Relativity

Einstien's famous theory of relativity states that "Measurements of various quantities are relative to the velocity of observers." Even though the theory is related to the field of physics, it is extremely relevant to the stock markets. The satisfaction and sense of achievement that a market participant derives from performance of his portfolio is relative to the performance of portfolios of other market participants. To a general investor, it does not matter whether he has done well in absolute terms, what matters more is how others have performed.

Sample this- last year my portfolio was up 110%  and I was so gung ho about it. I wrote this rather boastful article here. This year my portfolio returns have surpassed last years' returns in 8 months. But, I am not that excited this year. The reason being, last year I was not coming across people whose portfolios have done better than mine. This year every serious investor is claiming returns in triple digits. Even some of the mutual funds have given that kind of return.

Is 110% a bad return for 8 months? Of course not. Anyone should be extremely happy with that kind of performance. But then why I still believe that I have not done as well as I wanted to. I understand that there is theory of relativity that applies to stock markets as well. But that is just one part of the puzzle. The other part is even more interesting. Many stocks which were rejected as investment candidates by me are up by 300 to 400% YTD. I keep thinking that it was possible to construct a concentrated portfolio of following stocks to improve my performance by at least another 100%.

Stock	YTD Performance
Avanti Feeds	459.01%
Kitex Garments	309.92%
Granules India	307.51%
Symphony	227.64%
Shakti Pumps	218.62%
RS Software	211.86%
Acrysil India	204.88%

One would think that these stocks are picked on the basis of  "survivorship bias". But the truth is that I have considered all these stocks at some point of time in last one year and rejected all of them except RS Software for investment. These are very popular stocks among small investors and they exist in many portfolios. Actually, one can argue that these stocks were ignored because of "ownership bias" of existing stocks. Performance of "Ajanta Pharma" - up 70% for the year and "PI Industries"- up 80% for the year pales in comparison to these stocks. A "HCL Technologies" which is up by 35% for the year appears like an absolute dud.

Is this situation telling me something about the market conditions and an imminent market crash? I still believe that a significant market crash is far off as current PE of Sensex is only 18. Markets don't crash considerably from 18 PE. The other interesting fact is the growth of EPS of Sensex, which is more than 20% y-o-y for last 2 quarters. This is exactly what happened in 2003. The only difference being the Sensex PE, which was 11 then. Considering both these facts, it appears that a serious crash is far away.

If markets are not poised for a serious crash then the above discussion points me to a lacunae in my stock picking process. There are two clues about what can be improved. If one looks closely at the stocks mentioned above, all the stocks except for Symphony were trading at a single digit PE on trailing basis at the start of the year. Symphony itself was growing its profits by more than 200% per annum. These are probably two lead points that need to be kept in mind while selecting next set of stocks. If a stock matches these criteria, then it can be provided some leeway on management and business quality or on valuation front. That seems to be the only way to perform relatively better. Of course, one should not give so much leeway on quality front that instead of relative out performance one gets relative under performance. After all "Ati Sarvatr Varjayet".