I read this very interesting notes on trend identification from Basant Maheshwari’s Book : A Thoughtful Investor
There is always a bull market somewhere
- There is always a bull market in some asset class even as there is a bear market in another asset class in the same or a different geography
- A theme based bull run can create years of wealth in quickest possible time
- A bubble if handled well, can create a lifetime of earnings in about 36 to 48 months of work.
Bull Market Definition: Index convincingly crosses its previous high by more than 10% and keeps making new highs thereafter.
Whatever happens globally happens in India
Test of new Trend: The Business models should be proven in other parts of developed world. * Examples: IT was booming in developed world. Mortgage financiers have done very well in USA . Mobile telephony (2002) as Airtel was related to Vodafone
New Sector for each bull market
The bull market always happens in sectors which were not part of previously concluded bull markets and would normally be a sector.
- Examples: In IT Bull run of 2000, No one knew telecom, Infra , real-estate stock.
Logic of a fresh sector:
- Above average revenue growth cannot be expected to continue for two consecutive periods of time and slowly the market gets saturated.
- When there is a serious demand (E.g. IT), there are avalanche of new companies providing IT services and thereby exhausting the opportunities.
Conditions for a new bull market sector. It has to have minimum :
- public participation
- Investor ignorance
- general sense of disbelief for the business model of the companies in demand.
Identification of new Trend:
Watch the revenue growth of most companies in a specific sector. Most of them should have high revenue growth both individually and collectively as a sector
Scale of Opportunity
- The emerging trend has to be scalable.
- The market size should be several times the revenue of the sector leader.
- When the sector tops out, the market cap of the sector leader will be a lot closer to the size of the sector
First Generation Entrepreneurs
A new trend generally starts with new blood. A new promoter won’t have many choices and will have to raise money irrespective of the valuations. Banks probably would not finance him nor does he will have personal resources to fund the plans.
Stock hitting all time high:
- Stocks that hit new highs before the indices are more likely to extend their winning run in the next bull market. Wealth is also made by buying high and selling higher
- A stock that hits a fresh high does not stop at that but continues the trend and generally doubles in the next 12 to 18 months. The key is to look out for new high after time consolidation. Some kind of fundamental backing has to be there as just a mere movement of price beyond a level will not make it ready for that kind of move
Most of the new bull market stocks will be sector leaders having small market caps. E.g. Page , ITC, Infosys etc.
Relatively Expensive Valuations
- When the stocks delivers on earning promises, the market starts to put more trust on growth continuity and from current year earnings stocks start to discount earnings one year ahead.
- The actual threat to a bull market stock is not excessive valuations but slowing growth as valuations remain expensive and then over-stretched till such time that the company keeps delivering above average returns of growth.
Illiquid and Unpopular
- An illiquid stock suggests that investors are willing to take a long term view without undergoing quick buy and sell decisions.
- It also suggests that stock is unpopular and is not actively followed by the analysts and research houses.
- With time and performance , the liquidity and hence the P/e ratio of such stocks are bound to improve.
Lacks of Entry Barriers:
- For a sector to be a bull market leader, it should have little barriers to entry. This is contrarily to belief of high entry to barriers. Reason is that a new trend suggests a small number of companies growing in scale and size with the new entrants joining in to increase the investment pie.
- A spate of new IPOs towards the end is important and with very high entry barriers it will become difficult for new companies to join in .
- New companies with questionable management integrity is the necessary catalyst that cause a bull market bubble to burst.
- A frenzy bull market is not going to happen in consumer or pharma as these two sectors normally have high barriers to entry
Bear Market IPOs
- Most emerging companies are presented to investors through IPOs in bear Market.
- An astute investor should have a keen eye on the companies coming for an IPO rather than brushing aside all IPO’s with popular perception (Its probably overpriced)
- When Bear Market is around, Have a close look at the IPOs.
- A company that has worked with a private equity firm before coming for an IPO is generally assumed to have modeled its business well. Few reasons why PE exit a stock:
- They have found a better option somewhere
- The time period of the fund has ended and they need to return money. E.g. Jubilant Food, Page, Repco came this way.
- Look at red herring prospectus to get in before making the next move
Pickaxe and Shovel Theme
- When a sector reaches an extended level of valuation, an investor tries to identify company that will gain from the economic benefits of the underlying theme instead of buying the direct beneficiaries.
- E.g. During IT Boom, We could have looked at HDFC Bank as a beneficiary of computerization and Internet drive.
- E.g. HCL as an India franchise for Nokia make a lot of money because everyone getting a mobile connection has to buy a hand set.
- E.g. As Auto industry grew in past decade, Exide (25 times) and Amar-Raja (90 times) did well. Amara Raja also benefited for telecom sector boom as it supplied battery to telecom towers.
- The shares of the service providers will only do well if they can grow at a faster or similar rate that the industries to which these companies provide a service.
- While looking at pick Axe and shovel theory , a company will do well only on the basis of its own earnings growth only.