mumbo jumbo.

The point of the post is that an investor cannot control when the market will correct the undervaluation, but he or she can look for sound companies selling below intrinsic value, buy them and hold a portfolio of such companies with patience. Some of the holdings may take time, but over the course of time the portfolio as a whole will do reasonably well to be worth your while.

2 Comments

  1. anurag says:

    Dear Sir,

    As you have invited opinion without much mumbo jumbo,Few Golden rules of the Mktg are as under.

    1)When TV experts or Media say BUY a particular share, then wait for some days. Exit from the current position on immediate rise. The price will come down. Do not be in HURRY. Some big players offload their shares during that time.
    Corollary Price will be UP for that or next one or two days. SELL if you have the HOLDing during the artificial RISE. BUY back later provided the script is fundamentally good.

    2) For investors, Total Volume traded has no significance. Important is the volume of shares changing hands.Investors ideally should check the delivery figure from nseindia to get an idea what is going in a particular share.

    3) EUR DOLLAR RATIO =Global cues,always track the Money index.

    4)In TA always believe only rising wedge,rest all like RSI,MACD,etc can be manipulated.But rising wedge cannot be manipulated.

    5)For global cues always look at S&P 500,only,as this index is a index of top 500 fortune cos,and cannot be manipulated.

    6)Never ever attempt to time the mktg,always remeber Mktg are supreme.

    7)Always buy the Fear and Sell the Greed

    8)Never ever short a Mktg,which has corrected by 12% and is holding onto that level for two days.

    Regards
    Anurag Awasthi

  2. admin says:

    Hi anurag
    i am really not into technical analysis. but you mention that one should not time the market ..so how that view point reconcile with points 2 and point 8 ?
    regards
    rohit

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