BUBBLE AND ANTI-BUBBLE

How to Spot Value in an Exuberant Market

Balaji G R – Head of Research and Co-Fund Manager at ithought
Financial Consulting LLP

“It’s not supposed to be easy. Anyone who finds it

easy is stupid” – Charlie Munger

“Investment success doesn’t come from

buying good things but rather from
buying things well” – Howard Marks
 AUTHOR’S NOTE
The following analysis summarizes our current thinking about market’s
exuberance. As Frida Khalo says, “I don´t want you to think like myself
(like us) but I want you to think”.

The analysis is not exhaustive but tries to be as objective as possible.

Whether we agree, disagree, or simply ‘agree that we disagree’, I hope the
arguments will help you reach your own conclusions and avoid herd
mentality .

Let’s start with a simple definition of a ‘Bubble’.

Bubbles are artificially expensive assets driven by a false belief known as a

misconception. They reflect situations where ‘the Emperor has no clothes’
and will collapse - ‘a matter of when, not if’.
 Vantage Points: 7 Points of view for evaluating potential
Market Exuberance -

1. Higher number of new Investors entering the market in a particular Asset

Class

2. Leverage Play

3. Market Sentiment – Higher flow of Capital to a particular Asset Class

4. Issue of large planned IPOs

5. Higher confidence on predictive power

6. Higher trade in Smallcap Stocks

7. Sudden rise in valuations which were unseen in the past

Marker 1: New Investors entering the market in a particular asset class
1.42 Crs new DEMAT accounts were added during FY 2020-21 which is 300% more than
the previous FY 2019-20 where the growth was only 50 lakh DEMAT accounts.
The average age of the new investors is trending lower and the mix is getting skewed towards
Tier 2 and 3 locations. This indicates that new investors with limited experience are entering
the market. Most of them have experienced only a one-way upward rally in the last 15
months.

Source : NSE Market Pulse – June 2021

Source : Angel Broking Q1 2022

Marker 2: Leverage Play
Clients are willing to take on more leverage to benefit from the rally. Most of the broking
houses’ Margin funding book has doubled in the last year.
Leverage is a double edged sword. During good times, leverage magnifies the return and
during a downturn, which is generally inevitable, it takes away a lot of capital earned during
the rising market. Unless used wisely – leverage does more harm than good to the investor
(AKA Speculators).

Source: Angel Broking Q1 2022

Marker 3: Positive Market Sentiment
Raising money with ease is one of the biggest signs of market sentiment as investor risk
appetite at this juncture is very high.
Investors are willing to allocate more than their usual capital towards asset classes which
have done exceedingly well in recent times. Record collection by new funds, Grey market
premium (GMP) and large IPO subscription are testimonies to this sentiment.

ICICI Pru Flexicap NFO garners Rs. 10,000 Crore

Zomato IPO – Issue subscribed 40.55 times

Tatva Chintan – Grey Market premium at 60%

Source : Business Standard

Source : Business Standard

Marker 4: Issue of Large planned IPOs
One more sign of a potential bubble is large IPOs starting to hit the market and getting over-
subscribed.
When new IPOs are subscribed with a lot of enthusiasm, most of the investors tend to sell
their long term wealth creator stocks to participate in new stock ideas which get all the
attention at the point of time.
As investors, we need to remember the base rate of success while making investment
decisions in new age start-ups. In high probability, few of these companies might become
wealth creators in the future but assuming ALL the new age companies are going to perform
like Amazon/Netflix is a big assumption to make and only long term evidence can support
such strong narration.

Source : Business Standard

Marker 5: Higher confidence on predictive power
Another sign of market exuburance is to check the degree of confidence among market
participants on future prediction. In the game of uncertainty – seeking certainty is not a wise
game.
The below graph clearly highlights how we are generally very optimistic on projections but
reality turns out to be very bleak for many reasons. It’s wise to have conservative estimates.
We should allow the companies to exceed our conservative expectations rather than setting
a very high bar and expecting them to exceed it. It is neither prudent nor realistic in nature.
Marker 6: Higher trade in Smallcap Stocks – NIFTY Smallcap Traded

