Bubble Wrap

FOR SOMEONE WHO has suddenly become one of the richest men in India, Radhakishan Damani does not have much of a public persona. There are no records of an interview by him ever to the media. When The Economic Times did a profile in April, the daily spoke to 30 friends and acquaintances except Damani himself. That is unusual for a man considered one of the biggest players of Indian stock markets through the boom of the past three decades. And even more unusual that he should stay so rigidly private while launching in March the IPO of the company he founded, Avenue Supermarts, which owns the DMart chain of retail stores.

It has not stopped stock markets from finding in Damani their darling of the moment, however. Business owners in India often have disdain for the interests of minority shareholders. As an investor of standing himself, Damani was counted on the side of the latter. He also built a damn good brand. If you want to keep a share price going up, then the business needs to grow relentlessly without being pulled down by factors like excessive debt. Damani had made the right moves after setting up DMart in 2002. Instead of renting premises, the company owned its stores and so its operating costs were less. If real estate prices went on an upswing, the value of its assets would increase manifold, giving it additional strength. DMart stores are lean, busy and full of customers. They are good with inventory management as compared to competitors and growing at a blistering pace. Avenue went public timed with the present bull market, but that it would create a perfect IPO storm even Damani might not have anticipated. The issue was oversubscribed by 100 times. Each share was priced at Rs 299, valuing the company at a little under Rs 20,000 crore. On listing, the stock immediately doubled, and as of today, it is somewhere in the Rs 1,200 range. The market cap of the company has quadrupled to a little under Rs 80,000 crore in half a year. Damani, who owns 82 per cent of it, is worth more than Rs 60,000 crore.

THIS WEEK, THE Sensex and Nifty touched an all-time high, indicating that the bull market is at full steam. One of the indications of this is not when a stock like Avenue, which has pedigree going for it, makes a fourfold jump, but when just about everything that an investor touches seems to turn to gold. More than Rs 50,000 crore has been raised in IPOs this year. According to Moneycontrol Research, of the 45 IPOs this year, 33 gained rightaway on listing. Small companies, whose market cap is usually a few hundred crores, are thought to be risky investments, but the Smallcap Index keeps on peaking. Money from domestic investors is pouring into mutual funds and the present bull run is largely driven by systematic investment plans (SIPs), in which people put a fixed sum regularly. The Association of Mutual Funds in India pegs the number of such SIP accounts at 16.6 million, and 880,000 new ones are being opened every month. In financial year 2016-17, Rs 43,921 crore was invested through SIPs, and in the first six months of this financial year, between April and September, the number stood at Rs 29,266 crore.

Fingers have always been burnt badly in times of market exuberance and yet it has never prevented the next mania. Why would people become blind to risk? Greed is the obvious foundation for bubbles. It begins with the delight that comes from the first taste of unexpected profits. This leads to the expectation that a good thing can keep going and if enough people believe in such a delusion, then it becomes a self-fulfilling prophecy until the crash. Warren Buffett, the most successful investor of this age, had a succinct explanation for bubbles. He was speaking to a group set up by US Congress to look into the housing bubble that led to the 2007 subprime crisis and the transcript, unclassified last year, was published in Business Insider where Buffett says, “… My former boss, Ben Graham, made an observation 50 or so years ago to me that it really stuck in my mind and now I’ve seen evidence of it. He said, ‘You can get in a whole lot more trouble in investing with a sound premise than with a false premise.’… So this sound premise that it’s a good idea to buy a house this year because it’s probably going to cost more next year and you’re going to want a home, and the fact that you can finance it gets distorted over time if housing prices are going up 10 per cent a year and inflation is a couple per cent a year. Soon the price action—or at some point the price action takes over, and you want to buy three houses and five houses and you want to buy it with nothing down and you want to agree to payments that you can’t make and all of that sort of thing, because it doesn’t make any difference: It’s going to be worth more next year. And the lender feels the same way. It really doesn’t make a difference if it’s a liar’s loan or you know what I mean? […] Because even if they have to take it over, it’s going to be worth more next year. And once that gathers momentum and it gets reinforced by price action and the original premise is forgotten, which it was in 1929 (the bubble before the Great Depression). The Internet (the Dotcom bubble of the late 1990s) was the same thing. The Internet was going to change our lives. But it didn’t mean that every company was worth $50 billion that could dream up a prospectus. And the price action becomes so important to people that it takes over the—it takes over their minds…”

THE PRIMARY DIFFICULTY of staying away from a bubble is that no one can predict when it will burst. The Economic Times profile of Damani had a quote from an investor acquainted with him, who said, “The stock is clearly overpriced now… RD would have shorted the counter if this was not his company.” The price of Avenue was Rs 780 at the time, and since then it has gone up by 50 per cent. If Damani had sold his own stock short, as the investor imagined, then he would have been looking at a serious loss.

