AUTHOR: – JAIDEEP BHALLA
(Company Secretary (Aspirant), LL.B, B.COM Graduate, An Investment Portfolio analysts,
First Runner-up winner Moot Court Competition Organised by ICSI Noida Chapter)
Mobile No. 7838684213
“I will tell you How To Become RICH. Be fearful when others are greedy and Be greedy when others are Fearful”. – Warren Buffet
Introduction
The coronavirus (COVID-19) outbreak is causing widespread concern and economic hardship for consumers, businesses and communities across the globe. The world is experiencing social distancing, travel restriction, restricted travel, scaling down of business operation, disruption of supply chain, reduced demand and an overall contraction of economic activity.
Fears of a global Covid-19 pandemic have battered the stock market and the strain of the virus is sending ripples through the stock market, business, and world economy.
Indian equity markets have corrected significantly over the last one month (Nifty down ~26% from its 52-week high of 12,362 to the lows of 16th March 20) in tandem with global equity markets due to headwinds from the Covid-19 outbreak across multiple countries
The brutality of the stock market crash has caught everyone off guard. Within 20 trading days, starting 24 February, the Sensex has declined nearly 15,000 points
Nifty going down to multi-month lows, investors are struggling to find the right stocks for investing. There is a bearish sentiment in the market and hence, it is imperative to note that what investor do in the current scenarios.
The Psychology of Investment
Ben Graham, widely known as father of financial analysis, has taught three generation how to navigate the market. Graham observed that an investor’s worst enemy was not stock market but oneself.
Imagine that you and Mr. Market (“Nifty/Sensex”) are partners in a private business. Each day, without fail, Mr. Market quotes a price at which he is willing to either to buy your interest or sell his.
The business you both own is fortunate to have stable economics characteristics, but. You see, Mr. Market is emotionally unstable. Some day he is cheerful and can only see brighter days ahead. On these days, he quotes a very high price for share in your business. On the other, hand Mr. Market is discouraged and, seeing nothing but trouble ahead, quotes a very low price. If Mr. Market’s quotes are ignored, he will be back again tomorrow with new quote. However, If Mr. Market is in drunken mood, you are free to ignore him or take the advantage of him.
Analysis of Mr. Market and Impact of Coronavirus
In the past couple of years, the Gross Domestic Product (“GDP”) in local current prices has grown at annual rate of 16 % over the 5 years. Please note the GDP rate includes the effect of price inflation and it is NOT the real GDP. Further, it is imperative to note that the P/E (“Price- Earning Ratio”) since 5 months was in in range bound 25-28. Whereas, in last couple of weeks due to the pandemic Coronavirus shaved of the one third of the market cap and hit dramatically. Consequently, P/E ratio scourge to 17-19. Thus, considering the Current scenario we may say that to earn Rs.1 we need the investment of Rs. 17
P/E Ratio = Price/ Earning = 17/1
Assuming that due to pandemic Coronavirus the earnings would brutally whipped out, there is going to be a slowdown of business operations, there would be NPA issues, some of the sectors would virtually down, and some of them will be on the verge of bankruptcy.
Considering the fact, thus, assuming that earnings would fall from 1 to 0.5 and followed by the principle of Efficient-market hypothesis, assuming that price would be reflected at 8.5. Therefore, the P/E ratio would be 17. P/E Ratio = 8.5/0.5.
Now further, assuming the fact that down the line 5 years, Indian economy strives to recover from a slowdown and the earning would start recovering, and GDP would start surging at annual rate of 15% Compounded annually. Consequently, the earning would be double from Rs.1 to 2 and Mr. Market again start trading at the P/E Ratio of 25.
Explaining the mathematical pristine of the P/E ratio considering the aforesaid assumption as follows:
P/E ratio = Price/ Earning
25 = Price/ 2, Price = P/e * earning Price = 50.
Thus, based on aforesaid assumption we may conclude that to earn Rs. 2 we need the investment of Rs. 50.
Now Synchronizing, the current scenario of the market with the aforesaid assumption we may conclude that if we Invest Rs.17 in the current market and assuming that the Mr. Market recover all the loss aversion and rationally correct itself in the next 5 years and left over all the physical and mental languishments of coronavirus the price would be Rs.50.
Therefore, conclude that Rs. 17 invest in current market would be payoff the Rs.50. Perhaps clear demonstrate the Mr. Market may compound at the rate of 25% from current scenarios.
A simple illustration let us imagine that you are running a business and you are earning Rs. 1 Crore annually from your business, and market price of your business is Rs.25 Crore. Thus, P/e ratio of your business exhibited at 25. Then suddenly the pandemic coronavirus hit dramatically on economic hardship of your business and your business earnings would start fading out goes to 0.5 Crore, having said that the price would rationally followed, thereby assuming the price would be 8.5 Crore. Concluding that P/e ratio is 17. Now my question to you would you sell your business.
If answer is no, assuming the crisis of outbreak of pandemic is over and economy start recovering and your business again start paying off and down the line 5 years the business start paying the earning of 2 Crore followed by the market price of your business is Rs.50 Crore.
Market cap to GDP (also known as the Buffett Indicator)
A common metric of measuring whether market is overvalued or undervalued is to gauged by the Indicator warren Buffet Indicator
The Warren Buffet Indicators defined as total value of a market relative to the economy GDP. A value below 100 per cent suggests the market is undervalued and is due for recovery.
Ratio of total market cap over GDP: Maximum – 158%; Minimum – 40% Considering the present scenario
Current Annual GDP: $2,879 billion US dollars or 216,455 in billions of national currency and market cap on 26th March, 2020 is 97,728.60 billions of national currency (Source NSE)
=97,728.60 / 216,455*100
=45.15%
Interpretation
- If the Ratio is :
- 50% to 75%, the market is said to be modestly undervalued
- 75% to 90%, the market may be fair valued
- 90% to 115%, the market is said to be modestly overvalued
Concluding, that Mr. Market is displaying a collective frenzy leading to a disruption in price discovery and sharp differences in bid-ask rates.
Key takeaways from market cap to GDP
- In current Equity market outlook as on March 26, 2020, India’s Market Cap to GDP ratio sharply at 45.15% clearly shows that the Mr. Market is trading certainly low and undervalued.
- The current Equity market is trading at the significant margin of safety of more than 50%
- The current market is trading significantly below to its intrinsic value.
- When the cycle of greed and fear plays itself out over and Mr. Market start recovering, it may certainly surge to 100%. Therefore, the clear indication of more than 50% up trend from this point.