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What Money Monarchs expect this year
BS Smart Investor Team | January 30, 2006
Seven stock market stalwarts debate the prospects for Indian stocks in the annual round-table organised by Capitalideasonline.com.
Here's what they have to say:
Ramesh Damani: Good evening ladies and gentlemen and welcome to this round table. In the comedy "Shall we dance" actress Susan Sarandon, talking to an acquaintance, poses the question, "why is it that people get married?"
People get married, she muses, because they want a witness to their lives. Fast forward to 2006. The romance with Indian equities is in full bloom and today we assemble, the great witnesses to what we call the great Indian bull market.
In this cathedral to capitalism, in this hallowed hall, the soul of the Indian stock market, if you will, when this group of witnesses last assembled in 2003, the Sensex was at 3000 -- it has now tripled; the number of Indian companies with a $1 billion market cap has crossed 75 and India's market cap is over $500 billion.
In 2003, when we asked our panelists what they thought of the market, the opinion was unanimous and prophetic. They all said "bull market ahead." What are they saying in 2006?
Is India today where Japan was in the 1960s? Are these valuations sustainable?
Can oil prices or terrorism or the Iran American conflict derail this global economic expansion? These are just some of the questions that we are going to pose today. And as usual, we start with Rakesh because you can't keep him quiet for half an hour!
In November 2003, Rakesh said I am an India bull and we are just watching the trailer. My first question today is: Have the hero and heroine met or are the credits rolling?
Rakesh Jhunjhunwala: I would say the trailer has given us confidence that the movie is going to be very good. I think the momentum in the Indian economy now, is like never before.
With every passing day, every Indian is getting more confident. Of course, this is being helped by the fact that he is making money when he invests in the markets. So, I would say that the trailer is over. About the hero and heroine – I don't know.
I'm not a scriptwriter but my feeling is that at this juncture, there is good growth momentum and people are confident that this will sustain. I think that's important because that itself will contribute to the growth of the economy and the momentum.
Ramesh Damani: In terms of the movie analogy, are we at the interval?
Rakesh Jhunjhunwala: I think we are just seeing the titles. After the trailer, you see the titles, no? I am not some political theorist or economics professor, I am share bazaar road cheap.
But I feel that kind of prosperity towards which India is marching and the manner in which it is marching is unbelievable. It's not a view because the index is 10,000. Even if the index falls to 7000 tomorrow, I will hold the same view.
Ramesh Damani: Rakesh, is there anything you'd like to see in the budget?
Rakesh Jhunjhunwala: Sometimes I wonder about the reforms we have had the last 24 months. Right? Now we had a very skillful Finance Minister who has been able to meet so-called social needs, through small doses of taxation. We have had VAT. What I feel now is that governments are inconsequential. And I draw comfort from my study of history which tells me that when a democratic society decides what is in its favor, the happening of that is inevitable. There are Communists in Delhi and capitalists in Calcutta. Every politician realizes the inevitability of reform.
And what will the government do in the budget? They will tinker a bit here and there. I only hope that the FBT goes and that the STT does not increase. You know the government of India might never have collected even Rs 1000 crore (Rs billion)s as long-term capital gain tax.
And they have collected Rs 3000 crore (Rs billion)s through STT this year. And they want to increase the rate? The only thing that is disturbing is that something which pays is being taxed to death. My only wish is this should not happen.
Ramesh Damani: Right. Rakesh, you know, three years ago there were many doubters even in this audience about whether India was heading for this long structural secular bull market you talked about so passionately. Are you astonished at what has happened?
Rakesh Jhunjhunwala: You know sometimes I feel like singing "ki shayed tu aise hai jaisaa maine socha tha." Right? By God's grace things have panned out as I envisaged them. But the true believers will be seen when the index corrects by 2000 points.
Ramesh Damani: Doesn't the pace and the resilience astonish you?
Rakesh Jhunjhunwala: I personally feel that at this level, we are entering the first stage of the domestic inflows. The moment the investors gain, they will invest more. And I think there is humungous domestic money to come. Unimaginable. You know Indian savings in 2010 is projected to be $410 billion.
If 10 per cent is to flow, it will be $40 billion. So even if the index goes down 1000 or 2000 points, as long as India's growth story continues, the economic story continues, I think the market is just going to march ahead. Of course there will be periods of correction. We don't know.
Ramesh Damani: Rakesh, what would be the themes that are important for the market in 06?
Rakesh Jhunjhunwala: Two things worry me. First , the world economy, because I think American consumption has to come down. How it will come down, how global currencies will realign, what effect is it going to have on global demand, that's going to be very important.
The American economy is going to tank in my opinion. When that happens, it will have a big effect on the sentiment towards equity. So we must be alert. Second, I think oil prices beyond a point are going to lead to higher inflation and higher interest rates.
Corporate profit growth in India may slow down. But if the essential story of an improvement in quality of profits, higher consumption, and a growth rate of 8 per cent is intact, I don't think a fall from 25 per cent growth in profits to 15 per cent is really going to disturb the market. It is events outside of the market, which will shake the confidence and also affect corporate profits substantially that would worry me.
Ramesh Damani: Rakesh, net net will 2006 be another positive year?
Rakesh Jhunjhunwala: If you ask any Dow theorists, they will tell you that if the market goes up for 3 days then it goes up for 5, and if it goes up for 5 days continuously, then it goes up for 8 etc. But it is reasonable to expect that this could be a negative year. But what difference is that going to make?
My investments have a entry value and a terminal value. And while trading, the screen talks to you and tells you. So badega to lenge, ghatega to bech denge. If it corrects, so be it. It's not going to affect my investment thoughts.
Ramesh Damani: You know it might correct within the year but overall we are still in the structural secular bull market?
