The markets are continuously becoming increasingly divided on valuations. Expensive stocks are quickly becoming very expensive. Cheap stocks trade cheaper with every passing day. This dichotomy is furthering more investors to believe in and own only popular stocks. Fund managers are also riding the wave of success delivered by a handful of overvalued stocks.
The principles of value investing are being mocked and questioned as they seem to have failed in the current market context. But, in reality, it is investor behaviour rather than investing principles that are on trial.
While one must congratulate investors who made returns on the trend created in expensive stocks, it is equally important to understand that trends can well reverse. When the reversal happens, it is important not to get caught with an expensive stock portfolio. The value investors also need to be cognizant of the risks of their holdings losing further value if the equity market cracks up. When markets crack up, it tends to punish all schools of investing. It pays little importance to valuations when we see a marketwide correction. Good stocks will fall. Out of favour stocks will fall even more.
But, across two market cycles, we will see a significant divergence in stock price behaviour. The stocks which are completely out of favour in one cycle may well become the darlings of the next cycle. The markets are clearly giving us a great opportunity to buy such stocks at rock bottom valuations. A time will come over the next few years when these ignored stocks will become market darlings.
It requires foresight, patience, conviction, and courage to invest in such stocks. Mutual funds too offer thematic opportunities in beaten stocks. Now, it is time for investors to walk the talk.
