Sensex 60,000 Before Sensex 100,000? 

The market can stay irrational longer than you can stay solvent.

This oft-cited quote, or versions of it, is attributed to famous economist John Maynard Keynes.

However, its significance is often lost on investors who like to believe that market downsides always come with loud warnings. Or that a market index cannot correct 30% after having gained 50%.

Such investors stop looking for cues of risk and mistake the frothiness in stocks for real upside.

For that matter, even words of caution from the people managing businesses that have sustained for decades, falls on deaf ears.

It is rare to find insiders less enthusiastic about a business than external investors. However, when such rare admissions occur, it is important to take notice.

Cases in point are the management conference calls post the June 2024 quarter results.

Unfortunately, there were barely few managements that sounded super confident and optimistic and near-term earnings growth. Even as market buoyancy continues to thrill investors, company managements don't seem as excited.

Here is what the management of L&T, India's leading engineering and infrastructure company with presence across diversified business streams, had to say...

• With the Union elections behind and the likely political stability, the government's continued thrust on capex and business optimism augurs well for investment activity. However, the pace on infrastructure progress could slow down due to skilled labour shortage in certain sectors.

Now, one can reason that infrastructure growth is cyclical and therefore execution risks could be the norm. However, even the non-cyclical growth requires funding. And with banks in a tight liquidity squeeze, that too seems difficult.

Here is what the largest PSU bank, SBI, had to say about whether banks will resort to extreme measures to improve credit growth...

• It should be the self-control mechanism for each of the entity. They will have to decide whether they should have the loan growth, they should not have the loan growth. One of the entities has already offered to sell part of their asset book. So, I think these are the kind of adjustments which people will be resorting to.

So, the key worry is that despite market speculations, the underlying earnings growth that are supposed to drive stock prices continue to deteriorate.

Investors chasing lofty valuations with the fear of missing out (FOMO) need to be wary of the following risks before buying stocks.

Key Risks to Lofty Valuations

Too Good to be True

Companies claiming to invest in R&D and capacity for diversification in new businesses could face significant hurdles. More importantly, in many cases, hasty attempts to diversify could lead to 'diworsification'.

In other words, companies may end up putting good money after bad by investing in relatively low returns businesses or buying poorly run businesses at lofty valuations. Therefore, chances are that the valuations factoring in a significant and profitable pivot in the company's financials could turn out too good to be true.

Plans on Paper

About a dozen homegrown startups have got successfully listed over the past 5 years. Nearly double that number are set to seek debut on the bourses in the coming years.

You can track the recent IPOs and upcoming IPOs of startups here.

However, the problem with startup IPOs is that barely few have the track record of earnings growth and sustainability to show. Most are still in the process of getting regulated. And many are handling or licensing technologies that are yet to find enough market.

So, investors must remember that the promises made in the IPO prospectus could remain on paper in case the company managements are not geared to tackle the obstacles.

Also, overpaying for growth could be a significant risks as has already been seen in the post IPO debacle of startups like Paytm and Zomato.

Earnings Management

We certainly cannot paint every high growth company with the same brush. However, the pressure to report obscene growth numbers quarter after quarter to prevent market disappointment can take a toll. Even seasoned managements of large companies are known to fall into such traps.

So, it cannot be denied that at least a handful of high growth businesses are trying to 'manage' their reported earnings so as to not disappoint large investors in the bull market. Such companies could, in the worst case, also end up stepping on the wring side of law in their frenzy to please shareholders.

Investors must not forget the cases like Vakrangee, Manpasand Beverages or for that matter IL&FS to warn themselves of not going overboard for growth.

Even auditor notes and AAA ratings of such companies have been no guarantee of sanctity.

So, companies with a history of managing earnings in the past should all the more be handled with sufficient caution.

Story Becomes Fiction

Bulk of the action in stocks are in the primary markets these days. There are a dime a dozen IPOs soliciting investors with their fancy stories. The SME IPOs, in particular, have fetched plenty of attention in recent weeks.

Frail business models with limited or no visibility have been flying off the shelves in the SME IPO market. So even the market regulator has warned investors about not buying into these fictional stories too easily.

What You Must Remember

Just as the benchmark Sensex could rise from 60,000 to 80,000 levels within months, a correction could take the index back to the older milestones.

There is no denying that Sensex 100,000 is inevitable. However, the journey to Sensex 100,000 may not be a smooth one. And only the most rugged riders could finally reach their destination.

Hope you like this video. Thanks for watching.