The Year of Common Sense

That time of the year when we put on our reflecting hats, and take stock of what we earned and what we learnt! :)

The past year has been a good one from an Indian capital markets perspective. I will not go into what worked and what worked less (because anecdotally hardly anything didn’t do well). Hopefully, all of you are participating because it’s just the start of a long value-creation journey in India.

Back to our Samvat reflections, I think this year will be the year of Common Sense – Yes, the one factor that is most obvious and the least pervasive. So, I thought of jotting down a few common sensical learnings that might come in handy for us as we renew our bahi khatas:

• Market Efficiency: In the era where there is hardly any information arbitrage and where unique insights have a very small shelf life due to widespread digital distribution channels, individual behavioral aspects become the true moats of an investor. It's not just superior intellectual capabilities, but the ability to stay through the course and stomach the volatility of business building and market vagaries that unlocks wealth creation. After a one-way run, we have seen a rough patch in the past few months, wherein participants suddenly started getting pessimistic due to?recency bias. At the same time, liquidity flows have also been robust, leading to swift market recoveries. Essentially nobody knows the short term, hence stick to the basics over the longer term.

• Valuation: The masses in the capital markets index more on proximate changes than on ultimate changes. One overestimates what can happen in the short term and underestimates what can happen in the longer term. This phenomenon leads to some stocks and sectors running way ahead of their fundamentals. The price starts factoring in multiple years of earnings growth and does not provide any room for execution risks or external factor risks. Over the past year, we have seen this play out in multiple hot stocks and sectors and it would be good to recalibrate future expectations there. Essentially need to find the right balance between extremes.

• Competitive Advantage: Sustainable value creation is indexed on two vectors: One needs to understand how much can a company grow (illustrated by earnings growth) and how long can a company keep growing (depicted by the earnings multiples at which it trades). In the past Samvat we have seen the competitive advantage of multiple companies in the same sector increase manifold which begs the question – Is there an infinite TAM? or are all the companies in a particular sector equally skilled to keep reimagining the TAM? It's very difficult to ascertain sustainable competitive advantage. Hence, it's essential to grasp the nuances of market shares, profitability, and the true causality between these factors to have an informed view.

• Decision Making: Narratives compound, as they are fuelled by confirmation biases (tendency to give greater credence to evidence that fits with existing beliefs), especially in a bull market. In the past year, we have witnessed an unprecedented boom in the SME capital markets which was primarily an extrapolation of narratives to eternity. It is thus essential to have a sound decision-making framework that weighs the fundamentals rather than just votes on?a story.

This Diwali let’s pray to Goddess Lakshmi as well as Goddess Saraswati to bless our portfolios and to bestow upon us the common sense to stay the course of quiet compounding. Bookmark this for the days when markets test your resolve!

Wish you a J-curve returns Diwali :)

Sources for graphics: DSP Mutual Fund, Web in general