Cheap Midcaps May Remain Cheap Forever !

Biggest Lesson We Learnt In 2014.

Cheap Midcaps May Remain Cheap Forever !

 

 Our effort should always be to find quality midcaps having extremely high growth potential & are trading at fairly cheap prices. No matter whichever the high quality stock is, we are never comfortable to buy them at high valuations. Quality midcaps operate in businesses, where the external opportunity is too big. These companies can pass on the price increase to their customers over a period of time. We can get such companies at cheap prices in 3 cases,

1. Outlook for that sector is depressed
2. Overall stock markets are depressed
3. The company is facing a temporary problem 

Here the 3rd point is the most crucial. How do we identify whether the problem is temporary or permanent ? There is a very thin line. If it is a temporary problem, the company may overcome the issue in medium to long term, can successfully turnaround and give fantastic returns. Because, generally markets don’t see beyond next 3 to 4 quarters. That is where we can buy stocks cheap, and stay invested. Generally these companies have the capacity to emerge as leaders from their category over a period of time. When they emerge as leaders & gain major market share, they gain pricing power with consumers & bargaining power with suppliers / vendors.

However if the problem is permanent, the valuations may just keep dropping & the stock price may never revive at all. The valuations keep getting cheaper & cheaper, and stock price looks extremely attractive. This is where the trap is. Investors may think the stock price is just too cheap & things won’t get worse than this. Things don’t get worse, but they don’t even revive by a single percentage. Things stay same or even keep getting worse. Such stocks will remain cheap forever.

Some of our stocks acted in the same manner. And we have moved them to ‘Exit’ or ‘Wait & Watch’ list accordingly. We thought the valuations are cheap, there is nothing to lose. But the problems turned out to be permanent & these companies were no where becoming the leaders in their segment too. Result : Stocks are trading at the same price, valuations still look cheap. And they may just stay there forever !

Before investing  into any troubled company or a possible turnaround, we must try to find answers for 2 questions.

1. Is the company in a leadership position or among top few leaders in its category ?
2. What is the nature of the problem company is facing, temporary or permanent ?

If the nature turns out to be permanent, better to exit & shift. Better to take a temporary loss than taking a permanent under performance.

 Happy Investing

Source:AlphaInvesco