Threat of a poor monsoon, and fear of reduces MSPs for crops to control inflation seems to have got Dalal street in a tizzy with many brokerages recommending investors stay off Rural plays. 

Many analysts favour use of Discounted Cash Flow analysis to value companies where perennially, ~70-80% of the value of a company is ascribed to “terminal value”, i.e. the period beyond which forecasts cannot be made.  We believe the DCF approach to valuation in a high growth economy is humbug, but that is the subject matter of another blog.

If 70% of the value is ascribed to a time period beyond 5 years, it would be fair to assume that the immediate year’s performance, should not account for more than 10% of a company’s total worth (perhaps far less).  So should one ignore or dump a good franchise if its performance is considered to be under threat in the next year, that too because of factors which are not certain? Many Mutual Funds are marketed based on short term performance to unsuspecting buyers.  This puts immense pressure on the fund management team to ensure short term performance does not dip as that impacts inflow of funds. 

Long term (LT) investors could use the impatience of others to their advantage.  If market participants are selling stocks based on a hypothesis/fear of short term under performance, some of these assets “should” be available at lower than fair prices.   Contrary to brokerage recommendations, this would be the time for LT investors to study and pick quality franchises serving Rural India.  Sure, the companies will report a weak performance this year and the Investor NAV performance may lag markets, but quality franchises will bounce back stronger by taking market share from weaker players and using the tough conditions to prune costs and further streamline processes.  When conditions normalize, earnings will rebound exponentially.  A combination of exponential earnings growth and multiple re-rating could deliver far higher than market returns over 3 years.  

There are of course risks, one of which is entering too early.  However, entering a stock early is the “curse of the value investor”.  LT investors with patience should look at this scenario as being able to buy more at lower prices.