Mutual Funds

‘Listed companies will grow at a faster rate compared to nominal GDP growth’: Quantum Advisors

Lokeshwarri S K | Updated on June 13, 2021

Market share of such firms improve with each event that hits smaller companies, says Ajit Dayal

On the occasion of Quantum Advisors completing 25 years, Ajit Dayal, Founder, Quantum Advisors and I V Subbramaniam, MD, & Group Head (Equities), Quantum Advisors. share their views on long-term growth prospects and current conditions in the Indian equity market in this exclusive interview with BusinessLine. Excerpts:

You have both seen many market cycles, including the 2000 and 2008 bull markets. What is your sense about the ongoing phase in Indian stock markets? Are we near the peak?

Subbu: Basically, there will be economic cycles and changes in interest rates, markets will witness gyrations. What looked like a peak at one point will not look like a peak at another point in time. We have a long way to go for India because the economy is still growing, but there could be short-term corrections.

One factor that has changed over the last few years is the environment in which listed companies operate, because of which we don’t think valuations are expensive. Events such as demonetisation and GST have made it very difficult for smaller companies to survive. This helps larger listed companies. Add to this the pandemic effect that has placed larger companies with capital in a much more favourable position than smaller companies. So, before saying that a stock is expensive based on current EPS numbers, we have to check if the EPS number has a chance of being upgraded.

We think India will grow at 6.5 per cent real GDP growth but some of these large companies will grow at a faster growth rate, they will have pricing power which will reflect in their margins and profitability, because of which the forward PE ratio may not be expensive.

That said, we do recognise that certain segments and stock prices have run up very rapidly so we are trimming and raising cash, to some extent. We think that some stocks or sectors such as IT look expensive but we also think there is upside left in many other sectors.

Ajit Dayal: An investor should never be out of equity. Depending on age, risk profile, the portfolio allocation may change but you should never be completely out of equity. If you have just begun investing and have a 20-30 year horizon, you should not bother if the market is expensive or not.

Having said that, when the market is in a decline, like March, 2020, you should put a lump sum in equity. You should add to the SIP, not reduce. If the market runs up, it’s okay, because you should focus on the long-term rate of return. You should have a longer time horizon to be in equity since most individuals are very underweight in their equity allocation.

What is the likely long-term rate of return for Indian equity?

Subbu: The way we look at a long-term rate of return is to use the long-term real GDP growth of 6.5 per cent and add inflation of about 5 per cent, which gives nominal GDP growth of 11.5 per cent. That’s the growth we can expect from Indian companies’ top lines over the long term.

Some listed large companies may grow their revenues faster by around 200 basis points. Some companies manage their costs very well and that can make the earnings grow faster by around 15 per cent. So in the Indian stock market, 13 to 15 per cent growth looks feasible.

Ajit: From 1980 to now, average GDP growth has been 6.5 per cent across nine governments. For the next 15-20 years, it will be safe to assume that we get to that 6-6.5 per cent growth. Inflation will be around 5 per cent, because of supply constraints and sustained consumption growth.

We have seen 18-19 per cent compounded annual growth in the Sensex since 1980; this ties with GDP growth, inflation, etc. Companies that are listed are the winners, the losing companies do not get listed. So the self-selection process will ensure that you get a higher rate of return from investing in the listed companies when compared to the nominal GDP growth.

With a savings rate of 28 per cent of GDP, the Incremental Capital Output Ratio (ICOR) ratio for India, which is the incremental capital you have to put in the economy to generate growth, is 4:1. This meant that we had to invest ₹4 billion to get ₹1 billion revenue from my factory. Because we were a manufacturing economy in the past, the ICOR ratio for India was high.

If I assume that 28 per cent saving is invested in the economy, it adds 7 per cent to GDP (28/4 or 4:1). We know that all the saving is not effectively utilised since a lot of it is in gold or real estate. If we remove 20 per cent from savings, we still get 5.6 per cent growth. Add the FDI, MNC money, FPI money, this gives a much higher growth rate.

India is changing rapidly with a higher share of services companies that do not need high capital expenditure. ICOR ratio is therefore coming down and it can move to 2, which will result in a higher potential growth rate.

How has the second wave of Covid-19 changed the demand outlook for Indian companies? How long do you think it will last?

Subbu: Last year, none of the companies were prepared for the lockdowns and its impact on their profitability and businesses. This year they are better prepared and have managed to control their costs very well, conducting their businesses reasonably well through new methods of reaching out to customers. The impact on demand will, therefore, not be as severe now as it was last year.

We can argue that the spread this time is more in rural areas, impacting growth. Yes, but the pandemic has impacted smaller companies much more than the larger listed ones.

Has the handling of the second wave impacted the way FPIs view Indian equity?

Ajit: Globally, there is a divorce between markets and the real economy. From a developmental economics perspective, we are in deep trouble. The middle class is losing money, the poor are getting poorer and the rich are getting richer because of the vaccination missteps, plus every wave will require more spends on hospitalisation and medication. The middle class and lower income sections of society will be spending money on survival rather than on consumption and on enjoying life.

But if you are an investor in the stock market, the fact that smaller companies are getting hit strengthens the case for being in stock markets. Market share of listed companies improved with each of these events that hit smaller companies — demonetisation, GST, Covid-19.

FPIs are not going to live in India, the social imbalances will not affect them as such, they are only taking a call on how companies will perform. So their stance towards Indian equity is unlikely to change and will remain positive.

Published on June 12, 2021

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