I will give you a stock...
a company that is going to grow its revenues at 30% annually and profits at 39% annually for the next 7 years.
would you buy this stock?
many of you would say a big "
yes".
many had said "
yes" in the last bull run too.
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today, they regret their decision.
this is not the story of any Pentamedia Graphics or HFCL. These are hard facts about India's IT major Wipro.
7 years back, in the bull run of 1999-2000 people had become extremely bullish about the IT stocks. They foresaw a strong and bright future for the IT stocks. Yes it did happen. The bigger IT companies have grown from strength to strength in the last 7 years.
Wipro's revenues in FY 2000: Rs 2300 crore.
Wipro's revenues in FY 2007: Rs 15000 crore. (30% compounded annual growth).
Wipro's profits in FY 2000: Rs 300 crore.
Wipro's profits in FY 2007: Rs 2942 crore. (39% compounded annual growth).
Still many investors of that time have lost money in Wipro.
Lets look at the
average stock price of Wipro for some quarters in FY 2000 and FY 2001.
All prices are already adjusted for bonuses and stock splits. In the last few years, dividend yield of IT companies has been very small compared to their prices and can be neglected.
Q1 FY 2000 (April-June 1999): Rs 133.
Q2 FY 2000 (July-September 1999): Rs. 182.
Q3 FY 2000 (October-December 1999): Rs. 276
Q4 FY 2000 (January-March 2000): Rs. 900.
Q1 FY 2001 (April-June 2000): Rs 487.
Q2 FY 2001 (July-September 2000): Rs 472.
Q3 FY 2001 (October-December 2000): 428.
Q4 FY 2001 (January-March 2001): 344.
Let us assume an investor bought Wipro shares in each quarter at the average price prevalent in the respective quarter.
What returns he would have got in these seven years?
(Current Price of Wipro: Rs 441)
Q1 FY 2000 bought at Rs 133. (returns in 7 years: 18.7% annualized)
Q2 FY 2000 bought at Rs 182. (returns in 7 years: 13.5% annualized)
Q3 FY 2000 bought at Rs 276. (returns in 7 years: 6.9% annualized)
Q4 FY 2000 bought at Rs 900. (returns in 7 years: -9.7% annualized)
Q1 FY 2001 bought at Rs 487. (returns in 7 years: -1.4% annualized)
Q2 FY 2001 bought at Rs 472. (returns in 7 years: -1.0% annualized)
Q3 FY 2001 bought at Rs 428. (returns in 7 years: 0.004% annualized)
Q4 FY 2001 bought at Rs 344. (returns in 7 years: 3.6% annualized)
For anyone who bought between FY 2000 Q3 and FY 2001 Q4, the stock either gave negative returns or returns less than that given by a simple fixed deposit.
This is the case of a leading IT company.
Here is the weekly price chart of Wipro. The light blue ribbon is the average price of 13 weeks (1 Quarter).
If, I had done the same analysis for smaller IT companies like Polaris, the returns from most quarters would have been negative.
If, I had done the same analysis for hot stocks of that time like Pentamedia, the investors would have been left with an amount equal to the brokerage that they paid for buying these stocks.
So what went wrong?
The problem was discounting the future too much.
The fact that a company is going to show strong growth in next few years, does not mean its stock will grow at the same pace too.
As the saying is "
a good company is not a good stock, unless you get it at a good price".
The Maruti 800 is a great car, but will you pay Rs 10 lac for it?
No.
The same logic works for stocks. There is a price at which a good company is a good investment.
If a stock price is already factoring growth of next five years, there is no way it is going to good returns in next few years.
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Another thing that I would like to point out from the above analysis is the
diversion of price and value.
If you look at the above returns table, you would say the stock had little value above Rs 250 in 1999-2000.
Did that mean the stock did not go above Rs
250?
No.
The stock actually went to Rs
1500+ levels.
Why?
because
this is how bull markets work.
many people tell me - "you said stock ABC was overvalued and still it went up 20%-30%."
this is because
bull markets don't stop at fair valuations. they can go much beyond fair valuations.
in a bull markets, stocks usually don't go below fair valuations.
on the upside, they can go anywhere. thus, for a fresh buy in bullish stocks, buying at little below fair valuations would be a good idea.
but for selling, it is difficult to give a target.
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it works in the opposite manner in a bear market.
in bear markets, stocks don't rise much above fair valuations.
on the downside, they can go anywhere. thus, for a sell in a bear market, selling at little over fair valuations would be a good idea.
but for buying, it is difficult to predict a level -
bear markets can take stocks to highly undervalued levels.
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The current bull market is not as ferocious as the 1999-2000 one, but there are certainly many stocks in which the markets have already factored 3-5 years of growth - especially in the so called "high growth" sectors.
Investors would do themselves a lot of good, if they start looking, not just at company's future growth, but also at
valuations.
Bull Markets, Bear Markets and Investing
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