The Hindu Business Line : Mr Market is knocking at the door!

When one door closes, another opens; but we often look so long and so regretfully upon the closed door that we do not see the one which has opened for us.

— Alexander Graham Bell

If one reads into the recent widespread fall of the Indian equity market, it would appear as if all entry doors to the market are firmly shut while exit doors are flung wide open to accommodate the stampede! Over the last six months, the market capitalisation has fallen from $1.8 trillion to $0.95 trillion: the sharpest and swiftest over the last two decades.

True, an ocean of worries seems to be ruling the horizons: rising crude and commodity prices, the sub-prime issue, apparent US recession, high inflation, higher interest rates, currency volatility, fiscal deficit, slower corporate earnings growth and so on. And in a matter of a few months, focus has moved from global concerns to domestic issues and macro issues have begun to impact micros.

But the same issues have been counted and recounted several times over disproportionately such that “fear” rather than “caution” is deciding the course of the markets. Six months back, it was as if India could do no wrong, and now it is made to appear that India can get nothing right. In my view, the situation is somewhere in between. But prices now clearly lag reality, and by a margin.

As you shift your gaze from the closed doors to the opening ones, the picture looks more balanced, if not opportune. I can’t predict whether the worst is over. It probably is not. In the short run, it is entirely possible that prices (not reality) may get worse before they start to get better. But if one is looking for high quality at attractive prices, then the proverbial Mr Market is knocking at the door.

While possible short-term negativity cannot be ruled out, long-term opportunity cannot be ignored. I believe that the picture ahead will be far better than what is being priced in by the markets today. These are, no doubt, challenging times, but India has faced far more daunting challenges in its post-Independence history and yet has grown throughout.

Overall strength of broad macroeconomic fundamentals (notwithstanding recent challenges) and robustness of corporate sector micros has never been better in the past than today. In our opinion, these are mere interruptions than disruptions in a much longer-term phenomenon. India continues to be a large sized opportunity with durable and high growth supported by remarkable capital efficiency — all essential ingredients for good equity investing.

structural phenomenon

The reforms initiated in India during the early 1990s started bearing fruit some time in the beginning of this century, when India moved up to a “structurally” higher GDP growth rate. The GDP growth “potential” of India in the long term is considered the highest among all the emerging economies. However, at various stages, India has hit the barrier of infrastructure. It remains, and will remain for a while, an important issue. But despite all obstacles, the infrastructure spend as a ratio to GDP has inched up from 3.5 per cent (2004) to current 6 per cent (exp 2008) and is expected to touch 9 per cent of GDP by 2010-11. This on a GDP which itself has grown at a rapid clip of 9 per cent over last few years.

Simultaneously, with the rise of service and manufacturing sectors, the per capita income has more then doubled over last seven years, domestic savings to GDP has increased to well over 35 per cent and the disposable incomes are slated to double again by 2015. India’s growth is well founded on all the three vital pillars for a secular economic growth – robust consumption, healthy savings rate and a strong investment rate.

There are problems being faced today, and there are solutions. The recent world-scale natural gas discoveries, 39 per cent growth in the tax collections for the quarter ended June’ 08, better then expected performance in food-grains output are some of the positive developments that have probably been harshly shrugged off by the markets.

Estimates for GDP growth in the current year vary, but even the most conservative estimate puts the number at above 7.5 per cent. True, it is not the same as 9 per cent (over the last three years), but it would still be very robust and one of the highest globally.

The situation today suggests that the outlook for the year ahead is even better. Markets always tend to overshoot in either direction, and there is nothing new this time. The valuation of about 12 times FY09 earnings for the Sensex / Nifty, when the markets bottomed out a couple of weeks ago, saw us come full circle to the 2003 levels; the last time when such valuations were reached, and that year actually marked the beginning of a nearly five-year secular rise in the Indian markets.

If one searches beyond the top 30-50 companies, then the picture is even better: many top quality businesses can be had at single digit or bare double digit valuations. I am confident that many stocks have a potential to multiply in their prices over the next three years, if not sooner.

Flushing out shocks

The biggest positive in the current situation is the extreme sentiment negativity (although in the last one week it would seem to have reversed somewhat); that flushes out the possibility of shocks from a stretched market.

All bear markets are born out of unbounded optimism, just the way all the bull markets have to rise over walls of worry.

At this juncture, it is important to realise that what can be counted by everyone is usually not what decides the eventual course of markets. It would be prudent to bear a perspective that differentiates between secular long-term growth engine from the intermittent short-term bouts (of optimism or pessimism). The former is intact, the latter is transitory.

India, in our opinion, remains an attractive and almost indispensable investment choice for any serious long-term investor. This has not changed over the last six months, though prices have. That is a fresh opportunity all over again, rather than a threat.

However, the businesses that I like have to pass a few critical tests: strong and durable earnings growth, robust capital efficiency, large size of opportunity and reasonable value. Other things being equal, I favour stocks that have adequate liquidity.

Currently, the Sensex trades at rather modest 13-14 times FY09 earnings, with many quality businesses being much cheaper. This valuation needs to be assessed in the backdrop of a corporate sector that can be globally benchmarked (Return on Capital Employed of over 20 per cent), earnings growth of 15 per cent for current year and better going ahead, durability of growth and large size of opportunity.

Without ignoring near-term concerns in the environment, we believe it is the time to step out in the open and engage into opportunities with an eclectic mix of patience and conviction. The results will be healthy.

(The author is CEO & Managing Partner ASK Investment Managers Pvt. Ltd.)

More Stories on : Insight | Stock Markets | Economy

Article E-Mail :: Comment :: Syndication :: Printer Friendly Page