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3 Reasons to start investing when the economy is weak

Warren Buffett has repeatedly said – “Be fearful when others are greedy, and greedy when others are fearful”.

Warren Buffett has repeatedly said – “Be fearful when others are greedy, and greedy when others are fearful”. 

With the Indian GDP showing a marked slowdown over the last 4 quarters, weakening tax collections, ongoing NBFC crisis and the weak stock market since Jan-2018, there is no better time to evaluate this statement. 

The fact is that investors are currently fearful. If that is so, why should investors invest in the stock markets at the present circumstances?

Here are 3 reasons why you and most other investors should.

1. Markets are cheap 

One golden rule of good investing is to buy things when they are cheap. This applies to property or stock markets. Stock markets have been in a corrective phase since Jan-2018 and nearly a third of the companies are down 50% from their peak levels. Stocks are far cheaper today than they were in Dec-2017.

2. Growth will revert 

The Indian economy is on a long term growth trajectory, driven by a highly favourable demographic profile – essentially the average working population is young, up-skilling themselves and will earn more in the coming years. They will also consume more, contributing to the economy. The current cyclical growth slow down should reverse and corporate growth rates should pick up.

When growth reverts, the exact opposite happens to these companies. Inventory re-stocking, returning consumers lead to much higher sales growth. Earnings grow faster than sales growth as margins expand. 

3. Accelerated growth catch up

When the economy slows down, corporate earnings falls even more severely. For example, when the GDP growth slowed down from 7% to 5%, many business saw sales actually fall and profits fall even more. This happens due to a combination of reasons. 

Firstly, many companies have a fixed cost which they need to bear. When revenues fall, while the company continues to bear its fixed cost, its profits fall even further. Margins exhibited in such a situation tend to be less than long term margins. Moreover, many companies work through a distribution system and when demand falls, the distributor reduces inventory in the system leading to much sharper fall in revenue for the company compared to end user demand.

When growth reverts, the exact opposite happens to these companies. Inventory re-stocking, returning consumers lead to much higher sales growth. Earnings grow faster than sales growth as margins expand. 

With stocks being cheap, possibility of increased revenue growth rates when the economy recovers and even higher earnings growth rate in this period is the reason the statement – “Be fearful when others are greedy, and greedy when others are fearful” – is justified.

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