PMS Bazaar recently organized a webinar titled “Fund Manager’s Proven Strategy for Consistent Returns - Stock Selection Case Studies” which featured Mr. Arpit Shah, Co-Founder and Member of Investment Team of Care Portfolio Managers Pvt Ltd.(Care PMS). This blog covers the important points shared in this insightful webinar.

The webinar blog covers insights from Mr. Shah on market trends, investment narratives, and the transition from fundamentals to speculative hype. It explored stock life cycles, case studies of Asian Paints and Sarama, market patterns, small-cap stock opportunities, and portfolio concentration. Mr. Shah emphasised shifting from narrative-driven investments to fundamentally strong companies for long-term success.

Key aspects covered in this webinar blog are

• Understanding market trends and investment narratives
• Identifying narrative-based investments
• The life cycle of a stock or sector
• Case studies: Asian Paints and Sarama
• Recognising market patterns
• Shifting from narratives to fundamentals
• The role of small-cap stocks in market trends
• The importance of portfolio concentration and emotional discipline

Summary: Mr. Arpit Shah explained how investments shift from fundamentals to narratives as markets mature, often inflating stock valuations. He outlined the life cycle of stocks, highlighting risks of hype-driven speculation. Case studies like Asian Paints and Sarama illustrated narrative shifts. He advised investors to focus on fundamentals, real growth companies, and cash-generating businesses. Emphasizing portfolio concentration over excessive diversification, he stressed patience and courage in investing, concluding that long-term success lies in strong financial health, not speculation.

Understanding Market Trends and Investment Narratives

Mr. Arpit Shah recently started by sharing his insights on how investment patterns shift during different market cycles. He emphasised that, at times, market participants tend to base their investment decisions on narratives rather than fundamentals, which often leads to a significant impact on stock valuations.

He noted that in the early stages of a bull market, investments are usually driven by strong fundamentals, but as the market matures, narratives begin to take precedence. According to him, this transition from fundamentals to narratives is a key signal for investors to reassess their portfolios.

Identifying Narrative-Based Investments

Mr. Shah explained that narrative-driven investments function similarly to a cyclone—they spread rapidly and can disrupt many investors' portfolios. He highlighted that understanding different stages of such investments is crucial for making informed decisions.

While discussing this phenomenon, he clarified that narrative-driven stocks are not necessarily weak or poor companies. Instead, their valuations often extend beyond reasonable levels due to excessive speculation, social media hype, or macroeconomic trends.

The Life Cycle of a Stock or Sector

To understand how stocks transition from being fundamentally strong to narrative-based, Mr. Shah elaborated on the life cycle of a company or sector. He categorised the stages into the following:

1. Discovery Stage

At this phase, fundamentals start improving, financials bottom out, and valuations remain reasonable. Retail investors typically overlook stocks in this stage. He gave an example of how certain sectors, such as agriculture and pharmaceuticals, were ignored at the peak of 2024. Macro tailwinds also play a role in identifying promising sectors at this stage.

2. Growth and Re-Rating

Strong management, financial improvements, and external tailwinds help companies grow. As a result, they begin receiving higher valuations. Mr. Shah pointed out that this phase mostly occurs in bear markets when institutional investors have limited participation. Once stocks gain traction, social media buzz and extensive reports further fuel interest, leading to institutional investments.

3. Peak Valuation and Market Consensus

At this point, market participants accept the new valuations. If a stock initially traded at 15-20 times its earnings, it may now command 40-100 times earnings. Investors justify such valuations based on projected future growth, often overlooking underlying risks.

4. Distribution Phase

As stocks continue rallying, market enthusiasm increases. At this stage, most reports focus on narratives rather than fundamentals. Negative news gets discounted, and retail investors take significant positions. Promoters or institutional investors may start reducing their holdings, leading to distribution among smaller investors.

Case Study: Asian Paints and Narrative Shifts

To illustrate the impact of narratives, Mr. Shah discussed the case of Asian Paints. A few years ago, the company was widely regarded as an invincible leader in the paint industry. Market confidence in its business model led to exceptionally high valuations.

He pointed out that in Q2 FY22, the company’s management confidently dismissed competitive pressures. However, by Q4 FY23, they acknowledged increased competition affecting growth. Despite reporting improved financials, the company’s Price-to-Earnings (P/E) ratio dropped from 97 to 53, highlighting how narratives shift when market sentiment changes.

Case Study: Event-Driven Investing in the Entertainment Sector

Mr. Shah also referred to an investment in Sarama, a company within the entertainment industry. During a period of hype surrounding live concerts, the company’s stock surged significantly. However, once the enthusiasm settled, the stock price corrected. He noted that since his fund had a long-term investment in Sarama, they did not participate in this short-term rally, as they were aware that revenue from live events was minimal.

Recognising Market Patterns

According to Mr. Shah, understanding key patterns in narrative-based investing can help investors navigate market cycles. Some common indicators include:

1. Ignoring Financial Results

During excessive hype, market participants focus more on future projections rather than actual financial performance. He highlighted that in the case of electric vehicle (EV) companies, valuations often rise based on announced capital expenditure plans rather than concrete financial results.

