Could you talk about two sectors and stock picks that delivered very good returns for your funds in 2012 and why you bought them?
Pharmaceuticals, media and entertainment are two sectors that have particularly worked very well for us. Both the sectors are largely a play on the Indian consumption story and have been direct beneficiaries of fundamentally strong Indian growth.
For the past three years, pharma and consumer stocks, cash-rich companies and multinationals have delivered great returns. Will the same themes work in 2013?
India has inherently strong fundamentals due to favourable demographics, high savings rate and huge potential for an investment-led growth.
High growth sectors generally tend to perform very well in such economies. However, the last few years have been exceptional, due to the global crisis and certain domestic concerns. Companies in the defensive sectors such as FMCG and pharma and consumption-led sectors have done very well as a result. High interest rates have also resulted in companies with low leverage doing relatively well. However, with expectations of interest rates going down and with confidence slowly coming back into the system, we expect interest rate sensitive, capex-driven and growth sectors such as power, auto and banks to make a comeback.
Much of the 2012 rally has come on the back of expectations that earnings of companies will not get worse from here. What could be the triggers for corporate profits to pick up in 2013?
Corporate earnings have been subdued due to the slowdown over the last few years and the high interest rate scenario. We have also not seen significant capital spending, interest rates having been stubbornly high for a long period of time. But now, with expectation of interest rate trending downwards, demand picking up and confidence slowly coming back into the system, the downside for corporate profits is very limited. On the other hand, there could be surprises on earnings. We also expect capex to pick up in the coming year.
Valuations are below long term averages. But with return on equity for firms also declining, should you buy?
One year forward price-earnings multiple of the broad market is approximately around 14, which is reasonable from a historic perspective. A recent analysis done by us of valuations over the last 10 years indicated that investments made when valuations are around these levels have more than a 80 per cent probability of generating positive returns in the next one to two years. The average one-year return tends to be around 23 per cent, while the two- year return was around 50 per cent.
Corporate earnings have indeed been subdued in the last few years. However, with some of the headwinds that kept markets under pressure subsiding at the margin, recent developments on Government reforms and expectations of lower interest rates, we believe corporate earnings have the potential to surprise us. We should also remember that the market tends to discount most known parameters, in this case lower earnings, and is forward-looking. After this prolonged period of underperformance and consolidation, the chances of making better returns from equities are much higher now.
What is the one investment that investors should avoid in 2013? And one must-have stock or sector in the portfolio?
Indian investors don’t own enough equities. To give a perspective, Indian households own a whopping $1.5 trillion in gold and silver, while it is estimated that they own in excess of $15 trillion of real-estate. Compare this with equity — the combined market capitalisation of all the listed companies is only around $1.25 trillion! Therefore, Indians can buy the entire equity market with what they own as gold and silver, and still be left with a surplus. Regardless of intermittent volatility and without unduly worrying about selecting the right sectors, investors should make their due allocation to equities.