Build Wealth with Stocks

The year 2020 has been eventful for the equity markets.
Covid-19 Coronavirus was first detected in China in Dec-19 and quickly spread throughout the world. Though we have past precedents of different strains of Coronavirus spreading like SARS, MERS, Ebola etc. Covid-19 spreads much faster than all the previous instances.

The black swan event for equity markets was not that the Coronavirus spread globally; what was unexpected was that simultaneously complete lockdown of the economy had to be implemented all across the globe. Businesses and factories were shut and the global economy came to a halt for 3 months.  There has been a severe impact on the global economy and stock markets all across the globe fell drastically in Mar-20

Let us look at the behavior of the Nifty50 index between 1^st Feb-20 and 19th Jun-20.

The impact of the Coronavirus was not visible on the markets as of 1^st Feb-20 and the highest Nifty level in this period was 12,201 on 12^th Feb..
Once the Coronavirus fever spread to the markets, panic spread very fast and the market made a bottom on 23^rd of Mar-20. The Nifty closed at 7610 on 23^rd Mar-20 down by (-38%) in just 40 days. As of 19th Jun-20, the Nifty is still (-16%) down from its high of 12,201 of 12^th Feb.

What has happened to individual stocks in this interim period?
Nifty50 has increased to 10,245 an increase of 34% from the bottom of 7610
From the market bottom on 23^rd Mar, out of the 2600+ stocks traded on BSE

1377 stocks have increased by more than 30%
846 stocks have increased by more than 50%
219 stocks have increased by more than 100%

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Let us assume that when the market started falling in February, we just got scared and switched off the TV and the moneycontrol app and only looked at the stock prices again on 19th Jun.

The stock price of 637 stocks is more than what it was on 1^st Feb
The stock price of 198 stocks has increased by more than 30%
The stock price of 128 stocks has increased by more than 50%
In fact, stock price of 31 stocks has increased by more than 100% compared to their price on 1^st Feb-20.

Job loss, impact on the economy, human suffering, upcoming global slowdown has occupied the newspapers, television channels and whatsapp groups since Mar-20 when the Coronavirus impact became visible to everyone.
But, think – in the last 4 months, were you better off trying to find at least 1 of those 128 stocks that went up by more than 50% since 1^st Feb or you were better off trying to predict the bottom of the market and thinking about where the markets and the economy are headed?

What else does the above data tell us?

• The stock market bottom and the individual stock price bottom may not coincide
• Maybe, the overall stock market index will go up, but the stock we have purchased will not go up or the vice versa may happen, the stock we are interested in will go up even if the overall market index remains down.
• You will either get certainty or cheap valuations/prices – never both
• Even in this market, there could be stocks whose prospects have actually increased several times because of the Coronavirus pandemic – think of Zoom, Big Basket, 4G/5G data provisors, youtube etc.

We invest in the stock markets to make money.
So, let us ask ourselves some deeper questions

What is risk?

“The stock price goes down after I purchase the stock”?
Is that what risk is to you?
The financial world also defines risk in similar terms – volatility ie price movements (up/down)

However, to my mind, the real meaning of risk is the chance that I will permanently lose money in the stock markets.
When will this happen?
If I make mistakes in buying ie the companies I bought go bankrupt or their business suffers some major permanent setbacks/declines.

How do I avoid this scenario?

1. I invest in profitable companies with a history of good performance of at least a decade.
2. I invest in companies that have come out stronger on the other side of past economic recessions like the one in 2012-13 and the global financial crisis of 2008.
3. I choose companies that do not have a lot of debt – no debt, no need to make draconian choices especially during economic downturns we are witnessing right now due to Coronavirus.
4. I invest in companies that have a certain competitive advantage – companies whose customers do not have much of a choice but to buy from my company.

If your investment strategy revolves around trying to identify and invest in 5-10 such companies as described above what is your bigger worry?

Will the market go down in the next 3 months?
Or
Is the company I have invested in really as good as I imagine it to be?
Is it really as good as an Asian Paints or a HDFC Bank?

But falling markets is a reality.
Then, how else can you insulate yourself from a severe market decline?

Investment time horizon
Indian economy has grown by an average 6% in the last 30 years with average inflation of 5%. This means, in absolute terms, Indian economy grows by 11% on average.
Which means the economy itself at least doubles every 7 years.
If your time horizon is 5-7 years or more and you have chosen the type of companies we have described above, the chances that you will permanently lose your capital (risk) drastically reduces.

Now, let us ask ourselves another simple question
How is big money made in the stock market?

By buying stocks cheap in bear markets
Or
Buying stocks during bull markets when they have already gone up substantially?

Your investment strategy will completely depend on your answer to the above question.
I am the former sort of the person. I will carefully select companies and invest the maximum money during a bear market to create real wealth when stock markets substantially go up during the next bull market.

