Intrinsic Value Feb newsletter

The Market correction that we were waiting for is here. It has come with uncertainties But it usually does. It is the nature of the market.

I feel there is a major cyclical shift is going on. Most of the stocks that have performed better in last 2-3 years will not work in next 3 year.

For those who are not familiar with our understanding of cyclical behavior of the market, let me give you a brief.

Our Model assesses different market cycle and give us the Minimum and maximum Intrinsic value of a business given the fundamentals and behavior of market.

There are predominantly 3 cycles which affect and decide the price of business.

1. Economic cycle- Country’s economic cycles are decadal stories, if you look at India’s Growth you can see an average growth rate of 6-7% from last 20 years or so. It is a no-brainer. you don’t have to understand macros in detail to understand that your country is in Up economic cycle

So just for illustrative purpose, the economic cycle for the short term (7 years) it will look like this.

2. Sectoral cycle- Industries and sectors go through cycles due to continuous variation in supply/Demand, commodity prices, agricultural output, import/Export, Government actions (Incentives, tax rebates, Tax imposition, Dumping duty, subsidies)

This cycle is very subtle and it continues for years until things are changed. Diff sectors can have different period of cycle though.

     3. Sentimental cycle (Bear/Bull phase)- This is the ups and Downs the market faces due to liquidity, value, Public sentiments. We look at stocks going plus/minus 20% every year mean while the fundamentals of company remain the same. Since it has very little to do with the business fundamentals, this cycle goes up and down frequently. This cycle is very quick, volatile but the significance is relatively low.

Stock price is nothing but the superimposition of these three cycles.

So in order to make big money you have to

1. Ignore the economic cycle but have to factor in company’s worth.
2. Get the sectoral cycle right.
3. Take benefit of sudden ups and downs.

Our mathematical model reverse Engineers the process and tries to find out the price where both cycles bottom in order to make big money.

So as shown below become our preferred buying (Green) and selling (Red) zone.

We call them Min intrinsic value and Max intrinsic Value.

Minimum intrinsic Value means the Minimum possible value at which a stock can trade given economy, company fundamentals, and market sentiments.

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, we calculate the Min and Max Intrinsic Value of the company every year.

Below is what Min. and Max. intrinsic Value looks like when compared to stock price.

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TRAPS- Now I can see a lot of fellow investors putting their money in businesses that have already given great returns over the last 2 years.

Most of the investors want to put money in stocks that have given 6-8X and now have corrected by 30-40%. Here is why I think its not a good idea.

Lets take an example of IT or speciality- chemical companies.

Businesses have performed well in past, Stock price has out-done the performance. Even next 2 year forward fundamentals are priced in their stock price and now as they have corrected, this is where they are.

In this case they may see a short term upside but I can see a long underperformance after this which can go on for years. (Highlighted by red)

So if your objective is to make big money in long term, such opportunities look like trap to me.

OPPORTUNITIES- We should look opportunities in the sectors that have not seen a Up cycle from last 3-5 or even 7 years and due to current correction we may be able to catch the bottom (Highlighted).

Sectors which have not performed well in last years

1. Real-estate
2. Engineering and Infra
3. Tobacco
4. Media- Entertainment etc.

When the cycle turns these will be the biggest wealth creators for next years to come.

IMPORTANT Notes-

* You never know in advance when the upcycle will start, you may have to wait even for 2-3 years before any return. A value investor should practice patience to hold businesses for that amount of time.

* Predicting the start of the next Upcycle is almost impossible but estimating whether the sector is in the down cycle is extremely easy as all the past and present data is already available.

All you have to do is acknowledge it, take action and then wait.

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We at intrinsic value work towards finding the right cycles and riding it to the fullest.

Recently based on this approach we have created a small-case also which you can subscribe

https://intrinsicvalue.smallcase.com/

We had launched it on 16Feb and due to current market conditions, it is also down which makes it the best time to invest in undervalued stocks as we don’t know the future of Nifty. Russia- Ukraine issue may be just one of the many reason for fall of the market.

Thanks for reading

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Regards,

Intrinsic Value