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Stock market at a two-year high: Your options now

Smart investors with a long-term horizon are well placed, argues Raamdeo Agrawal.

Raamdeo Agrawal | Print Edition: May 2, 2010

With stock markets touching a two-year high last fortnight, some investors might be wondering if this is just a temporary bull run. Or is this surge backed by solid fundamentals? There are no simple answers. How a retail investor interprets the current scenario depends on a host of factors like his or her investment horizon, risk appetite, investing experience, objectives, etc. Investing with a shorttime investment horizon can be speculative now. Even for an investor who wants to invest for a year or so, the return expectations ought to be muted.

For a new investor, the markets do hold promises in the long term, but there is a strong chance of capital loss as you enter the markets. One should be ready for a 20-30 per cent correction in the immediate future. For existing investors who stick to their investing principles, there is nothing to worry about. Such investors should maintain their exposure or can even buy more stocks of select good companies as the market outlook is still positive.

Raamdeo's Guidance

  • Expect annual returns of 15 per cent from the Sensex for the next five years.
  • The Sensex is trading at a P/E ratio of 21, which is reasonable and comparable with China.
  • If corporate earnings grow by 25-30 per cent for 2009-10, P/E levels will go down by 10-15 per cent.
  • Cement, telecom, oil marketing companies, public sector banks and textiles look good for the long term.
  • Don't buy on fundamentals alone; instead, select companies with a sound management.
Today, the Sensex is trading at a P/E (price-to-earnings) ratio of 21, which is a reasonable valuation. China, another emerging market, is also trading at a similar P/E level. A lot of things hinge upon corporate earnings, the monsoon and the disinvestment programme.

A market cap of Rs 64 lakh crore on profits of Rs 3.2 lakh crore looks slightly overvalued. Yet, if corporate earnings grow by 25-30 per cent for the financial year 2009-10, the P/E levels will go down by 10-15 per cent. That, in turn, would send the Sensex into a 15-20 per cent yield mode. Although the impact of the monsoon on the Indian economy has become less in the last few years, it is difficult to ignore it. A poor monsoon may not directly impact the economy (agriculture's contribution to GDP is only 17 per cent), but it can build inflationary pressure.

March has been a remarkable month for the Indian stock markets. Not only has the Sensex jumped 8-9 per cent on the back of aggressive buying by both domestic and foreign institutional investors (foreign funds pumped in $4 billion in March alone), a vast majority of stocks witnessed a sharp decline in volatility. Given that the markets may well turn volatile again, smart investors can use that volatility as a tool to make money. Volatility gives you an opportunity to sell expensive and buy cheap. However, if you are not smart enough, don't try it.

Buying stock in this market can be tricky. Don't buy them just on the basis of fundamentals and marketcap; try to buy into a company with a good management team instead. Interestingly, sectors like public sector banks, cement, telecom, oil marketing companies and textiles are suffering from pessimism. While these businesses are excellent, somehow they are being ignored by the traders as they are tackling various issues. In telecom, for example, there is intense competition. Cement is burdened with excess capacity.

Stocks in these sectors are available at a 30-50 per cent discount to what they should have been. Anyone with a long-term view (read five years) can buy into these businesses. Alternatively, you can enter equitymarkets through mutual funds. Pick up established funds with a proven record and avoid new ones. I would suggest the SIP route, given market conditions. Through SIP, you invest in both good and bad times and thus average the purchase cost. If you don't know the game, don't hesitate to take advice from experts.

Time and again, we have seen that investors link the bullishness in economy with stock market surges. But the way economy moves is different from the stock market movement. The growth of an economy is often a straight line, whereas stock market charts can be scratchy. For instance, while the Sensex has almost doubled in the last one year, the real GDP (gross domestic product) grew at around 9 per cent during the same period. The market has its own rhythm and it is difficult to align it with the GDP numbers. Broadly speaking, I expect annual returns of 15 per cent from Sensex for the next five years.

— The author is Director and Co-founder, Motilal Oswal Financial Services

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