We all have learnt to analyse stocks in a certain manner – corporate governance, growth opportunity, competitive pressures, returns, capital allocation etc etc etc…
Based on our understanding of these factors, we try to arrive at fair valuation of a stock and decide to buy if market price is lower than the fair price. Bigger the difference, bigger the margin of safety and hence more attractive the buy.
Theoretically, everything is perfect in this approach and we should get adequately rewarded for our work by the Mr Market. Actually, over long term that’s how it finally turns out, provided we have been true to our analysis.
The confusion, however, arises in the interim period – our attractive pick goes nowhere or continues to go down, whereas a seemingly expensive/ mismanaged stock continues to climb ladders. (Am sure you can relate)
Result – we keep wondering what is happening. The analysis seems proper but then why Mr Market is behaving so irrationally.
Now if you are a long term disciplined investor, you may suggest to simply ignore these interim inefficiencies and focus on the long term and I would principally agree.
However, the reality is – it’s easier said than done. All of us are humans and besides how does one actually define long term – 5 yrs, 10 yrs, 20 yrs or eternity ?
At some point every investor is bound to ask himself – am I missing something ? (Am sure you will agree)
I have asked this to myself numerous times over the years and have come to a conclusion that one key factor I should always try to understand is – “The Character of the Stock”.
What exactly is The Character of a Stock?
It’s how the Company is currently defined by Mr Market.
I believe there is a ‘character attribution’ that a Company implicitly receives from Mr Market at any given point of time. This character attribution happens due to varied reasons including but not limited to – historical track record, management quality, group structure, growth opportunity, FOMO, macro environment, regulatory dynamics etc etc.
Market factors in everything and then focuses on selective positives or negatives about a company at any given point in time.
Some examples:
- Bajaj Finance – solid execution track record, always beating the expectations
- Asian Paints – a difficult to beat leader
- Fortis healthcare – Struggling with regulators
- Paytm – uncertain profit path
- Ajanta Pharma – conservative boring management
Why trying to understand Character is important?
Because that can potentially help understand the movement in stock price over the short to medium term
- If character remains same – direction of stock price movement may remain similar as before.
- If character starts changing – direction of the stock might also start changing
Examples –
Paytm
Biggest question in everyone’s mind today is about how and when Paytm can turn profitable? Everything else including corporate governance, growth rates, capital structure etc are relatively less focused upon.
Till the time Paytm doesn’t show a profit (even nominal), very unlikely that the stock’s major downward trend will reverse. The moment it reports profits or even clear visibility of some profits, the stock may start seeing significant buying interest that may continue till ‘being profitable’ becomes a norm for it.
Once profits become a norm, market might decide to then start focusing upon something else e.g., corporate governance, consolidation, which may then become the new character of the stock.
Ajanta Pharma
A well managed company on all counts with reasonably attractive valuations. However, the management is not a big talker and is sometimes slow into launching new products.
Consequently, it gets characterised as defensive boring management with doubts on future growth potential. The fact remains that it continues to grow quietly and steadily.
The stock might continue frustrating short term investors till this character is not changed by sustained launch of new products through organic/ inorganic route.
Is the Character permanent or it changes ?
I believe it changes.
Reasons –
- Some character attributes are temporary
- e.g., Fortis. It’s suffering from the regulatory overhang for now and once that is cleared it might get peer benchmarked quickly. Then a new character might emerge (say a good/ poor capital allocator)
- Mean reversion. Excesses rarely sustain over the long periods
- e.g., Bajaj Finance. At some point over expectations do become a problem to manage.
This is a topic on which a lot more can be written. However, I believe the above would have given you a fair idea to think upon and check if it’s relatable with your own experience.
I would be keen to hear your views in the comments section. Also feel free to reach me at nitin@inves4.com to discuss anything. I try my best to answer each and every email.
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