2. Discounting Negative News

When narratives dominate, any negative developments are often overlooked. Investors justify valuations based on potential future success rather than current financial stability.

3. Sudden Shifts in Market Sentiment

Eventually, the hype fades, and stock prices adjust to more realistic levels. Those who invested based solely on narratives often face significant losses when the market corrects.

The Importance of Shifting from Narratives to Fundamentals

Mr. Shah advised investors to be cautious when markets are driven by narratives rather than financial performance. He suggested that this phase of the market could be an ideal time to reassess portfolios and transition towards fundamentally strong investments.

He reiterated that bull runs often have new leaders, and recognising these shifts early can help investors make better decisions. By focusing on financial strength rather than market sentiment, investors can build a more resilient portfolio and avoid potential pitfalls associated with narrative-driven speculation.

The Reality of Narrative-Based Investments

Mr. Shah pointed out that narrative-based investments often follow patterns that result in the first set of results being ignored. He stated that a shift in valuations gradually becomes the "new normal," which should not be the case. He emphasized that in such a scenario, there is no margin for error, particularly when retail participation increases.

A poll conducted during his discussion revealed that nearly 70% of investors preferred fundamental-based investment strategies rather than relying on narratives. He considered this a positive sign, suggesting that investors were moving in the right direction.

The Fundamentals Approach: A Reversal of Narratives

Mr. Shah explained that unlike narrative-based investments, the fundamental approach takes a reverse stance. Factors that were previously ignored, such as industry trends and valuations, gain significance. He noted that in this approach, valuations remain comfortable, providing a good margin of safety. Most importantly, investments made on fundamentals are not dictated by market hype.

He illustrated that in some cases, companies may not appear profitable in the short term but could be undergoing a transformation from losses to profits. Observing financial results, he advised, was a key criterion for making informed investment decisions.

A Case Study: The Agriculture Sector

Mr. Shah provided an example of investments in the agriculture sector. He recalled that during the election period, the rural economy, particularly agriculture-related companies, was largely ignored. However, there were significant triggers, such as expectations of a good monsoon and an increased government focus on rural development post-elections. He pointed out that budget allocations reflected this shift, as sectors like defense and railways saw increased funding, while rural and agricultural initiatives also received attention.

Having identified this trend early, he and his team had invested in fertilizer companies, seed manufacturers, and dairy industry stocks. He noted that these investments exhibited strong fundamentals and good market prices, reinforcing his belief in the potential of fundamental analysis.

Market Trends and the Role of Small-Cap Stocks

Mr. Shah observed that many companies poised for future growth may not always belong to the large or mid-cap category. He explained that during market corrections, investors often move towards large-cap stocks, perceiving them as safer options. However, this shift causes many small-cap stocks to be overlooked, despite their potential for high returns in a bull market.

According to his analysis, market indices had declined around 12%, with small-cap stocks experiencing a steeper fall of nearly 15%. Furthermore, 81% of companies had seen their stock prices drop by more than 20%. He emphasized that during such downturns, even high-quality companies suffer temporary declines, making it an opportune time to shift from narrative-driven investments to fundamentally strong stocks.

The Transition from Narrative to Fundamental Investing

Mr. Shah stressed the importance of this shift at the present moment. He outlined several key traits that investors should focus on when making this transition:

1. Moving Towards Real Growth Companies – Investors should prioritize companies with solid fundamentals rather than those driven by speculative narratives.

2. Evaluating Results and Valuations – A thorough assessment of financial performance and valuations is essential.

3. Shifting from Cash-Burning to Cash-Generating Businesses – He noted that businesses with high cash burn rates should be avoided, while companies generating positive cash flow present better opportunities.

The Importance of Portfolio Concentration

Another key point Mr. Shah discussed was the need to concentrate investments rather than diversifying excessively. He observed that during bull markets, investors tend to buy stocks based on prevailing narratives, leading to an overly diversified portfolio. However, when the market corrects, such diversification dilutes potential gains.

At his investment firm, they maintained a strategy where 45-50% of their portfolio weightage was allocated to their top five or six stocks. He emphasized that such a strategy allowed for better returns while maintaining a solid risk management approach.

Emotional Traits in Investing: Patience and Courage

Mr. Shah highlighted two critical emotional traits investors need: patience and courage. He acknowledged that shifting from one investment strategy to another often involves seeing previously held stocks rise while newly invested stocks take time to perform. However, he reassured investors that staying committed to fundamentally strong stocks would yield greater returns over time.

He emphasized that while narrative-based investments could sometimes create excitement, the real wealth-building opportunities lay in fundamental investing. With this perspective, he concluded his discussion, reiterating that long-term investors must remain focused on businesses with strong financial health rather than market speculation.

Mr. Arpit Shah covered all the topics mentioned above in-depth and answered questions from the audience toward the end of the session. For more such insights on this webinar, watch the recording of this insightful session through the appended link below.

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