Should I Buy Stocks? Should I Wait?

Imagine a scene from a typical 1990s romantic Bollywood movie. The heroine is sitting with a friend under a tree pulling leaves from a stem while chanting, “He loves me? He loves me not? He loves me…”

Her idea is to reach a positive response (‘He loves me’) by the time she reaches the final leaf.

Now replace the heroine with a stock market investor, and you might not need to replace the scene. Most investors I meet these days have the same question to ask.

“Should I Buy Stocks? Should I Wait? Should I Buy Stocks? Should I Wait?”

I hope that ‘leaf strategy’ worked in the stock markets as well!

Anyways, before we move ahead to answer this question our way, first let us look at this chart that shows the movement of Sensex and its P/E (price to earnings) since the start of the financial crisis in 2008.

Data Source: BSE
As the chart shows, both the Sensex and its P/E (average P/E of 30 companies that comprise the Sensex) are considerably up from their lows of end-2008.

However, if one were to look at the last 1-year performance (since October 2010), the Sensex P/E has fallen much faster than the Sensex itself.

What does this suggest?

The simple formula for P/E is: Price divided by earnings.

Here, the price is the Sensex’s market capitalization. And earnings represent the combined earnings of all the 30 Sensex companies.

Now since P/E has fallen faster than the price (Sensex), it means earnings have risen.

The math is – when numerator falls fast and the ratio of numerator to denominator falls faster, it’s largely because the denominator has risen, even if at a low rate.

What does this mean? Isn’t the Indian economy facing a slowdown? So why are the earnings rising?

The simple answer is that the impact of an economic slowdown, rising inflation, and rising interest rate is seen on corporate profitability with a lag.

This is because in crunch times, the first response of companies is to maintain revenues and profits by reducing prices and lowering their costs.

But when the slowdown persists, ultimately companies see a decline in their sales and they don’t have many levers left to cut costs further.

This is when they see a negative impact on profits, which is what we expect Indian companies to start seeing in the future.

What this means is that while we have seen ‘some’ impact of the slowdown on stock prices already, the real impact on corporate profits will start to show soon.

Also, if the global slowdown persists, and in case a few Eurozone countries go bust (the likelihood of which is increasing by the day), the impact will be deeper on the profits of Indian companies.

This will also impact stock prices further.

Okay, so what?
“So you expect Indian markets to fall further from here?” you may ask.

See, I don’t have the ability to predict the future (and I don’t have the magical leaves to help me!), so I won’t say a definite ‘Yes’ to your question.

But yes, most factors as of now are pointing to a deeper crisis for the world economy. And this could most possibly mean an extended pain for stock prices in India.

“Let’s cut it short here! Just tell me whether I should invest or wait for markets to fall further. Or should I sell given that markets may fall further?”

I can understand your dilemma, dear investor, and this is my answer.

Sell stocks with poor business fundamentals and shift that money into companies you really want to own – the ones with sound business models, ethical managements, and those that can survive a deep economic slowdown.

Most importantly, keep buying using the dollar cost averaging method – bits and pieces every month like you do via the SIP method in mutual funds.

See, there is no sense in making all-or-nothing decisions when that type of thinking doesn’t fit market conditions.

Remember, you miss 100% of the shots you don’t take, so getting to the sidelines is not a profitable plan.

Staying in the game always has been, and always will be, the way to profit.

In short, buy in small chunks…then wait…then buy more.