Stock Market Investment: When do you make money on quality stocks?

Updated: Nov 27, 2019 8:29 AM

Whether you buy quality at a perceivedly high price or say non-quality at a juicy price, eventually if prospects remain prospects, you will be left only with quality losses.

Stock Market Investment, stock markets, quality stocks, money, NPA, NBFC, NiftyIllustration: Rohnit Phore

By Aashish Somaiyaa

Equity markets are witnessing polarised behaviour. While Nifty 50 is rising, broader markets encompassing small and midcaps are 40% and 23% lower from respective peaks. This is causing individual investors to feel aggrieved because they have exposure to broad markets where they have lost money, albeit it is just for now, while the “market”, as they willy-nilly call the Nifty is at all-time highs.

Within Nifty again, the upmove is with 10 stocks while the rest are languishing way below recent highs. The economy is starved for growth and companies that are still growing, sustaining growth through this phase are getting a premium. Can’t complain about tall pigmies! Can you? This is called a “quality bubble” in some quarters. I am calling it ‘quality conundrum’ because equity investing, as is often portrayed, is not about black or white, right or wrong or similar other definitive conclusions—it’s about context, perspective and evolving ideas.

Quality stocks

What is quality? Are a few B2C consumer companies quality? Are the handful of lenders who didn’t get caught in the NPA or NBFC sector crisis proving their franchise, quality? Some of them are clearly trading expensive and may deliver no return in the near to medium-term but are they the start and end of quality? As investors, it’s our job to look for quality at all times, and at a reasonable price.

On the other hand, does anyone look for bad quality? Is quality an absolute term with junk being its alternative or is it a continuum from white on one end followed by shades of gray fusing finally into black? Ultimately every investor is looking for better earnings prospects for businesses, and whatever your definition of quality; you pay a reasonable or cheaper than what you think is reasonable price, and hold for your hypothesis to play out. Whether you buy quality at a perceivedly high price or say non-quality at a juicy price, eventually if prospects remain prospects, you will be left only with quality losses.

Do companies and businesses evolve on quality or stay labelled forever? Say, a lender believed to have issues pointed out by regulators undergoes a board and management shakeout, fortifies controls, corrects course and reports steady improvement in fundamentals; does it qualify as quality? Does a PSU which sees deregulation and withdrawal of government control evolve to becoming quality? Do economy-sensitive core sector companies that don’t over-leverage and maintain acceptable RoEs even at bottom of the cycle qualify as quality?

There are sound reasons why some businesses always ‘appear’to be expensive – but just as beauty lies in the eyes of the beholder, valuation which is a matter of the owner’s perspective also depends on multiple factors like growth, quality of growth itself and related return ratios, sustainability of growth and most importantly the holding periods – if at all you end up buying a quality business at the wrong price, your worst outcome could be a time correction, inordinate length of holding periods and opportunity loss for some time.

On the other hand if you buy what turns out non-quality at an attractive price, your worst outcome could be a permanent capital loss.

(The writer is managing director & CEO, Motilal Oswal Asset Management Company)

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