At most times, the stocks of large-cap, well-known and thriving companies trade at high PEs. If you invest in them, the only way you can expect to make money is by hoping that momentum will drive their already-elevated valuations further up. If you have a "value" bent, you would be loath to go down that path. What's the alternative then? One way out is to make distress and time your allies in the stock market.
In times of distress, many otherwise highly valuable assets become available at large discounts. During the Second World War, a few bombs, fired by passing enemy ships, fell in Sydney. Alarmed, many Australians sold off their properties and moved further inland. Recent immigrants from Europe and England, who had lived through heavy bombing during the blitzkrieg, merrily bought these properties. This windfall laid the foundation of many of the big post-War fortunes in Australia.
How did steel magnate L. N. Mittal make his fortune? As Mohnish Pabrai, who runs the Pabrai Fund in the US points out in his book, The Dhandho Investor, Mittal used distress thrice over. He invested in steel mills that were in distress; in those times the entire steel industry was in distress; and often he made these investments in highly distressed geographies (the erstwhile Soviet republics, eastern Europe, and so on). After buying these mills at throwaway prices, he employed his considerable expertise to turn them around.
We may have come a way long way since our ancestors lived in caves, but many atavistic instincts remain alive within us. When the lion roars, i.e., a piece of misfortune befalls us, our instinctive response is to run. Pausing for a while to evaluate the seriousness of the threat doesn't come easily to most. Not surprisingly, those few who are able to keep their wits and review the situation calmly tend to have a better investment record than the majority.
Another approach that would serve us well in troubles situations would be to ask: will time remedy this problem?
Take a few examples from the current market. Today many cement stocks are trading at attractive valuations. The consensus view is: overcapacity in the sector will affect the pricing power, and hence the margins, of cement producers. Which then begs the question: in an economy where the government intends to double the outlay on infrastructure from around $500 billion (in the 11th five-year plan) to $1 trillion (in the 12th five-year plan), how long will this overcapacity last?
Stocks of many public-sector banks are also in the doghouse today. The reason: many have large holdings of government paper, and as interest rates rise, they will incur large mark-to-market losses on them. Again, the question to ask is: how long will the current upsurge in interest rates last? And what will happen when interest rates turn downward again?
Within the telecom industry, a bruising price war has driven valuations of even market leaders to low levels. But the price wars are likely to be followed by a phase of consolidation. And those left standing at the end of this battle will regain pricing power.
My hunch is that the majority of stock market participants have an investment horizon of one year or less. By adopting a longer investment horizon of, say, three to five years, you will greatly improve your odds of success in the markets.
Happy Trading,
United we grow!!!
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