Frothless stock markets would enable value picks

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Tossed and turned by vast waves of money that seem to keep stock markets forever choppy, individual investors can hardly be expected to invest in equities for momentum gains. Euphoria one moment can turn into nausea the next, even as big players focus on financial tides turned by central banks for market cues. The King Canute of global finance, America’s Federal Reserve, has been trying to quell an upsurge of inflation with a monetary squeeze. After almost two years of a world flush with covid-relief cash, this policy reversal started shaking up stock indices earlier this year. India’s Reserve Bank has tightened its policy too. And should the US Fed strap itself firmly to the mast of price stability, which may see it harden its key lending rate far beyond its just-upped level, a resultant recession in the US economy could squash asset values everywhere, India included. If outflows of hot money from Indian bourses intensify—signs of which are obvious—even bulk buying done locally won’t be able to support our indices. In short, we can expect the whammy to worsen.

The jerky aftermath of an equity binge driven by easy money should deter retail investors looking for enlarged portfolios as judged by what their holdings are worth. Yet, a down-slide in share prices may soon open up space for investments guided by the idea of acquiring legal rights to slices of corporate profits. The basic appeal of corporate shares has always been the access they grant us to business surpluses with nothing at stake except the money we put in. Since overpriced shares defeat that purpose, paying back too little for too much invested, what matters are market prices as a ratio of company earnings per share, a broad yardstick to assess fair stock value. In dynamic settings, what’s earned tends to swing up and down, but any profit-enlarging firm’s share that’s available for less than 20 times its annual earnings could be a rewarding buy. Bought and held, unless its profit path droops at some point, it will pay its purchase price back in under 20 years if all the money made is shared. Even if some portion is retained to plough back, profit growth would surely shorten that payback period, with the stock’s rising resale value best seen as an underlying asset bonus.

After Wednesday’s close of trading on the Bombay Stock Exchange, its Sensex had a price-to-earnings (PE) ratio of just under 21.5. By rolling together the data of 30 companies, this figure offers a broad valuation that another market slump could push below 20, a signal of blue chips selling cheaply enough for value picks to be made. Of course, as dividend income is the objective, retail investors should opt for stocks with high dividend yields: i.e., large annual payouts as a percentage of prices. While it is rare for these yields to exceed what bank deposits pay, deflated markets have let such rarities exist even among well-reputed Indian companies. Ascribe this to the peculiar times we’re in. Post-pandemic normalcy is still some time away. Careful selection is therefore a must. As earnings got a boost in 2021-22 from cheap capital assured by an extraordinary policy, PE ratios and payout yields that look attractive today could let buyers down once interest burdens start going up. Last year’s profit spurt can easily turn out to be a one-off. Still, so long as India Inc’s prospects don’t take a gloomy turn as financial conditions tighten and the global outlook dims, less frothy stock markets should give us a chance to go on a value hunt.

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