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.
|NIFTY MID 50
|NIFTY MID 50
|NIFTY SMALL 100
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.
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.
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 ?
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 email@example.com
Just to add you can read a lot of Value Investors and Pretenders will be lapping up on reading