Cyclical Investing for growth stocks
Summarizing what we learned in the last section-
A typical market cycle plays out over a very long-time frame and inoculates with it several mini-cycles on the way along. For example, the Information Technology (IT) sector has been on a super growth cycle since 1991. There were occasional troughs such as during the Lehman crisis as a result of which IT spending was slashed by companies across the board. IT companies were booming before the crisis struck.
For example, IT behemoth TCS reported a 36% CAGR growth in revenues between FY05-08. This halved to 18% during FY11-14 and slid further to 9% in the subsequent three years.
Performance by Infosys was on similar lines. Revenues expanded 27% on a CAGR basis between FY05-08. Growth fell sharply between FY11-14 to a meagre 8% and further to less than 6% in the ensuing three years.
The growth of the Indian IT industry languished for much of the 2010 decade with further headwinds emerging in the form of the Eurozone crisis, Brexit woes, Oil price fluctuations, deglobalization, etc. (The Indian IT industry is export-oriented and hence moves in sync with the global economy. The industry contributes 8% to the Gross Domestic Product of the country and employs about 4.5 million people)
The present-day scenario is in stark contrast to what was earlier anticipated.
The IT industry has once again risen to prominence owing to the digital shift of brick-and-mortar giants after the pandemic. Even the stubbornest minds of all have embraced the need for going digital. Rajesh Gopinathan, CEO, TCS has termed the revival in demand as the start of a multi-year growth cycle.
And the stocks have already run-up in anticipation of the same. The moves have been stellar across both Largecap & Midcap IT. Name the stock and most probably it has just hit a new all-time high.
Do not get the wrong impression here that IT is a cyclical sector. The above illustration just goes on to show the importance of timing the market cycles even in the case of perennial growth stocks.
Another case in point is automobiles. In mature markets like those of the USA and Europe- Automobiles are regarded as cyclical stocks because the end-user markets for these products in these countries have saturated. Of course, companies like Tesla do not fall into this category as the market for electric vehicles is relatively young and is yet to make deep inroads. Look at the price chart of something like General Motors or Volkswagen Group. All these companies house enviable brands such as Jeep, Chevrolet, Cadillac, Audi, Porsche in their kitty. These brands are a source of envy in the neighborhood. However, the stock prices tell a different tale altogether. None of the stocks have built investor wealth and have languished the broad indices to a large extent.
Nonetheless, the Indian automobile market is young and agile. This can be explained by the massive under penetration - There are only 5.4 motor vehicles in India per 100 inhabitants * This number goes as high as 83.8 in the USA, 78.9 in Australia, 47.1 in the UK, and 19.6 in China.
* excluding motorcycles and two-wheelers, circa 2016, we have assumed a growth rate of 7% for the years 2016-20 for the Indian market.
This explains why we should not look upon automobile stocks as cyclical stocks but as growth stories from the Indian perspective.
Just like the IT sector, the Automobile sector in India is in a super bull cycle and one must make use of any steep correction in these companies as a buying opportunity.
Although, the peaks and troughs for automobile stocks are more severe than that of defensives such as IT, Pharma, and FMCG, yet they make for a solid investment case given the ever-growing consumption of India's rising middle class. Once again, timing is very important and you must press the accelerator when things look dim and valuations are attractive.
Case in point- Maruti Suzuki. The brand is almost synonymous with Indian households and commands a whopping 48.50% market share in the 4 wheeler space as of November 2020. For the uninformed, Maruti Suzuki is a JV formed in 1983 between Maruti Udyog of India and Suzuki Motor Corporation(SMC) of Japan. The parent company SMC owns a 56.37% stake in the JV as per the last available shareholding data. The stock is a consistent compounder and has found flavor with Foreign Institutional Investors. It has grown investor wealth at a 20% CAGR for the last decade.
Between 2011 and 2018, the stock price went up by more than 1000%, touching lifetime highs of ₹9,996 in January 2018. In the subsequent years, growth started to falter and the stock entered into bearish territory. No wonder, the same hot stock has given a -5% CAGR in the past three years.
These negative returns can be explained by a variety of factors including:
- Falling revenues
- India leapfrogging to BS-VI emission norms, skipping BS-V. Cost of production soared due to Regulatory compliances. High R&D spends hit margins.
- Input Cost pressures
- Company's inability to raise prices in a highly competitive market
- High crude oil prices (Negative correlation) during much of 2017-2020.
- Switch to only Petrol portfolio from April 2020
- Loss of market share due to the entry of aggressive Chinese competitors in the SUV space
- Overall economic slowdown
- Focus on EV transition and slow adoption
It's the start of 2021 and things have started looking bright for the company. Multiple tailwinds are aiding this recovery. The recent price hikes announced by the company will augur well for margins given that raw material costs have gone up significantly. Demand has proven to be sticky and sustainable unlike what analysts had penciled. The rise of personal mobility given the COVID situation will also be closely watched. The growth will be slow and gradual given we are not yet out of the woods but the future certainly looks promising
These examples go on to show that the Cyclical Investing approach is constructive even for growth stocks contrary to popular belief that this method works only for value stocks. The super bull cycles will provide you with ample mini bearish cycles on the way. The steps are not much different either- buy the gloom and sell the exuberance. Once you master industry cycles, you'll realize the paid propaganda and hollowness surrounding brokerage reports and credit ratings.
Repeat, Recite, Chant, and Meditate to the mantra -
" India is the only destination across the globe with the potential to grow 10% consistently for the next 10 years " and you will end up discovering a dozen multibaggers each day.