Fluctuations in share prices are as old as the concept of shares and stock markets themselves. Infact, had it not been for the regular fluctuations, stock market would have been a very boring place. It would be like a bond or a FD. And who would like that. 😉
As a long term investor, few things excite me more than the large fluctuations in share prices of individual companies. And I am not talking about small companies (having few crores market cap) here. I am referring to large caps, i.e. huge and well established companies of India.
Being a risk-averse investor, I have a liking for large businesses. Investing in well established and (supposedly) well-run businesses helps me sleep well at night. 😉 These businesses have witnessed and survived multiple bull and bear markets. So chances of them surviving again are pretty good.
And if we are patient enough, markets eventually do offer temporary mispricing in large caps shares.
But most investors believe that there are fewer opportunities to create money in large caps. I do not subscribe to this view and have already written about why it makes sense to consider large caps when others are looking elsewhere (This article was quotedby the CEO of a leading MF house in their monthly publication).
52-Week High Vs 52-Week Low
Now I did an interesting study comparing the 52-week lows with 52-week highs of various companies constituting Sensex and Nifty 50. Take a look at the analysis in tables below (share prices as of 30th June 2016). The column titled ‘% Change’ measures the difference between the 52-week high and 52-week low in percentage terms:
As you can see, there is a huge difference between the two numbers for most companies. Infact, the average difference between the 52-week highs and lows is more than 50%.
Now take a look at the Nifty 50 companies:
The story remains the same. Here too, the 52W-high is almost 150% of the 52W-low.
Now these companies are well-established and safe businesses (ofcourse if bought at the right price). But think of it – does it really make sense that a company like (say) TCS, is worth Rs 4.2 lac crore today and worth Rs 5.5 lac crores after few months?
No – I don’t think so.
For most of these large companies, there isn’t much that changes at actual business level in the course of few months. Its only the perception of market participants that changes and moves the prices.
The reason for such wide difference in perception of actual value (which drives market price) can be many. In a post about fluctuations in market price of large companies, John Huber mentions about two sources of market’s inefficiencies: 1) Disgust and 2) Neglect.
Now large cap companies are generally not mispriced due to neglect, given the analyst coverage and popularity they have.
More often, mispricing is because of disgust or pessimism. This temporary disgust can be due to bad results, negative news, temporary legal problems, etc. Large caps (or even the stocks in other categories) can get beaten down even when the general market environment is pessimistic. In bear markets, shares of companies with no significant problems at all, are beaten down because of general economic pessimism. Its like all boats (good and bad) come down when the water levels reduce in river.
Mr. Market (and not Mrs. Market)
I am sure you have heard of the concept of Mr. Market (created by Benjamin Graham). This concept is quite relevant here and hence, I mention it:
Every day, Mr. Market will come up to you and quote a price for a stock (or stocks).
When he is optimistic about the future of the business, he will quote a high price to buy or sell. On days when he is not feeling great about the future, he would quote a very low price.
But luckily for you, he does not force you take a decision. You can choose to do nothing about Mr. Market’s quotes and he still won’t mind (maybe that’s the reason Graham created Mr. Market and not Mrs. Market). 😉
And if you are sensible, you would sell to him at a high price AND buy from him when his price is lower than what you consider low-enough.
And this is the beauty of this game. You can always wait. You can wait till the stock you want to buy is mispriced (on lower side).
Mr. Market’s continuous irrationality and urge to give a quote to you everyday creates the opportunity, which you should wait for.
And as Charlie Munger points out: “For a security to be mispriced, someone else must be a damn fool.”
So all you need to do is to wait to find a damn fool on the other side of the trade you want to make. If not a damn fool, even a fool would do. 🙂
A Real Life Example of Mispricing
A friend of mine is into poultry farming. Now without sharing the real numbers, lets assume that few years back his business was churning out annual profits of Rs 50 lacs.
One day, things got bad and some bird-disease spread in his farm. He had to take the drastic step of eliminating all birds as is the norm in poultry business. The business was in distress. At that time, he received an offer from a competitor to purchase his business (including physical assets) for about Rs 5 crore.
He declined the offer as it was too low. Also because poultry was one of the many businesses he owned, he could chose to wait for things to get better as he was not going to go bankrupt due to the poultry fiasco.
Eventually, he revived the business in an year or so and got another offer for about Rs 12 crore. He did not sell even then. I don’t know what price he would have sold at. Maybe Rs 50 crore (Sell high. Remember?). I don’t know.
But what I am trying to say here is that inspite of the business generating profits as earlier, there were buyers willing to give more than twice the original offer. Ofcourse, the original offer was made at a time of distress. But that was a temporary distress. Different people were valuing the same business at different times differently.
The same happens in stock markets.
Temporary problems (leading to disgust) or general pessimism (bear markets) causes share prices to go down. This doesn’t mean that that is the end of the road for the businesses. Businesses recover. And this what an investor should remember.
Market prices will continue to fluctuate more than actual intrinsic values. So as a discerning investor, if you are willing to look further than other investors and are also ready to accept short term losses and volatility, then you can indeed benefit from these opportunities.
This is what Warren Buffett had to say about how we as investors can benefit from these mispricings:
If you look at the typical stock on the New York Stock Exchange, its high will be, perhaps, for the last 12 months will be 150 percent of its low so they’re bobbing all over the place. All you have to do is sit there and wait until something is really attractive that you understand.
And you can forget about everything else. That is a wonderful game to play in. There’s almost nothing where the game is stacked in your favor like the stock market.
What happens is people start listening to everybody talk on television or whatever it may be or read the paper, and they take what is a fundamental advantage and turn it into a disadvantage. There’s no easier game than stocks. You have to be sure you don’t play it too often.
People tell me that small and mid-caps offer far more opportunities than large caps. That is true. And many times, these opportunities offer potentially higher returns than what mispriced large caps might offer.
But small cap investing comes with higher degree of risks and as I have already mentioned, I have a bias for looking out for mispricing in large cap stocks.
So if like me, you are also interested in large cap stocks, then do keep track of index (Sensex, Nifty, etc.) stocks and their 52 week highs and lows. I do it using simple Google sheet (screenshot below):
I am sure that you will soon find large cap stocks getting mispriced. 🙂