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Soumik Kar

Perspective

Investing lessons from 2015
The year gone by was far from what most investors thought it would be

Jitendra Kumar Gupta

Investing mistakes lead to pain and capital drain. But as long as you learn from them, you can get it right the next time. Every year – and every kind of market – presents us some learning, and 2015 had its share. It was a year in which not everyone made money, but everyone surely learnt something. Here are five that stood out.

Sentiment and liquidity can be powerful drivers irrespective of fundamentals: Markets have three legs namely sentiment, liquidity and fundamentals. Starting April 2014, just before the general election, Sensex rose from 22,000 to 30,000 before the Union Budget in February 2015 which was a 36% return in 11 months. Local sentiment and global liquidity drove this spike, despite the fact that the Sensex earnings between 2014 and 2015 moved up barely 2%. From May 2014 till February 2015, FIIs had invested close to ₹93,000 crore as against ₹54,000 crore in the corresponding period last year. They were not alone. During the same period, domestic mutual funds bought equities worth ₹40,000 crore as against selling ₹16,000 crore in the corresponding period a year before.   

Consensus provides no assurance or reliability: Starting 2015, Dalal Street analysts were expecting Sensex EPS of ₹1,870 and based on that even when the Sensex hit 30,000, it was looking reasonably valued at 16x earnings. Today, consensus EPS for Sensex has fallen to ₹1,350 a share which is a 28% cut in estimate since January 2015. Analysts are factoring in a slower recovery, lower commodity prices, low export growth and the adverse impact of lower rural consumption. Data suggests that the earnings revision ratio (upgrades divided by downgrades) of BSE-100 companies fell from 81% in December 2014 to 34% by the end of May 2015. The ratio has since moved up 60% in October, even though the market continues to trade weak.

Bottom fishing in commodities is a play on the underlying: 2015 was difficult for most commodities particularly energy and metals which are trading at a multi-year low. While prices fell swiftly, the impact is getting reflected in the bottom-line of companies now. When crude oil prices started to decline, and shares of Cairn India started to fall from ₹220, analysts were arguing that the stock looked attractive at 15x earnings, offering 3% dividend yield and cash equivalent to 40% of its market capitalisation.

Today, at ₹130 the stock has fallen to a PE of 6 and offers 7% dividend yield. Cairn India is not alone, companies like NMDC, Nalco, Tata Steel all have reported decline in realisations quarter-on-quarter, which have only made them even more expensive based on future earnings. For instance, NMDC is trading at 6x FY15 earnings but based on FY16 earnings it’s actually not cheap at 14x. NMDC’s realisation per tonne fell from ₹4,274 per tonne in Q2FY15 to ₹2,716 per tonne in Q1FY16 and further to ₹2,480 per tonne in Q2FY16. In commodities, valuations move sharply in tandem with commodity prices. Effectively, you are taking a call on the commodity itself.    

Betting on leveraged companies can be fatal: After the Modi government came to power in May 2014, investors looked for turnaround stories. The hope being that a downward trend in interest rates will aid highly leveraged companies. So far this year, the RBI has cut rates by 125 basis points. While that thesis could have worked well, the longer than expected slowdown in capital intensive industries and excessive leverage in some of these cases have actually pushed many of these turnaround stories into a debt trap. IVRCL, Lanco, DLF, HCC, GMR, Bhushan Steel, REI Agro, JP Associates and many others continue to be stressed because of excessive financial leverage  and sticky policy issues in the sectors they operate in. Several companies have eroded their networth entirely and are well past any possibility of revival. That is something investors have learnt rather painfully this year. 

Hope can drive stock prices only so far:  In 2015 investors were hoping for a faster economic recovery. Hopes were built after the formation of the Modi Government in May 2014 that reforms will speed up. Just before its first full Union Budget in February 2015, the Sensex touched 30,000, valuing the benchmark index at 22x estimated FY16 earnings. Thereafter, the euphoria spilled over into mid-caps; the BSE Midcap Index made a new high in July 2015, trading at 24x earnings and 3x book value. Every stock surge was justified — faster recovery, margin expansion, valuation re-rating, operating leverage, sum of parts. No one bothered to pause and reflect.

In the second half of the year though, those hopes were dashed as they did not translate into earnings. In December 2014, there were 173 downgrades (for the BSE 100 companies) which shot up to 620 in January 2015 and 737 in February 2015. In the December 2014 quarter, the Nifty-50 companies reported a 9% decline in profit as against a 6% growth in the previous quarter. This was followed by a further 11% profit decline in the March 2015 quarter. Many stocks that made a high during this period went on a tailspin after reality struck. The point then is hope can drive prices for a while but earnings have to catch up.

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