The year 2025 is clearly turning out to be nightmarish for retail investors, particularly those heavily invested in smaller stocks. As high PE stocks have moderated quite a bit, do you see more pain ahead or gradual recovery as we step into FY26?
In the history of financial markets, one learns that though events may be unique, behavioural patterns are the same. Up to September last year, investors were experiencing a strong rally leading to quick gains in the equity markets. Especially, the mid cap and the small cap categories were seeing a strong up move. In many stocks of these categories, valuations were at or near all-time highs. Typically, such moves also set the ground for a correction. When there is even a small downgrade or disappointment, stocks fall sharply. Now, in many sectors, the valuations are back to reasonable levels. However, even in the current market, risk-reward is more favorable in large caps. Selective areas of mid cap and small cap stocks are now looking attractive.
Purely from a valuation and expected earnings growth perspective, do you think that small cap stocks, as a basket, are somewhere near the bottom?
If we take the category as a whole, small caps are not cheap yet. However, there are many companies which have taken a sharp correction and now look attractive. So better to look selectively in small caps for investment ideas. Ultimately, a good long-term investment is a good business run by competent management, bought at a reasonable valuation.
The ongoing bearish phase has punished stocks and sectors with decent outlook as well. Where do you see opportunities to buy the dip?
In a bull market, a lot of companies that may not really deserve a high valuation also get rerated upwards. In the same way, when the market undergoes a sharp correction, stocks with strong fundamentals and positive growth outlook also fall sharply. This definitely creates opportunities to buy or increase our holdings in these companies. Currently, Quality as a factor is available at attractive valuations. Hence one can screen companies on quality parameters and then look at valuations.
Upon inclusion from March-end, Zomato will become the most expensive stock in Nifty. As the constituents of the index change over time, does it really make sense to look at historical PE ratios to decide whether the index is cheap or not?
Whenever one looks at index valuations, the process one should follow is “anchor and adjust”. Anchor on the long term average but make adjustments for the changes in the quality and growth of underlying businesses. I will also mention that one particular stock being included in the index doesn’t change the valuations by a large margin since the entry weight will be small.
You specialize in behavioural finance. What are the most common biases you see affecting investors in India when portfolios are down 30-40% from peak?
Typically in a market fall like the one we are experiencing, fear and myopic loss aversion become the strongest emotions at play. Fear of further decline in the market, makes people panic or close their SIPs. Also, investors who have cash to invest may hold back worrying that they may lose in the short term even when the long-term outlook is attractive.
What behavioural mistakes, apart from buying at peak valuations, do you think retail investors made during the bull market that ended in September?
Bull markets usually attract a lot of investors who come in with recency bias, expecting the same quick returns that markets have delivered in the recent past. They ignore base rates or average returns that the market generates during a cycle. Rather, they solely focus on the short-term part that has generated high returns. With some good experience in the short-term, investors seek confirmation bias, become overconfident and ignore mean reversion. These biases lead to investors moving away from their asset allocation plans and also leverage their investments. These are some of the common biases and emotions impacting decision making.
In volatile markets, investors tend to panic or chase momentum. What strategies do you recommend counteracting these emotional reactions?
There are many behavioural tools that help investors identify their own biases and also the market/crowd bias. Those tools can be incorporated in the investment process. On a more general basis, I would suggest focusing on the long term, being patient, sticking to a good asset allocation plan and disciplined investment approach (like SIP) will help investors navigate volatility.