Coming back to the question of what is happening with the markets?
What are our worries today?

• How long will the recession last?
• How severe will the recession be?
• When will India/world economy start growing again
• What will be the impact of the India-China border clashes and the unfolding China Vs rest of the world cold war?

Let us take some help from the richest person in the world – Jeff Bezos of Amazon.
Amazon operates in the highly disruptive technology industry where the only constant thing is change and disruption. What does Jeff Bezos have to say about predicting the future?

Jeff Bezos became the richest person in the world on just one principle – “What is not going to change”

Similarly, instead of trying to predict where the markets are going, let us ask ourselves
What are we sure of?
That the entire globe is in an economic slowdown and we are definitely in a bear market.
And as we discussed above, how is the big money made in stock markets – by buying stocks cheap during bear markets.

Now, let us take some history lessons.
What happened to some of the quality companies during the global financial crisis in 2008?

Let us assume, you had no clue what was happening in the US housing market. You had no idea about mortgage-backed securities (MBS) and collateralized debt obligations (CDO). And you happened to identify a good business which you thought is worthy of a place in your portfolio.
You bought Eicher Motors – the makers of the Royal Enfield brand of motorcycles right at the top of the market in Oct-07 at Rs 480 per share.
Lehman brothers collapsed one year later in Sep-08, all hell broke loose and the stock of Eicher Motors kept falling. In hindsight, the market made a bottom in Mar-09 when the stock price went to as low as Rs 210.

This was a staggering drop of (-67%) in a span of 18 months.
Now, 18 months is not a short time period – it is very painful to hold on to such a huge loss for so long. I am sure any investor would have been cursing himself in 2009 for pressing the trigger to buy Eicher Motors.
Fast forward 11 years and the same stock is selling for Rs 16,800

Rs 1 Lac invested in Eicher Motors in Oct-07 at the peak of the market is worth Rs 35 Lac today.
If you were lucky/smart to have caught the bottom, the same Rs 1 Lac invested in Mar-09 would be worth Rs 80 Lac, a very handsome outcome indeed.

But, imagine what would have been going through your mind in Sep-08, in Dec-08, in Apr-08?
Wouldn’t you be thinking – “The world is screwed and the economy is screwed and it is going to take years for humankind to get out of this hole we have dug for ourselves. I am going to wait for another 10/12 months to see if things settle down and there are some green shoots in the economy before I start to buy the stocks again”.

Now, one may argue that Eicher Motors was a relatively unknown company back in 2007. Let us study what happened to the stock of Asian Paints – the then largest paints company in India.

Let us assume, you bought Asian Paints – right at its peak in Aug-08 at Rs 121 per share.
Lehman brothers collapsed one month later in Sep-08, all hell broke loose and the stock of Asian Paints started falling as soon as you bought it. In hindsight, the market made a bottom in Mar-09 when the stock price went down to Rs 74 – this is a fall of (-38%)
A fall of (-38%) in the bluest of the blue-chips is not small.
Fast forward 11 years and the same stock is selling for Rs 1610

Rs 1 Lac invested in Asian Paints in Aug-08 at its peak is worth Rs 12 Lac today.
If you were lucky/smart to have caught the bottom, the same Rs 1 Lac invested in Mar-09 would be worth Rs 22 Lac, a better outcome.

But what are the chances that you were able to catch the bottom?
Even if you did indeed buy at the rock bottom in Mar-09, do you think you would have had the courage to buy large quantities at the exact time of maximum pessimism?
There is no point in putting just Rs 1 Lac in this stock. In all probability, if you had Rs 1 Lac to invest in Asian Paints in Mar-09, your annual salary today must be touching Rs 1 Cr. The Rs 22 Lac you made in the Asian Paints stock does not move the needle so much for you today. What I want to stress is that just identifying the “market bottom” is not enough, betting enough money that will make a material difference to your wealth is more important – and this is the difficult part since everywhere the emotions are running very high and the fear is at its maximum.

Why have I dealt with this historical aspect in detail above?
To decide which amongst the below questions is more important

Is the market going to fall in the next 3/6 months?
OR
Am I invested in the right company which can increase by 10 times in 10 years?

Clearly, time and effort spent on the latter question is more productive and friendlier to our wallet.

Now, let me deal with the question of what I personally think is going on with the stock markets.
In hindsight, Mar-20 was the point of maximum pessimism. How did the world look like around 20^th Mar-20?
The developed world was down on its knees – Coronavirus was spreading very fast in Italy, United States, Germany, UK, Switzerland etc. Given the old population especially in European countries, death rate was high, there were vivid images of mass graves being dug up in the dark of the night. I especially remember a scene where the entire floorspace of a Church was filled-up with 200+ coffins and mass cremations were being carried about. Healthcare systems were getting clogged, we had no clue how to even partially cure the disease. Humanity was facing one of its gravest challenges.

