Listening to a ‘good corporate story’

It is unfortunate that a lot of stocks are marketed on “good corporate stories” in a bull market. A finance company coming from the reputed corporate group or a biotechnology firm having a solid reputation for its cumulative R&D continue to enjoy such good reputation for their corporate image and strong balance sheets – such stories largely remain same over a period of three to five years. However, the stock markets go through tremendous cyclical changes even within three to five years.   

In a bear market like September 2013, investors, who blindly picked up stocks based on good corporate stories/images would have largely made decent returns in this bull market. However, the reverse is not true, buying stocks purely on good corporate images or stories in a bull market need not fetch decent returns. Rather such moves could actually end up in destroying wealth.

By last week, over Rs 33 lakh crore of market cap was added to the overall market value of BSE-listed stocks since March 2015 when the Sensex was around 30,000. The overall market cap moved up by around 32% from Rs 103 lakh crore in March 2015 to Rs 136.50 lakh crore last week when the Sensex hit record high level of over 32,500. However, just in last four trading days, over Rs 4.50 lakh crore worth of overall market value was eroded while the broad indices like Sensex corrected only marginally. Many stocks of good corporate stories also joined this meltdown.

The truth is that the good corporate images/stories generally remain same irrespective of whether the markets are in bull phase or bear. However, their valuations undergo massive changes based on market cycles.

It is very unfortunate to see many retail investors blindly following good corporate stories and buying the stocks without considering their valuations and growth aspects in the current bull market. In fact, cheap valuations and good corporate stories failed to enthuse many investors to buy some stocks, which were available at around free cash they were holding in the bear market of 2013 - there were a few takers for these stocks or their stories.

However, strong following in storytelling has led to many investors accepting over 100 PE for service companies, 30 to 35 PE on one-year forward earnings of manufacturing companies and eight to twelve times book values for the financial services/insurance companies in this bull market. Listening to good corporate stories may be necessary, but certainly not sufficient in creating or avoiding destruction of wealth in the stock markets.

The writer is founder and managing director, Equinomics Research & Advisory Pvt Ltd