How often have we missed out on buying good stocks and chosen to compensate for the loss by buying alternative cheaper stocks? Anand Radhakrishnan, Managing Director & CIO – Emerging Markets Equity – India, Franklin Templeton highlights how many people make the mistake of investing in a company hoping that it would achieve the same valuation and stock price as its more esteemed peers. Radhakrishnan explained to Value Research how the “playing relative value” concept though would yield temporary profits but would not be viable in the long run.
Radhakrishnan further explains why this investment strategy popular among many investors, especially, those new to the idea of parking money in stocks, is flawed. The industry veteran goes on to say how this company would look cheap relative to the first company. However, with time, both companies would diverge in real business performance resulting in widely differing valuations.
Learning from the dot-com bubble
Radhakrishnan attributes his learnings to his experience during the tech boom days when information technology companies were growing fast and the prices of their shares skyrocketed within a few months. Then came the tech-bubble mayhem that exposed the futility of investing in alternative companies with less potential to grow and increased vulnerability to bust. When all others had fallen prey to the sudden stock market crash, Radhakrishnan considers himself lucky to have escaped the chaos.
This valuable learning applies to all sectors like banking, gold, retailing, telecom, etc. There is a reason why some companies continue to surge ahead and garner investors’ attention despite their high valuations. You must have the insight to understand why some companies are trading at a premium to others. Performance matters and this is what prompts some companies ahead of others. This explains why the valuation gaps do not go away so quickly.
A long stint
Associated with the management of investments since 1994, Radhakrishnan’s initial stint as the fund manager for Sundaram Mutual Fund and then later with SBI Funds Management Ltd as its deputy manager with equity research explains his understanding of share pricing and valuations. Having managed some of the top equity funds that involved constant monitoring of stocks and their constant price fluctuations, Radhakrishnan gauged the most important and relevant fact in the stock market, i.e., the performance of a company has a direct bearing on its stock prices. Demand for the stock and inordinate expectations from investors drive its valuation to a higher level.
That quality matters and is responsible for some crazy valuations, otherwise difficult to explain, is a factor that we must not discount while evaluating the quality of any stock before including it in your investment portfolio.