This is a quick post and more a post to get views from various readers. So there are more questions than answers or conclusions ? These are random ramblings on a Free Evening on a Saturday ( Have been writing such posts under a category – Sunday Thoughts )
Section 1 – Solid Returns in Last 3 years !!
In the last 3 years the markets have done really well even if we consider the lack of upside moves in 2015-2017 in Nifty. Its a good time to see these numbers as we are at or close to All Time Highs.
| Index | Absolute | CAGR |
| NIFTY 50 | 39% | 13.06% |
| NIFTY 100 | 52% | 15% |
| NIFTY 200 | 57% | 16.10% |
| NIFTY 500 | 61% | 17.35% |
| NIFTY MID 50 | 93% | 24.60% |
| NIFTY MID 50 | 93% | 24.60% |
| NIFTY SMALL 100 | 104% | 26.80% |
| BSE SMALLCAP | 110% | 28.40% |
What is amazing is the quantum of return keeps increasing as the market cap of the Index starts decreasing !! Essentially smaller the company – Higher is the Return.
Do note the above indices have higher market caps in the universe. A portfolio of small caps/midcaps would have much higher returns !!
Lets do another check on what are the returns of Midcap and Smallcap Mutual Fund Return.
Data from https://www.valueresearchonline.com
Equity Midcap Annualized Performance
Bottom 10 Returns = 12.25% to 24.2%
Top 10 Returns = 31.75% to 37.46%
Equity Smallcap Annualized Performance
Bottom 10 Returns = 23.7% to 38.2% ( It is amazing to note apart from 1 fund every fund in this segment has outperformed its benchmark)
Top 10 Returns = 33.7% to 43.53%
Even a Random Portfolio would have a CAGR of 25-45%. We may try to do this exercise in next post like we did in our earlier posts Part 1 & Part 2
How often has this happened – Higher Premium for Smaller Companies that to when Nifty or the Benchmark has not been in a strong Bull Market ?
Section 2 – Multiple Expansion and Not Earnings Expansion
In simpler terms Price or Market Cap Appreciation can generally be quantified in terms of Earnings or Price to Earnings Multiple.
The best case is when over a period of time Earnings grow fast along with market giving it a higher multiple.
The major return is made by multiple expansion. ( That is how craziness also happens in a Bull Market when 50-100 p-e 
)
)But in the current markets for India – The earnings have not gone up a way lot or rather been pretty subdued given the multiple expansion.
A depiction would be like this.
A simpler statement would be the Market Cap has gone up by 50-100% in last 3 years but earnings have not gone up similarly.
Questions ?
The new discussion for small cap is that 10-15 p-e is cheap irrespective of earnings growth or quality of earnings. Is this sustainable ?
Will the earnings catch up over the next 3-5 years or the P-E Multiples will catch up with the Earnings Growth ?
Section 3 – Investor Expectations of Double in 3 years and 10x in 10 years.
Generally in a good market the Investor Expectations continue to keep increasing as well as people start extrapolating the recent returns into a long future estimate.
I remember seeing 25% CAGR as a norm in marketing material of ULIPS and MFs in 2007
Also every Bull Market creates different set of Full Time Participants who shift professions.
People become Brokers/Investment Bankers/ Day Traders/Full Time Traders/Advisors/ Research Analysts/ Full Time Investors etc.
( As a matter of fact the Author i.e Nooresh Merani is a product of the 2003-2007 bull Market. Just completed 10 years being Full Time
I am a little perturbed by the number of people turning Full Time Investors / Full Time Traders and Investment Advisers. Its kind of deja vu to the 2007 times although the craziness is nowhere similar
The general expectations of some set of Investors. ( I will not speak about traders as they can have crazy expectations which are not easily met.)
1) Full Time Investors /Part Time Investors - Many expect double in 3 years and 10x in 10 years. Some are happy with 15-20% cagr too.
2) Independent Financial Advisers – ( MF sellers ) – Expecting 15-18% cagr from a mix of MF portfolio or say 5x in 10 years.
( Some are happy with 4-5% points or 30-40% more than the fixed income rate.)
I personally think the new Full Time Investors and IFAs who have built in 20-25% cagr into their excel sheets are in for a rude shock in terms of the lower than expected returns over period of time as well as the shocks and lumpiness with it.
Now there are simply two ways to make 25% CAGR
1) Find companies growing earnings at 25% and expected to do the same for long periods of time.
2) Find companies growing at 10-20% and expected to the same for long periods of time but available at lower PE to Growth Ratio.
One thing you got to remember is for Earnings to grow at High Rates for long periods of times one needs to have Sales Growth too. Margins cannot expand forever - aka the Operating Leverage , Commodity Price Run up, High Value Products , Moat etc is all jazz.
One of the reasons to write this post came after running a screen on www.screener.in with companies growing earnings at 15/20/25 % for last 3/5 years also adding up another filter of positive sales growth the no of companies are just 200-300. ( Just a quick check no deep dive into nos)
The startling fact was moment I put up another Filter of P-E < 25 the number of companies comes down too 150-180.
This only shows that companies growing at high growth rates are quoting at High P-E itself.
Some Questions ?
- How do you make 20-25% cagr when companies are not growing Earnings at 20- 25% ?
- How do you make 20-25% cagr when companies growing at 20-25% are at p-e north of 20-25 ?
- Will it be difficult to make 25% cagr or Impossible from Current Valuations ?
- Will you have to downgrade the quality of stocks you own for higher returns and subsequently take higher risk ?
