Indian Stocks – Time to aggressively load on!
My last article on October 07, 2007 titled “Sensex@2010 – Thoughts and Strategies” was written with some caution. While it is a great thing to be cautious before a big burst (either way) a cautious approach could be monetized in two ways
a) Actually raising cash and then re-deploying when the trend changes. I know no one who has been successful at this. If you sell at the highs then as the market falls your mind tells you that your initial decision of selling at the highs were correct and to actually transact diametrically opposite to a decision that has been proved correct by the market is almost impossible. The fear within the investor almost never lets him enter at the bottom.
b) By avoiding stocks that look frothy or where earnings could be in trouble and where the management pulls all the tricks from its bag to help create a market cap.
In my case I opted for option (b) but for the moment we have all become poorer unless anyone was 100% in cash.
The markets seem to be pricing in all the bad events, US recession, Indian election and are hesitant to make a major move ahead. While all of us know that political instability does not affect the markets in the longer run it does however make the foreign investors extremely jittery about putting in further cash.
The reality check: India’s GDP should grow at between 8% - 10% for the next couple of years; we add inflation as 5% and what we get is a nominal growth of 13% - 15%. Now if the average Joe on the street is growing at 13%-15% it would not take a big effort for the top 30 companies not to grow at a 5% premium to that or at something closer to 20%.
The sensex should report an EPS of Rs 1050 for Fy 09 and some companies in the sensex have subsidiaries that are not yet contributing to the bottomline. ICICI, Reliance are two such examples and it is estimated that such subsidiaries shall contribute around 2000 points to the index.
So adjusting for those subsidiaries our index trades at (16,300-2000)/1050 = 13.6 times Fy09. Incidentally the index has never traded at lower then 12 times in its entire lifetime!
Bear Market Case: If we are presenting a bear market case for India then this premise can arise only from these possibilities:
a) Our GDP growth actually slows down to 6% which (I shall later explain) looks extremely improbable.
b) Some of our companies report losses because of corporate action forex derivative losses, sub prime exposure (limited to banking companies only and also immaterial compared to the balance sheet size of those companies). In this case the sensex companies will show declining profits even as the GDP continues to grow as per our assumptions.
c) Some sort of a specific scam/scandal erupts where a major industrial group or a fund house is charged with improper dealings.
d) The US goes into a tailspin recession and carries the entire global markets with it. Though in that case our GDP could be affected by a 100-150 bps the overall impact will be minimal. Liquidity/fund flows are short term events and in the longer term liquidity will find its way into good stocks.
A point which should be noted here is that points (b) (c) and (d) are one off events and should not affect the markets in the longer run. In the short run they can cause massive havoc as they have al the ingredients to affect sentiments and markets are full of emotions.
GDP Growth could touch 10% - Our savings rate and investment rates are at closer to 32% -34% and backed by the recent changes in the budget should grow upwards from here. Assuming an FDI flow of 2% of GDP (US $ 20 bn) the economy’s potential capital formation works out to 36% over the next couple of years.
Using the ICOR at 4 times which is our historical figure, a 36% Investment rate should potentially create a GDP growth rate of 9% (36%/4).
Now if India has built all the roads, bridges, ports, power such heavy investments in infrastructure should create an increase in productivity. I assume an increase in productivity as a buffer or a margin of safety. For example once the golden quadrangle is completed a truck can move from Delhi to Mumbai in 24 hours instead of a few days just imagine the kind of gains it can result in for the system.
Final view: So for the investor who wants to have a longer term view of things this is almost a great time to buy stocks and get into the Indian story. Stocks are discounting all the bad news worst and at worst we could go down 10% and test our all time low on the forward PE basis.
The next big trigger that markets are waiting for is the interest rate cut and the bulls should be on their feet again before that cut is officially announced.
This bull market is very much alive and kicking and at the cost of putting my head out I would like to assume that we will see significantly higher levels before we get into an extended bear hug. This is as good a time to buy stocks.
As investors it will be more comforting to think the sensex at about 14 times FY 09 then getting obsessed with what is happening around us.
Edited by basant - 03/Apr/2008 at 8:26am