COVID-19 as a crisis looks increasingly like it is going to have a significant impact on earnings for the foreseeable future. Once the crisis passes, so will the attractive investment opportunities it created with it. The minimum rate of return on investments will always go to the passive investor who yearns for both safety and freedom from concern, the maximum return would be realized by the alert and enterprising investor, who exercises intelligence and skill. It is very important at this time to understand a couple of factors that will help you in your path.
What influences stock prices in short and long term?
Stock prices in the short term are driven by supply, be it from FIIs or nervous investors or pure speculators. In long term, fundamentals always determine the price range. When prices seek lower levels because of external events, one should see it as an opportunity to grab them at lower levels, provided their fundamentals are unlikely to be impacted by the event.
Systematic risk Vs Unsystematic risk
Risks impacting all stocks in the market are called systematic risks while risks impacting only specific stocks are called unsystematic risks. What kind of risk does COVID-19 pose, systematic or unsystematic? Major events like COVID-19 pose unsystematic risks to a few businesses and systematic risks to a few other. To understand businesses that cannot remain impacted longer than the duration of COVID-19, we need to understand discretionary (vs) non-discretionary spending by consumers
Demand for products or services offered by listed stocks can be broadly split between those that modeled their business on discretionary spending and non-discretionary spending by consumers. Simply speaking, spending can be classified as “wants” and “needs”. Industries catering to the “needs” segment will always have a higher chance to bounce back. Segments such as food, detergents, power, fertilizers, medicines, health services and software to name a few. Amongst stocks that comprise of these segments, another important parameter to take into consideration is the amount of debt they hold. More precisely to look at would be the debt-equity ratio (bodes even better if they have zero debt) along with some other contributing factors.
For example, the power sector is usually heavily burdened by large amounts of debt and may suffer due to liquidity squeeze. With governments directing non-essential industries to stop operations during this time, the lockdown may have an adverse impact on companies with large debt. As an exercise, we have shortlisted the leaders from these other industries to create baskets. Drawing an example from 2008 crisis and similar other drops, we tried to see how PE ratios contract in crisis and expand later.
You will notice that since Pharma stocks didn’t go down during the crisis, further upside could be limited and only last till the duration of the crisis. Hence, we don’t recommend Pharma at this point. For the other industries though, you can see how eerily similar the movement of PE has been for these industries during the crisis and also notice the stellar bounce back once recovered from the crisis. Risk averse investors should consider this option for additional investments because apart from adding diversity, these groups will recover their lost ground rather quickly.
With this theory above, we at Vivekam have developed Vivekam Baskets – Defensive. This product caters to risk averse investors during this crisis. Write to us at firstname.lastname@example.org or give us a call at 040-23549941/42 or +91 9100009891 to find out more.