A harsh lockdown was imposed globally and 2 months down the line most countries have flattened the curve. We have discovered that some of the existing cheap medicines like Hydroxychloroquine which are used to treat Malaria help some of the more severe patients. There is also strong evidence that countries like India which have universal BCG vaccination programs at birth have a much lesser infection/death rate. The Coronavirus is less harmful in tropical countries like with humid weather and where the malaria disease is rampant.
Today, the Coronavirus pandemic is still damaging but still somewhat manageable.

What about the economic impact of the Coronavirus pandemic?
The worst-case scenario for any of the economies is that because suddenly the incomes have become near zero for many businesses and individual people because of job losses, companies and individuals will find it difficult to repay loans. This will have cascading effect through the banking system and the flow of money will suddenly come to a stop.

However, this scenario seems to have been avoided. In the US, the federal reserve announced a massive bond buying program to prevent a panic in the credit markets. In India, the RBI announces loan moratorium first for 3 months which was extended by another 3 months. Because of the moratorium, repayment has got shifted by 6 months. What has essentially happened because of the economic lockdown is that incomes have just shifted by 6 months. Unlike a physical war or natural calamity, no factory has been destroyed, no houses are destroyed. All the assets are standing as they are, only there is a stoppage of income for 3 months of lockdown. This is probably not such a bad scenario.

India also ensured that there is no mass hunger. The first “economic package” that India announces was giving away of food-grains free.
In my opinion, that is probably the reason behind the swift recovery of the market form the lows of Mar-20.

However, one thing is certain – there will definitely be a slowdown in the global and Indian economy for a few years. People will not make big ticket purchases like a car, house, big flat screen TV etc. People will try to postpone expenses as much as possible. Banks and finance companies will have a very difficult 18 months. There is no saying how many will be able to repay their debt in full when the economy is back to normal.

If a 2^nd wave of Coronavirus comes, a lockdown will be of no use since the number of infected is already so high. There will be partial lockdowns and the economy will have to maneuver speedbreakers for some time to come. There is no denying a strong possibility that there could be another market sell-off in the near future.

The question is how will you make the most of it, when it happens?
What can you as an individual investor do?

What we need is a “system”, a process that will help us make money irrespective of whether the markets go up or down in the near-term.
We want a strategy that will allow us to focus on the important questions and not depend on predicting the market direction.

Let us not waste time trying to predict the market movement. Instead decide which are those good companies that you are confident about and want to buy. Decide a price X that you want to pay to own the company. Given that we are in a bear market, buy the company when the price falls to 0.7X. And then how does it matter if the stock price falls even more? If you have the funds and you are confident about the company, and the stock price falls even further, just go ahead and buy more.
Spare 4 mins and watch this video from 2009.
Just as markets fall deep, when they recover, they may recover ferociously. The above video is from the “Golden Monday” of 2009  when trading had to be halted because the Sensex and Nifty broke upper circuit as soon as trading started for the day. When such a thing happens, there is no opportunity to buy because there is no one selling their stocks.

“I think this rally since Mar-20 is a fake one and the markets are definitely going to fall.”

If you fall in the above category of investors, then please go ahead and short the market . Put your money where your tongue is. But, remember that the market can remain irrational longer than you can remain solvent.

If you are the conservative type of investor who genuinely believes that the markets will fall, I have a suggestion for you.
Good investors recognize that stock investing is a game of probability. There is nothing like 100% certainty – which means instead of predicting, we should be preparing.

Let us assume, you have a corpus of Rs 1 Cr which you want to invest in the markets. And you think markets are going to fall.
Today, the Nifty is around the 10,000 mark
Invest 30% if the Nifty falls to 9,000
Invest 30% more if the Nifty falls to 8,000
Invest another 20% if Nifty falls to 7,500
Invest the balance 20% if and when the Nifty falls to 7,000

And also plan for a scenario where the markets keep rising over the next 12/18 months

You may vary the Nifty levels at which you want to invest and the percentages you want to invest based on your judgment. However, putting in a system means that you don’t have to take a decision when emotions are the strongest especially when stocks are falling left-right and centre. The very purpose of designing a system-driven approach is that exactly when decision-making becomes tough, we have an algorithm which we can implement and benefit from.

To summarize, here’s how you can make the most of this bear market

1. Either you will get certainty or cheap prices/valuations – never both
2. Invest during bear markets to reap the benefits during bull markets
3. Work on what’s in your control
4. Build a system which you will be able to implement especially when there is blood on the street and fear is running high
5. Prepare your mind to act when the time comes

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Disclaimer:
Do not consider this article as a recommendation to buy or sell a stock.
Please seek advice from your investment advisor before making any investment decisions.
The author (@amey_candor) is a SEBI registered Investment Advisor.

If you want to seek investment advice click here and someone from my team will get in touch with you within 48 hours.