Cyclical investing: Quality investing in its purest form

Cyclical investing allows investors to make big money in a comparatively shorter period of time. Reason is its a dynamic journey marked by the pendulum swing from extreme pessimism to peak euphoria. The allure lies in seizing quality companies at the nadir of pessimism—what we often refer to as purchasing “Charlie Munger’s stocks at Ben Graham prices.”

wouldn’t that give us an edge?

Sounds very easy, right? Its not.

Let me pose a question: If I were to suggest investing in a lubricant company amidst the current frenzy for EV-related ventures, what would your immediate reaction be? That incredulous expression you’re wearing now epitomizes extreme pessimism—a sentiment we’ll circle back to later in this discourse.

Now, let’s dissect the three predominant cycles that exert profound influence on stock prices over protracted periods:

1. Economic Cycle: A nation’s economic trajectory unfolds across decades. While you needn’t be a macro expert to discern your country’s economic upswing, recognizing its cyclical nature is paramount.

           So if I have to illustrate the economic cycle for the decade it will look like this.

Its not a straight line, it’s a sinusoidal curve just like any other cycle, but the time period is in decades.

2. Sectoral cycle– Industries and sectors undergo cyclical shifts driven by factors like competition, supply-demand dynamics, commodity prices, agricultural output, and governmental interventions (Incentives, tax rebates, PLI, Tax imposition, Dumping duty, subsidies). These cycles persist for years until substantial changes occur. 

3. Sentimental cycle (Bear/Bull phase)– Market sentiment fluctuates rapidly and dramatically due to liquidity, perceived value, and public sentiments. This cycle, characterized by frequent volatility, operates largely independent of business fundamentals.

This cycle is frequent, quick, and volatile.

To summarize the above –

In essence, the superimposition of these cycles derives the stock price

So inshort if we disintigrate the stock price we will majorly get 3 components as shown above.

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Our model calculates Min intrinsic value and Maximum intrinsic value of businesses by reverse engineering and disintegrating stock price into sectoral and sentimental cycle.

So Minimum intrinsic Value means the Minimum possible value at which a stock can trade given company fundamentals and market conditions.

Similarly, Maximum intrinsic Value means the Maximum Possible value at which a stock can trade given the above parameters.

Since fundamentals only change once a year thus we calculate the Min and Max Intrinsic Value of the company every year.

This is what it looks like when compared to stock price.

Our model dissects stock prices, calculating the minimum and maximum intrinsic values annually based on business fundamentals and market conditions. When a stock descends to its minimum intrinsic value, we enter the market; conversely, when it ascends to its maximum intrinsic value, we exit.

We have already talked about How we rank Stocks in this article  where we rank stocks based on 3 year Sales, 3 year ROCE and P/B ratio and take top 10% stocks to start our analysis.

So it comes down to this.

1. Find undervalued sector.
2. Rank stocks within sector.
3. Buy top ranked businesses at their calculated Min intrinsic value.
4. Have patience.

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A key differentiator-  

It is very easy to say “Buy low & sell high”

But How low is actually low?

If a stock is trading at 100 Rs, can i call it buying at lower prices?

What about when if it is trading at 5 Rs?

We all have enough common-sense to understand that absolute values mean nothing not just in investing but in any other domain.

But what about PE? can PE be trusted. we see a lot of stocks going below PE of 15 towards PE of 2-3 while some of them don’t even come below PE of 35 and keep going towards 60-70. clearly PEs are important valuation tool but you can’t rely of PEs to take investment decision. Infact in case of commodity stocks you will end up broke if you are a PE investor as most of the commodity stocks are undervalued when they are near PE of 30-40 and are overvalued when at PE of 3-7.

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Why did we call it Quality investing at its purest form-

Consider this: investors often laud stocks like Asian Paints and HUL as quality stocks, yet names like MRF, L&T, HERO, or Castrol rarely receive the same accolades. The disparity stems from recent price performance rather than intrinsic quality.

In reality, quality transcends short-term performance—it withstands adverse conditions and emerges resilient. We apply this principle to businesses, seeking those that thrive amidst adversity. By focusing on sectors with lackluster performance over the past 5-7 years and evaluating stocks based on sales growth, ROCE, and P/B ratio within those sectors, we identify true quality—the essence of enduring success.

This is why i call it Quality at its purest form. 

In essence, while this framework is simple in theory, implementing it demands courage. It’s not easy to invest in businesses that have faltered in recent years and anticipate multibagger returns in the near future. Yet, it’s precisely this courage that distinguishes a cyclical investor.

I have talked about how to find Potential 10X opportunities in stock market

where i have talked about more than 4-5 multibaggers that i made and what are the constituents we saw in those companies when we bought. It can work as a great learning session for you in case you are interested in making multibaggers in the market.

#investing #Investingforbeginners #Valueinvesting #Longterminvesting #Mutualfunds #smallcase #personalfinance

About Author-

Nikhil Gangil is a SEBI registered Research analyst, founder of Intrinsic Value Equity Advisors, IIT Madras alumnus and a value investor. He comes with 11+ years of experience in the market and has worked with many reputed Oil and gas EPC companies like L&T and Worley and thus has industry experience in Construction, Infra, Steel, Oil and marine related businesses. His strength is to find well-growing companies at wonderful valuations.

Follow him on Twitter, Join his value investing community

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