Volumes as % of NIFTY 100 Traded Volumes

NIFTY Smallcap Traded Volumes as % of NIFTY 100 Traded

Volumes
60%

56%
55%

50%

45%

40%

35%

30%

Source : Ace Equity

Marker 7: Sudden rise in valuations which were unseen in the past
In every market cycle – a few sectors or a few type of stocks get all the attention. Below is
one such example where the company had a big tail-wind due to COVID-19 which led to a
sharp jump in its business. Profits almost doubled from FY 2020 to FY 2021, during a period
when our economy suffered one of the worst degrowth phases in our lifetimes. On top of this
elevated earnings base – the stock is currently trading at 75x reported earnings. This stock
usually trades in the range of 20-25 TTM PE as observed in the past.
As investors, our job is to not get too excited about the current earnings growth alone. We
need to focus on sustainable growth in the medium term and should also avoid overpaying
in order to improve our margin of safety.

Source : Screener.in

Source : ACE Equity

Conclusion: A bubble in the markets can be confirmed once it bursts.
However, explanations can only be constructed in retrospect because only once we know
the outcome can we decide on what to emphasize and what to ignore.
As investors, we do not have the ability of predicting the future but what we know for sure is
to look for all the evidence around us dis-passionately before taking decisions.
 ANTI-BUBBLE
When bubbles emerge, Anti-Bubbles also emerge. In 1980, Japan was at 15% of the world’s
GDP but was receiving 50% of the capital flow. During the same time, US was at an Anti-
Bubble stage.
Anti-Bubble: Defined by light trading with price stagnating at low levels despite solid growth
of the economy or sector or stock. Anti-bubbles struggle to attract the attention of the
investment world. Look for inexpensive growth stories.
As capital allocators, our primary job is to look for businesses which have long term potential
and to allocate capital at appropriate valuations.
In last 2 months, we initiated a few new positions in our portfolio which reflects our thinking
in terms of not chasing momentum and how we are moving up the quality ladder during
euphoric times like this.
One such example:
Company A: A chronic-focused leading MNC company and one of the market leaders in
diabetic therapy. More than 60% of the revenues come from chronic therapies like anti-
diabetic, cardiac, vaccines & respiratory.
The parent has over 5 decades of experience and is a leader in the global markets with a
presence in over 90 countries. The company has a debt-free balance sheet with a high
dividend pay-out ratio with healthy cash in the books.
However, the company trades at a significant discount compared to its peers.
The business was available for a Free Cashflow yield of 3% plus with long term growth in the
zone of 10-15%. This business generally trades at a premium to the broader index due to a
strong balance sheet and cashflows with MNC pedigree.
Due to near term earnings concern – the business started trading close to the broader market
multiple which gave us a great entry opportunity to buy a world class franchisee business
with ROIC upwards of 100%.
Concall Highlights from another player in the industry – on Diabetic Business

Source: Q4 2020-21 Conference Call

Company A’s price chart vs NIFTY – Rebased to Rs. 100

Source : ACE Equity

Company A’s trade Premium/Discount to NIFTY

Source : ACE Equity

Company A – Balance Sheet as on 31 December, 2020

Total Share Holders Capital: 2,119 Crs

Total Cash Equivalent: 1,675 Crs

Total Profit: 477 Crs

Cash % of Shareholders Capital: 79%

Pre-Tax ROIC: 132%

Source: Company Annual Report 2021

Conclusion: The market at a broad level looks expensive in certain pockets and cheap in
other pockets. As capital allocators, we should continue to move out of crowded trades and
deploy capital in durable ideas. Protecting the downside risk is one of our primary jobs in
addition to generating sustainable long term returns.

“Risk means more things can happen than will happen” – ElROY DIMSON

Happy Investing!!!

Disclaimer: All data/information used in the preparation of this material is dated and may or may
not be relevant any time after the issuance of this material. The recipient of this material is solely
responsible for any action taken based on this material. ithought Financial Consulting LLP takes no
responsibility of updating any data/information in this material from time to time. The statements
made in this presentation are forward looking and based on our current views and assumptions and
involve known and unknown uncertainties that may cause actual results or events to be materially
different from those expressed herewith. The information contained herein should not be construed
as forecast or promise.