Zerodha Founder Explains – Finding the Right Stock or Sector in Today’s Market
In a raging bull market like the current one, it is counterintuitive to think about betting badly, as everything seems to have the potential to make money. Such a market environment generally leads to complacency and participants shy away from caution in order to make the most of the situation. It is during these times that a nuanced approach is helpful in coming out better than the crowds.
A common theme that I have noticed during the past year is the disparity in performance between the constituent stocks of the same sector. After the March 2020 stock market crash, the rally may look general from a benchmark perspective. However, when analyzed closely, there is a considerable gap between the performance of industry peers. While it is difficult to identify the reasons for this phenomenon, the performance gap could possibly be attributed to fundamental reasons, depending on industry to industry. To give you an idea, at the start of last fiscal year, Tata Consumer Products was trading at around ₹280 while Marico was negotiating at ₹265. At the end of the exercise, the first was ₹639 while the latter was at ₹412. Tata’s consumer products returned 117% in those 12 months, compared to Marico’s 50%, and the FMCG index was around 27.5%. With the same market capitalization and industry, a slight lack of choice would have been vastly different for an individual.
The second part is about evaluations, perhaps the most discussed topic of late. As the markets are on the rise, it’s only natural for stocks to get expensive, primarily based on P / E ratios. Growth stocks continue to increase investor wealth while being expensive. We have had instances in the markets where a high P / E stock has shown better price appreciation year over year compared to a low P / E stock. It is important to understand the specific business dynamics of a company and should be prioritized alongside sectoral or macro indicators. The idea is that the company needs to rely on key fundamental drivers that would support its valuations, even when the markets are not doing well. These fundamental drivers will be more equity specific in nature and therefore more attention should be paid to specific selection.
Finally, from the point of view of volatility. In order for someone to protect their investments, it is crucial to consider the sensitivity of the stocks in their portfolio to the markets. The reason is that when bull markets level off, stocks with high market sensitivity tend to correct the most. Taking risks without a good understanding of the scenario is a recipe for disaster.
To conclude, retail investors should focus on preserving capital and not getting too expensive with their investment bets. There is no doubt that the equity markets have become a fairly viable asset class, especially given the current trends of high inflation. That said, over-indulgence in already overheated markets must be avoided at all costs. Acting on your risk appetite is important. Being risk blind at this point is the easiest thing to do.
* The article is written by Nikhil Kamath, co-founder, True Beacon and Zerodha.
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