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Belling the Bull

Investing in high-risk stocks for quick gains during a bull run may worsen your financial health. Here's a guide to investing in a bull market.

Illustration by Anirban Ghosh Illustration by Anirban Ghosh

A more than 100 per cent surge in equity markets has encouraged many small investors to start trading or directly invest in stocks. They have also been encouraged by the wave of initial public offerings (IPOs) that have given stupendous listing-day gains. Over 10 million demat accounts were opened in 2020, which is a record.

However, there is every chance that the easy gains of the past one year may make investors complacent and prone to taking riskier bets. Here’s how they can be cautious and yet partake of the bull market gains.

The Bull Market

After six to seven years of weak economic growth, we are at the cusp of economic revival. Companies are reporting good numbers despite the nation suffering the deadly second wave of the pandemic. The BSE Sensex has risen 120 per cent from the lows of April last year that it had touched amid the announcement of the nationwide lockdown. “Eventually, all market levels are a function of two things—corporate profitability and valuations driven by fund flows. Despite the first wave and the stringent lockdowns in Q1 of last year, corporate India has reported record profits,” says Nilesh Shetty, Fund Manager, Equity, Quantum AMC.

Most companies reported record margins and strong revenue growth in FY21. The year saw 15 per cent top line growth and 85 per cent bottom line growth at the index level (excluding financials).

How Long Will the 'Bull' Run?

There is a strong correlation between GDP growth, corporate earnings and equity returns. An expected double-digit GDP growth will boost corporate earnings. As long as corporate India continues to grow, share prices will keep going up, say experts.

The correlation between nominal GDP and Nifty 50 earnings growth, says Sujan Hajra, Chief Economist, Anand Rathi Securities, is about 0.7. Hajra believes nominal GDP growth of around 15 per cent suggests 20-25 per cent-plus earnings growth in FY22. “Since corporate earnings are more pro-cyclical vis-à-vis GDP, earnings can expand even further.”

How to Invest

The aim should be to own good businesses. So, buy quality stocks, after thorough research. This is especially true in a bull run, when everything looks attractive. “An investor should carefully select an industry that has large headroom for growth such as FMCG in the 1990s,” says Sameer Kaul, MD & CEO of TrustPlutus Wealth (India). New investors, of course, may need professional help for the analysis.

Keep an eye on under-valued stocks. Within an industry, do a peer-to-peer analysis by comparing the fundamental ratios of different stocks. Also, look at sector averages. “Compare companies on the basis of ratios such as price to earnings, forward earnings, price/earnings growth, debt to equity, price to book value, return on equity, etc., to select the sector’s top companies,” says Harsh Patidar, Senior Research Analyst, CapitalVia Global Research.

However, only quantitative research on the basis of financial ratios will not give you the best stocks unless you do qualitative research as well. “It is important to identify quality management that is focused on the industry and will not adventure into non-allied businesses or mistreat minority investors,” says Kaul.

Book Partial Gains or Buy Insurance

Markets behave the opposite of the way you expect them to. “Partial profit-booking becomes important in this kind of a market. If your stock has given good returns in, suppose, one year of the bull run, you must book some gains,” says Patidar of CapitalVia Global Research.

However, if you are still confused about whether to encash some gains or continue the investments, there is a way out. “You may spend money to buy protection,” says Kaul of TrustPlutus Wealth (India). He says insurance for stocks involves buying a put option. A put option is a contract that gives its holder the right to sell a number of shares at a set price. The investor can exercise the option when the stock falls below the strike price; this prevents losses. “At this juncture, volatility, as measured by the India VIX Index, has fallen to a low of about 13 per cent. This has brought the cost of buying protection substantially lower than it was a few months back,” says Kaul.

Anyway, most equity shares have given handsome double- and triple-digit returns in the past one year. Investors should spend some of those returns to protect their gains.

Asset Allocation is the Key

Irrespective of the market cycle, following your desired equity-to-debt allocation, after keeping a sum for contingencies, is a must. “Your emergency corpus should ideally be 6-24 months of expenses based on your risk profile,” says Nilesh Shetty of Quantum AMC.

Do not put all your eggs in one basket. You should not let multifold returns in a bull run trick you into deviating from your desired asset allocation. Even in a bull run, you should add other asset classes such as debt and gold to your portfolio depending on your goals and risk profile. “Invest 20 per cent in gold. In times of stress, gold generally tends to do well. It also acts as a diversifier against equity price fluctuations,” says Shetty. He adds that mutual fund investors, after keeping aside emergency funds, should put 80-85 per cent of their corpus in four to five diversified equity funds. “You don’t want to touch your investments in times of stress. Equity investments, especially, should be kept untouched for 10-15 years.”

Stagger your investments. You could put the initial 75 per cent now, says Shetty, and the rest 25 per cent if there is a correction. But if you are starting an SIP, it doesn’t matter, as it is a long-term investment.

The IPO Craze

The oversubscription levels in IPOs indicate very active retail participation. Easy returns like these make investors greedy and ready to pay fancy prices for stocks. That is why there is a mad rush among companies to launch IPOs in a bull market. The aim is to raise as much money as possible. It is up to the investors to keep their emotions under check.

“Generally speaking, more than 75 per cent of companies that go for an IPO trade lower than issue prices after two-three years,” says Kaul.

However, if you are convinced about the underlying story and still wish to invest in the business for the long term, you may go ahead and invest in an IPO. But investing in IPOs for listing gains should be avoided, says Kaul.

What to Buy?

Every market rally is followed by a correction. There is no need to worry, though, as any deep correction looks unlikely at this stage. In fact, a correction of 10-15 per cent will be a good accumulation point. “A 10-15 per cent correction in the mid-cap space is due anytime in another month. It should be a good level to buy quality stocks,” says Patidar of CapitalVia Global Research.

Small caps may also take a breather. “The Nifty Smallcap Index has approached the overbought territory after an over 230 per cent rally in the past 17 months, indicating an extended breather,” says Dharmesh Shah of ICICI Securities. “Capitalise on the dips to accumulate quality stocks,” he adds.

Sector-wise, IT stocks, which largely drove the first half of the bull run in 2020, are overvalued, especially the mid- and small-cap ones. “The large ones still have some value. They will be the front-runners in the IT space,” says Harsh Patidar. All big names in FMCG also seem overvalued, but with the festive season around the corner, they may do well, he adds.

Commodity, pharmaceutical and consumer companies, apart from public sector banks, will add to earnings, says Kaul. On the other hand, auto could underperform.

At a gross level, it can be argued that the market is not overpriced, but fully priced. However, certain companies, especially in IT, internet, platform companies and pharmaceuticals, are overvalued. In addition, we are in a curious situation where the private space is certainly more expensive than the listed space, concludes Kaul.

@avn_kaur