How to make the most of the stock market correction

But this correction was a long time coming. The valuations of most small caps and mid caps made little sense, and were high enough to make a true-blue value investor consider retirement.

So here we are.

The Sensex is down 12% from its 52-week high.

The small cap indices are officially in a bear market, having dropped 20% or more. The BSE Smallcap Index, for instance,is down 22% from its peak in December.

A celebrated fund manager recently advised caution even for SIPs in small caps and mid caps, unless you keep at it for two decades. He reportedly said,”We think it is a clear time to take out lock, stock, and barrel from small and mid caps.”

I’m not sure if he actually said that, but if he did, I disagree.

As the correction in individual small caps is a lot sharper than the index itself, valuations look better now than a few weeks ago.

Also read: FPIs sold ₹780 bn in Indian equities in Jan—Here’s where they raised their stake

Now, the correction could deepen further. You see, the smallcap to Sensex ratio is at 0.59, a premium to long-term median of 0.45. But the worst thing you could do now is press the panic button. It’s crucial to differentiate the ongoing market volatility from risk, which is a phenomenon that leads to permanent loss of capital.

While more pain could be in store, the key to making good returns is staying in the game. Asset allocation and margin of safety in valuations may not give you immunity against a correction, but can certainly give you staying power.

Opportunity knocks

For a long-term investor, this is a better (if not the best) time to invest in small caps than two months ago. A good number of individual small caps have corrected a lot more than the index, providing opportunities to buy more for the long term.

However, many people tend to take past prices as a benchmark, and see corrections as a buying opportunity irrespective of what’s happening at the industry and company level.

But simply looking at stocks that are at 52-week lows isn’t enough. The winners in the next cycle could be different from those in the last rally. So keep your eye on the business trajectory rather than just the extent of the correction.

Also read: These five stocks have rallied up to 70% during the smids bloodbath

Where should you start looking for opportunities? A few days ago, I shared a watch list based on insider buying during the market correction.

Promoters typically have a long-term mindset. As such, if they see a correction as a buying opportunity, there is a good chance that the business has more value than is reflected in the stock price.

Here are some stocks insiders have bought in February. Note that this is just a watch list and no recommendation is implied.

Stocks with insider buying in February

Also read: Ace investor Madhusudan Kela picks up stake in India’s largest solar module maker

Another way to start would be to look at earnings. Most if not all companies have announced their results for the December quarter and for the nine months to December. As such, it would be a good idea to build a watch list of companies that have performed well but seen their stocks caught up in the broader market correction. I’ll dig deeper into this once the earnings season is over.

Happy investing!

Disclaimer: This article is for information purposes only. It is not a stock recommendation and should not be treated as such.

This article is syndicated from Equitymaster.com