Surviving the 2008 Stock Market Meltdown – Part 1

Posted on March 27, 2011


In the week that Warren Buffett made his first trip to India, I thought it appropriate to share my experience in using the value investing approach to pick stocks. Buffett is arguably the world’s most successful and certainly the most celebrated practitioner of the value investing approach and it was indeed his success story that got me interested in learning more about the value investing approach and formulate my own stock picking criteria.

To those that are unfamiliar with the value investing approach, here’s a quick introduction: For various reasons the price of a stock rarely reflects the true value of the underlying business – often the price is in excess of the value and sometimes a stock is available at a discount to its true value. The value investing approach propounds that if an investor, through careful study, can identify a stock that is trading at a price that is sufficiently discounted from its value, then the investor would do well to invest in such stock and hold it irrespective of any short term changes to the price. Specifically, the investor must not exit a stock so chosen even if the market continues to price the stock below its value or, worse, further erodes its price. An intelligent value investor would have carefully selected the stocks to invest in and is guaranteed that the market will eventually price the stock at its true value and thereby deliver an appropriate return to the investor. Click here for more details on the value investing approach.

I have been actively investing (my own capital) on the Indian stock market since 2002 and I have developed my own stock picking criteria based on the value investing approach. For the 8 year period 2002-2010, my portfolio delivered a post-tax compounded annual growth rate (CAGR) of 34.15%. For the same period, India’s leading stock market index, the S&P CNX Nifty, delivered a CAGR of 23.73%.  I would like to ascribe the significantly superior results of my portfolio to it being based on the value investing approach. This, however, is not the story I want to tell. I want to tell the story of how my portfolio, or atleast a part of it, survived the 2008 stock market meltdown.

This is an important story to tell because it truly highlights the power of the value investing approach. Moreover, the period 2002-07 was marked by unprecedented and uninterrupted price rise in he Indian stock market and, in such rising market, I couldn’t have convinced even myself the efficacy of my value investing based method. A high tide lifts all boats and who’s to say that value investing approach was behind my success during the 2002-07 period. That is why the period of 2008-09 is important because it is only in a steeply falling (and subsequently recovering) market can one really test any stock picking approach. But first some context.

Leading upto early 2008, prices on the Indian stock market flirted with new highs every month . However the bursting of the sub-prime mortgage bubble in the United States caused the prices in the Indian stock market to erode sharply. The decline began gradually but gained momentum with each passing day and by the end of 2008, the Nifty was less than half its value at the beginning of 2008. Such massive decline was unprecedented and many an investor completely exited the stock market by selling all their stocks, sometimes at significant loss. The decline continued into the first quarter of 2009, reversing the trend only in the second quarter of 2009, then gaining momentum and ending 2009 at significantly higher levels than the beginning of the year. However, inspite of the recovery in 2009, the Nifty still ended 2009 15% lower than its value at the beginning of 2008. The adjacent chart tells this rather gruesome story. It was in this context that I made some investment decisions in early 2008 – 30th Jan. 2008 to be precise.

Unfortunately on 30th Jan. 2008 nobody could have predicted that in 12 months prices would be down to less than half their current value. If they had, I would have not made the investments that I did; on second thought, I would have probably ignored such dire predictions given that we have just finished 5 years of continuous growth on the Indian stock market. Importantly, making the decision to invest just before the meltdown was not hard to live with; one could always rationalize the decision by saying that the future is unknown and difficult to predict with any accuracy.  The harder part was watching your investment go down in value every day for almost 15 months and stopping yourself from following the herd and selling. There was a general sense of panic and investors were selling out even as they made significant losses on their investment. Those were the toughest 15 months of my life as an investor and severely tested my belief in the value investment approach and the stocks that I had picked.

I will detail, in part 2, what happened to my 30th Jan. 2008  investment. 🙂

Part 2 now avaliable here.