With the stock markets falling from recent peaks, investors have two questions. Is it time to buy yet, or will markets correct further? If I decide to buy, what should I be buying? We attempt to answer this.
Where they stand
Stock market moves are decided by an interplay of many factors — expected economic growth, earnings growth of companies, interest rates, money flows from retail investors, domestic institutions and foreign investors and so on. Given that all of these factors are hard to predict, no one can tell you in advance if stock markets will fall further or rebound from here.
While the above factors drive stock prices in the short run, in the long run there is only one driver of stock prices. That is the earnings growth of the underlying companies. Therefore, you can gauge ‘good’ levels to buy stocks based on valuation.
On valuations, large-caps today offer more attractive opportunities than small-caps or mid-caps. From the market peak in September 2024, the large-cap Nifty100 has corrected 14 per cent, leading to its PE (price earnings ratio) dipping from 25 to 20 times. This is in line with its 10-year average. The Nifty Midcap 150 has declined 20 per cent, with its PE moderating from 46 to 34 times. The Nifty Smallcap 250 has fallen 24 per cent, with its PE shrinking from 32 to 27 times. (Data as of March 14). These indices trade well above their long-term averages in terms of valuation.
Broadly, the mid-cap and small-cap segments of the market still factor in earnings growth of 25-35 per cent, while large-caps are building in 12-15 per cent. Therefore, there seem to be more buying opportunities among large-caps than in mid-caps or small-caps, though there are exceptions.
Past cycles have also shown us that large-caps are the first to bottom out and rebound from a bear market when growth picks up or liquidity returns. Mid- and small-cap stocks begin their upmove only after a bull run in large-caps is well-established. Therefore, investors should do their bottom-fishing in large-caps first and wait for the correction to play out in mid- and small-caps.
MF categories to buy
For amateur investors looking to buy into the correction, taking the mutual fund route is easier than ferreting out individual stocks.
One, with Trump announcements coming thick and fast, it can be tough to figure out sectors/companies which can weather global uncertainties. Two, volatile markets do not give you a lot of time to research businesses and a professional fund manager is better-placed to do it. Three, a good fund manager will keep altering his portfolio to navigate global events and changing prospects without your having to constantly keep an eye on events or markets.
However, given that further market declines cannot be ruled out, you need to be selective with your fund choices. Some types of funds contain losses better than others. You can invest a lumpsum in the following types but deploy it in phases.
Large-cap funds: Funds investing only in the top 100 stocks may weather both earnings and market risks better than others. Today, the large weightage of reasonably-valued financial stocks in large-caps strengthens the case for owning this basket. You can take this exposure through Nifty 100 index funds or active large-cap funds that figure on our recommendation list (Invesco Large-cap, ICICI Pru Bluechip).
Value style funds: When markets rebound after a painful correction, the value style of investing outperforms other styles. This is because investors, battered by severe wealth destruction, become very wary of overpaying. Value style funds, even if they invest in small-/mid-caps, are good at containing downside, as they own portfolios that are cheaper than markets. Here, don’t just look for funds labelled as “value” but look for candidates across the value, contra, dividend yield and flexi-cap categories. The fund’s portfolio PE being lower than the market, is a good test of whether the fund truly follows the value style. ICICI Pru Value Discovery (portfolio PE of 19), Parag Parikh Flexicap (18.7) are two funds that meet this description.
Quality style funds: If focusing on reasonably-valued stocks is one way to play it safe, the other is to focus on high-quality businesses with strong cash flows, high shareholder returns and profit growth. Quality companies have underperformed markets in the last five years. While active funds following the quality style are hard to identify, index funds mirroring the Nifty 200 Quality 30 and Nifty Midcap 150 Quality 50 indices are a good option.
Filters for stocks
If you have the time and skills to pick stocks on your own, keep the following factors in mind while choosing them.
Frugal on valuations: Trending bull markets like the one post-Covid convince investors that valuations don’t matter as long as they can find companies with exciting prospects. But in bear phases, markets become skeptical about growth and focus more on what they are paying for it. This has been very evident in recent weeks, where high-PE stocks failing to meet expectations have been ruthlessly battered. This calls for sticking with stocks at moderate valuations. A good measure of moderate valuations is how the stock compares with the Nifty50 on PE, price to book value and dividend yield. Currently, the Nifty50 is at a PE of 20, P/B of 3.4 and dividend yield of 1.4 per cent.
Numbers over narratives: In bull markets, narratives about a business having a large addressable market is enough to propel it towards the stratosphere. Current numbers don’t matter in such idea-driven stocks. But when a bear phase arrives, the pendulum swings to skepticism and markets focus entirely on a company’s ability to deliver growth with sound metrics. This makes it necessary for you to ignore narratives and focus on earnings. This is time to switch from exciting businesses and go back to boring ones that have been around for a few decades.
Avoid recent favourites: When markets tumble after a raging bull run, newbie investors make the mistake of buying the dip on stocks that were the darlings of the bull market. But market cycles tell us that when there’s a market reset like the one we’re going through, new sectors take the lead while the old favourites fall by the wayside. This argues for staying away from the popular themes of the post-Covid bull run such as renewable energy, green energy, defense, government capex, digital businesses and so on.
Focus on quality: In the last legs of a big bull market, investors ignore essentials such as a company’s ROE/ROCE (return on equity and capital employed), balance sheet metrics on debt and receivables, free cash flows, good governance and management quality, and so on. But when the tide of liquidity recedes, companies that fail these tests get exposed. This prompts a return to quality checks. If buying stocks today, stick to companies that meet a high bar on ROE, ROCE, management quality and cash flows. Prefer companies with a history of regular dividend payouts and a yield of 2 per cent plus.