- Do you need to tone down your return expectations from the market given that the Fixed Income Return as well as Inflation is closer to 6-9% ?
- Do you need to time the market and be opportunistic to make better returns – Example Budget 2016 , Brexit , Surgical Strikes, Demonetization/Trump ?
Conclusion –
Being and Investor/Trader above are the questions I have too. Would love the comments section to be more longer this time.
You can also mail me on nooreshtech@analyseindia.com
Just to add you can read a lot of Value Investors and Pretenders will be lapping up on reading
February 26, 2017
Thought provokingly, deep analysis. Need to trim down return expectations.
February 26, 2017
As an IFA I too have been hounded by this question. Typical investor is good at extrapolating past returns. Here is a blog I wrote in Oct when midcaps/smallcaps were running amok. The idea was to crib return expectations & identify opportunities where risk-reward looked favorable for higher returns.
https://makingmoneywork4u.wordpress.com/2016/10/15/recipe-for-massive-returns-in-equities/
February 26, 2017
Timing the market is the worst thing in market. Staying in Cash is like losing opportunity. There can be many right stocks even in overall expensive market or unsuitable macros.
If base is low, returns expectaions can be high; however with high base, returns expectations has to be toned down steadily.
Everytime, it’s the allocation matters the most to generate outperforming returns.
Twitter: https://twitter.com/AnyBodyCanFly
@AnyBodyCanFly
February 26, 2017
Yes at this point in time there are not many companies whose sales are growing margin are constant even in small cap and micro or midcap
The one which have grown a little are commanding pe above 30-700
It is very difficult to find good stable 10-15% leave apart 25% cagr kind of companies
But yes turnarounds are happening in loss making because of low interest npa management etc and commodity rising
February 26, 2017
Good analysis Nooresh. An average investor becomes a trader as he is quick in taking profits just in case the price goes down. An uninformed trader becomes an investor in the hope of a turnaround in fortunes. That is why MFs become an easy way out – outsource the hassle and be content with 10-12% returns.
I do not know if there is any data that can show how many investors actually managed to get returns of the level mentioned in your post. May be a few smart and few lucky would have but majority would not have.
My limited experience makes me believe that returns above the average rate of inflation and other similar measures if managed over a very long period of time can build wealth – if one looks at % all the while, decisions become biased – which means, big money is possible if you have reasonable money.
Average Indian is far less financially aware and alert to believe that money can be made by having even a small account. Till the time that a DeMo like revolution comes in the financial awareness and alertness areas, the Big investors would keep logging returns mentioned in your mail and the majority would be accepting what the MFs would be parting with.
I have attempted to make several people financially aware but they always feel that MF and in some cases FDs are the best options. So if they read this post, they may believe something is wrong! When what you have mentioned is factual and quite possible to achieve once one knows the game of trading and investing.
I am not a fundamentalist so I do not follow P/E etc., but believe that a small / micro-cap company can manage its affairs flexibly if done professionally rat her than a large / very large cap where the size becomes a pain rather a gain. I have been reading in trading books that many successful traders at some point or the other feel that having too large a corpus makes it difficult for them to get the return that they would have had the size would have been small. So my view is supported by their experience.
However, the real challenge is which company to invest in – for example – Alok Industries or Century Textiles / TAMO or Maruti / MRF or JK Tyres – such decisions make a great difference in the quality and quantity of returns. I know persons who always look for value investing in companies whose CMP is less than Rs. 5. The belief is — that is the way to become a value investor. Experience indicates that such companies generally leave behind a bruised investor who then decides to go the MF way.
So only few thousands of investors / traders are may be able to take full advantage of the benefits of what you have mentioned. My mission is to be one of them.
February 26, 2017
We are nowhere near 2007-2008 Nooresh. We are more like in 2003-2004. We have seen nothing as yet :-). If someone is in right stocks/sectors without any cap bias one can hit goldmine over next 4-5 years. I could be wrong in this view.
February 26, 2017
This situation may continue for 1 or 2 years. The reason being high liquidity in the system.There are around Rs 5000 cr infused into the market every month via SIP. MF managers have to put this money into the market.So in this scenario, if money keep coming into the market and earnings don’t grow,then PE multiples are set to increase even further from here.I guess it’s first time in the history that domestic inflows have over powered FII outflow.Dont know how long it will continue..but till then can’t be on sidelines..
February 28, 2017
Low interest rate environment coupled with liquidity means a push into public equity, meaning this trend will continue for at least a year. But valuations are getting stretched and there is difficulty finding low PE multiples for high growth expectations. Perhaps there can be a solution in the debt space which offers consistent returns of >15%, and less of the uncertainty…
March 3, 2017
There are some great tools to deal with such situations
1. Asset allocation…Let’s say one decided with n equity allocation of 65℅… 3 yrs ago…The curr bull mkt would have raised the equity allocation to 80℅ plus..One should tried down the exposure at every 10℅ above the predecided allocation
2. Just like systematic investment plan there can be a systematic withdrawal plan… I prefer n trust the PE stats very much.. if I had above 24 times ttm – thee is a 0℅ chance I would have made money 1 year hence- I have verified the stats – u can do it too..Hence every time we cross 22 times we should start the systematic withdrawal plan… I will loose out on euphoric gains ..But one has to be satisfied as stats show that 1 year hence u will have lower levels to invest in…
3. I am a big proponent of hedges … One can buy puts which shall safeguard you of some losses..Though when to book n how much are difficult questions