Bubbles become self-evident, but even otherwise, there are metrics which indicate it. The Price-to-Earnings metric or PE ratio is one of the most popular in deciding whether a stock is cheap or expensive. It is the market price divided by earnings or profit per share. If a company has 100 shares selling for a rupee each and has made a profit of Rs 100 in a year, then its PE is Rs 1; if each share is trading at Rs 10 and it made the same profit, then the PE is 10. A higher PE indicates that it is an expensive stock. If it is 30, for instance, then the business would have to make its present profit for 30 years to equal the price of the stock. By taking aggregate numbers, a PE can also be calculated of the Nifty 50, the group of the largest companies in the National Stock Exchange. The Nifty PE tells you how the market as a whole is priced. In January 2008, at the peak of bull market before that year’s crash, the Nifty stood at a 28.25, just a little ahead. By October end 2008, after US investment banks went under, the Nifty PE had nosedived to under 12. Making money should be the easiest thing to do: just buy stocks when the Nifty is at 12 and sell when it is as 28.25. Instead, people do exactly the opposite because stock investing is essentially a reflection of behaviour which is determined by hope and fear. A line by Buffett, which is probably both the most quoted in the investment world and the least followed, goes thus: ‘Be Fearful When Others Are Greedy and Greedy When Others Are Fearful’.

At present, the Nifty PE is around 26.5. It is still a little behind the 2008 peak. On the other hand, the economy then was flying with GDP growing at close to 9 per cent. Economic growth is almost 3 per cent less now but the stock market seems to be saying it does not matter. Also, businesses now are still to recover from the jolts of demonetisation and GST. The value of a stock is based on future expectations. The market expects the economy to reverse and start galloping. However, the odds are still not in favour of someone who decides to invest now, even if the economy does as expected because current prices have already factored in a revival. To make money from these levels, the economy must outperform extreme expectations. Anyone who invests his money in the market is essentially making a bet on that optimism.

The price point that one gets into even the best of stocks means the difference between making or losing a million. Another company that is the beacon of this bull run is Bajaj Finance. The Bajaj group represents the best of Indian business; market leaders with a reputation for honesty and competence, farsighted and concerned about shareholders. For an indication of what this stock has done, consider a Financial Express article of August 2016 which said, ‘Bajaj Finance shares jumped over 16,000 per cent in the past seven-and-a-half years till July 2016. The share price of the company soared from Rs 63.10 on December 31, 2008 to Rs 10,357.25 on July 29, 2016.’ If you had put Rs 63,000 into the stock then, you would have made over Rs 1 crore a year ago. But the story didn’t end there. Since then the Bajaj Finance stock price has doubled again. So you would have made Rs 2 crore by now. On October 16th, when it released its second quarter numbers, profits had jumped 37 per cent despite the economic slowdown. No company in the world has been able to maintain a growth of such high double digits for a long time. At some point, there will be reversion to the mean. But those who invest in Bajaj Finance at present are essentially banking on this pace being maintained for decades, and this is typical of bull market favourites. It is possible but unlikely to happen. The lesson on getting rich from Bajaj Finance is to get the entry point correct; not to join the party paying a fat entry fee when the night might be getting over.

There is no way to predict how long a bull market can last because it is entirely driven by sentiment. Even portfolio managers, who recognise this, therefore buy stocks like Bajaj Finance at astronomical valuations. The bet pays off till it does not. Bajaj Finance or Avenue Supermarts could double again and there will still be buyers. There is something known as the Greater Fool Theory which, according to Investopedia, ‘is the theory that states it is possible to make money by buying securities, whether overvalued or not, and later selling them at a profit because there will always be someone (a bigger or greater fool) who is willing to pay the higher price.’ There is, however, also a Last Fool, the person after whom there is no greater fool. And he is the one who pays the bill for all the rest.

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