Friday, June 3, 2011

Stock stories and Risk-Reward bargains

Earnings season for Q4-FY2011 is now over. It was a mixed bag and these are the best times to accumulate fundamentally sound stocks when liquidity is running low and market is in nowhere-to-go zone. We have discussed valuation basics here. We now take a macro view on relationship between understanding stock stories and attendant valuation risks:

  1. For very easy stock stories like strong Brands & mature FMCGs, the valuations remain very high vis-à-vis future business growth which may be average.
  2. For easy stock stories like emerging Consumer plays, valuations are uncomfortably high with issues of sustainability of future earnings growth and/or risks of expansion or roll-out not happening as anticipated.
  3. For nearly easy stock stories like established Pharma, valuations are high vis-à-vis muted revenue uptick, off-patents risks by 2012 and dependence on new research break-through.
  4. For moderately easy stock stories like IT, valuations are tricky given defensive nature and good business models but affected by global uncertainties, attrition issues, poor volume growth, cuts in spend by clients.
  5. For less than easy stock stories like Metals and Commodities, valuations may never catch up if your entry into the stock is at the wrong end of the economic cycle or ill-timed.
  6. For difficult stock stories like Infrastructure/power, valuations are tough to comprehend in view of project execution challenges, land acquisition & environmental issues, capex requirements, longer gestation periods and reliability of fuel linkages.
  7. For very difficult stock stories like Turnaround case or good company but management facing court case/ inquiry, valuations are also difficult since past earnings are no indication, financial impairment is difficult to assess but rewards can be equally big.
This is what makes equity investing interesting. I believe in bottom-up stock picking where valuations are fair to attractive, and in some cases they are compelling.

At this point, risk-reward trade-off favours the patient investor. Make the most of it!

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