Last week a media person asked me a very good question. I thought it deserved a detailed explanation.

She said “The world has not seen such a turmoil ever. You can say keep investing in a SIP for 2-3-5 years, but where is the evidence that with so much of volatility, for equities to do well – is it not better to put money in debt instruments like PPF?”

Very fair question – and since I could not ask a woman her age, let me guess – she must be less than 25 years of age.

When equity markets are low one needs more confidence to be in the equity markets. To be in cash or debt markets seems to be the more sensible thing to do now. Why? Because everybody is doing it….right?

Well the market is a funny animal. It is also a slave of the earnings and another multiple called the ‘price earning ratio’. Without getting into too much of detail let us look at why does a person buy equities?

It is for 2 reasons:

– dividend income (not easy to predict, but at least an attempt can be made) and

– speculative income ( change in price earning ratio – far more difficult to predict).

Now let us take the example of a good company quoting at a price of Rs. 100. Let us assume that this company is T and has an EPS of Rs. 10 and has a price earning of 10 (Rs. 10 X 10 = Rs. 100).

Let us also assume that historically this share used to sell at a higher price earning – of say 15, but as the markets are down (i.e. the people do not want to pay a higher p-e for the market as a whole).

Now over the next 3 years – 2012, 2013 and 2014 the EPS of the company are 12, 18 and 20 respectively. What will happen to the price of the share?

Assuming that the companies future looks bright…etc. the likely scenario are as under:

Market remaining depressed ( i.e. p/e remaining at 10) the prices would be 100, 120, 180 and Rs. 200 over the next 3 years.

Market getting better (i.e. p/e remaining at 15) the prices would be 150, 180, 270 and Rs. 300 over the next 3 years.

Market clearly is a slave of these 2 numbers – there is no escaping at all.

Then why is everybody not buying? Just because of the following fears:

– what if it gets worse than what it is now?

– what if the price-earning ratio goes down?

– what if the earnings of the company go DOWN instead of going UP as you are saying?

– nobody is buying…why should I buy?

– FIIs are selling, why should I be buying?

– Every expert in the media is saying ‘do not catch a falling knife’ – is it not scary?

Frankly there are no easy answers – nor does any one person have an answer to all these questions. I am very comfortable answering these questions POSITIVELY for a large number of listed shares – just as I know that many companies will do badly! So answering for individual companies looks difficult, but as usual I am optimistic on a group.

A SIP in a good mutual fund (or an index if you wish!) over the next 3-5-7 years should see a return better than a debt fund. If you are more scared stick to a balanced fund (like say Hdfc Prudence – 65% in equities) and sit through the troubled times. Like Peter Lynch says one of the factors needed for making money in the markets is the ‘stomach to see churns’…

Answering her question of  ‘Is it the worst time in world affairs’…No my dear girl, no. This is the worst churn that YOU are seeing. Markets have seen famines, depressions, tsunamis, wars, riots, world wars, cold war, epidemics, bankruptcies, insolvencies, cheating, frauds, over optimism, over pessimism, …etc. etc. See a long term chart of say 150 years of the stock market existence – each of these events look like a blip.

The most important thing for an equity market to do well is DEMOCRACY – so next time there is an election – get off your butt and vote. No democracy no markets  – no wealth 🙁



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  1. I guess I can argue both ways.
    EPS will go up because rupee will be devalued a lot.
    EPS will go down because there would be less demand because of low growth in Europe and US.

    Pick your choice.

  2. This is my view on the market in general – not specific to Nov 2011. Shankar Sharma’s view is as on Nov 2011.

    I do not agree or disagree with SS. My visibility in the market today is 60 days. Beyond that I will continue my portfolio bias (I have equities, so I want equities to do well), my optimism bias (if you are not optimistic you should not be in the markets), and the fact that in life you will draw from your own past experience bias.

    Currently I am continuing my SIPs but my direct equity investments are not happening – mentally ready to see the market at 4200. Will it happen? no clue, but just preparing for that.

  3. More than anything else, I understand market is a slave to growth. Any ratios or earnings look to this economy growth to send positive/negative signals. The current direction for next couple of years is very clear. We are plagued with sky rocket inflation, high interest rates, hike in wages and limited govt spending and not to talk about currency devaluation pinching the import bills. In simple sense, this situation leads to sqeeze. 1. Demand comes down either from public or clients. 2. All the input costs (wages, raw materials) of the companies are tend to go up irrespective of their output/service costs. In such a situation profitability is a big question and survival becomes important. Yes, these are cycles but accepting that we are in downward cycle is an important realization for investors.

  4. I think we should mentally prepare ourselves for a more moderate economic growth of around 6.5 to 7% which looks more sustainable given our quality of governance and the resultant constraints. If congress looks to be in shambles, others are worse. Good leadership just doesn’t seem in sight.

    An overambitious target of 9 or 10% growth is just not practicable in the immediate future and will only lead to huge supply-demand mismatch & spikes in inflation. And we may need to include this reality in companies’ earnings and multiples.

  5. Subra sir

    A perfect reminder and my SIP goes on stroger than ever to prepare for the next big spike hopefully need not and should not come till a year or two before my retirement.

    Only one thing i was curious in SS interview was – he mentioned that the 30yr Gilt had given a better return than DOW for that time. Is he really right? If yes a real great food for thought…

  6. What I’m beginning to realize is that this crazy dependence of growth for prosperity and happiness will be our downfall. Look, we can’t have growth in everything forever. Especially exponential growth, which we see as a percentage growth year after year. What happens if we CAN’T grow? Why are our economies structured such that only if there is no growth, people will literally die. Permanent growth is a fantasy and unsustainable. Our planet is not growing, its natural resources are not growing, water is not growing, the sun is not growing. Does anybody in their right mind believe that X% growth till infinity is possible?

  7. Stay Out Of Stock Market for at least 2-3 years—

    You should remain out of the stock market. This is not a down market cycle and don’t assume that the stock market will rise soon as it did in the previous stock market crashes. This time scenario is different. In the short-term the stock market may rise if the Fed and Central banks around the world pass another stimulus plan (Print Money).

    The Global economy is heading for another recession. The world has never seen the problems like the U.S Government Deficit and European banking system. China’s real estate market is also at its peak and about to crash.

    I cannot predict the future but the stock market and real estate prices all around the world are falling against Gold. My advise would be to stay out of equity market and invest your money in safe investments.

    Gold has been considered as the symbol of wealth from Last 6000 years. The prices of gold are rising very rapidly from last 10 years because the governments of every country are printing so much money each day….

    Governments around the world know only one way to come out of the recession and that is by printing more Money and if they will continue print more money then the prices of Gold will rise certainly.

  8. Subra Sir,
    Bang on target as usual.
    Like a wise man said “It is always darkest before dawn”.
    Like you, I too am baised towards equities and I will stick my neck out and say, Equities WILL do well going forward

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