Rakesh Jhunjhunwala: Very much. And I don't think something can slow it.
Ramesh Damani: Thanks, Rakesh. Let me turn next to Raamdeo Agarwal from Motilal Oswal Securities. Raamdeo, oil, art, gold, real estate -- how long can they all go up?
Raamdeo Agarwal: I think that's the funny part that this is a very strange time when all assets are at all-time high. Four or five years back if somebody had said that oil is going to $70, I mean would you touch stocks?
Common sense would suggest that you should be out of stocks. But when oil hits $70, the stock market also hit an all-time high. I think, it is because of global liquidity. Like Warren Buffett has said, at any point of time, the tiniest change in the interest rates will change the value of every single form of asset in every part of the world. And I think it's coming true. The world is floating in liquidity.
Ramesh Damani: In 2003 you also said, Raamdeo, that every one knows the price, but no one knows the value. Today, are you seeing price and value converging?
Raamdeo Agarwal: Equity allocation is most irrational not only in India but all over the world. The highest allocations come at the peak of the market. And the lowest allocations come at the bottom of the market. If you see the RBI data in last 10-15 years, I think financial investing constitutes about 0.2 per cent of the total GDP.
When our savings rate has gone up to as high as 30 per cent, your risk-free return has come down from 15 per cent to about 5-6 per cent. When your risk-free return is 5 per cent, you equity allocation has to be the highest. But...
Ramesh Damani: ...it's the other way around.
Raamdeo Agarwal: ...unfortunately, allocation is still low. So, it is very clear that people understand only price. Fortunately for three consecutive years we have had a fantastic rise, first year 85 per cent, then 16 per cent, and now close to 40 per cent.
Now people are realizing that bank deposits at 5-6 per cent are not worthwhile. Let's look at the Indian stock market.I think this is not the best time to buy into the stock market. I'm not saying that we are beyond the interval or anything like that. But what I am saying is that if allocations increase, it could really blow up.
Ramesh Damani: It's time to turn to the professor, Sanjoy. In 2003 you said India would grow at 6-7 per cent for 2-3 years, but then would sputter. So at the end of three years, is the ship sinking or is it smooth sailing ahead?
Sanjoy Bhattacharya: I recognize the folly of my words, I had no clue of what I was saying. Hopefully I have learned from it. So I'm not going to make any predictions right now.
Ramesh Damani: But the economy looks good to you?
Sanjoy Bhattacharya: I think it's fair to say that both Rakesh and Raamdeo have said and they certainly have more wisdom than I have. I think the message that I got from them is that these markets are not as easy for the bulls to make money as they were some time ago though there are still opportunities to make money undoubtedly and there are lot of positive macro factors.
Ramesh Damani: But do you think in the context of a structural bull market, there is going to be one tough year ?
Sanjoy Bhattacharya: I think, Rakesh put it very well, he said, if you look at it in the context of the next decade or the next 15 years, there is absolutely no doubt about how markets will move. And I'm proud to be an Indian today. This is a very exciting country to be in right now.
At this point, I need to emphasise that a hell of a lot of growth that we are going to see in the next two or three years is not going to be profitable growth, but unprofitable growth.
Ramesh Damani: And is it also priced into those stock prices?
Sanjoy Bhattacharya: To me it appears that way.
Ramesh Damani: Sanjoy, I probably know the answer, but I'm going to ask everyone as the last question. What's up for 2006?
Sanjoy Bhattacharya: If I had to toss a coin, I think the answer would be minus. But I'll say, there will be opportunities to make money in 2006. There will be those who will be smiling like Cheshire cats at the end of 2006. But it will require much greater brain, intellect, certainly large dollops of luck and discipline to make money this year.
Ramesh Damani: OK. Bharatbhai, let me turn to you. In 2003, you said and I quote, "India has found a destiny under the sun." Will the sun keep shining in 2006?
Bharat Shah: In the context of the life of a country or our own investing life, one year is not so critical. I think there is huge opportunity for compounding, whether this year will be it on not, I don't know, but I certainly do believe that for next few years that these are great money making opportunities.
As Sanjoy rightly mentioned, there are some outstanding opportunities, in every bull market and there are ideas -- ideas which are still attractive. And in every bear market there are some overvalued businesses. I don't see that changing now.
Ramesh Damani: Bharatbhai, the third quarter has seen some slowdown in the profit growth. Does that worry you?
Bharat Shah: Clearly, I think if we look at the period from 1997-98 which was roughly the time when good companies decided they had to ramp up, cut costs, become efficient,go global, improve manpower quality, raise the asset efficiency, improve working capital efficiency and all of that.
Many good companies have done that, and used capital very wisely. They didn't really inject any money in into the business, and turnover grew modestly but the profits grew much faster.
From around 2003 onwards we are sing companies putting more money into the business, they are raising the scale and that's the phase that we are seeing a little bit more of capital intensity creeping into the overall corporate environment.
I think in these 2-3 years, the easy pickings of the earlier years have gone and that was a phase where x percentage growth in topline produced x plus y percentage growth in operating profits and disproportionately larger x+y+z kind of effect at a pretax profit level.
So companies did extremely well on the bottom line front. I think last couple of years, we are seeing a mild correlation of x percentage growth in topline leading to maybe a modest x+y percentage growth in profits.
Going forward, I think there is every possibility for many of the businesses that x percentage growth in topline will mean x minus y in the bottom line. And I think it is important to be aware of that.
You don't want to be touching the ones who are embarking on capex, but you want to hunt for the businesses receiving capex. So rather than hunting for Tiscos of the world who want grow their capacity 10 time in next 15 years, I would probably like to look at businesses which will benefit from that.
I have to ask the question. Am I going to risk some money by investing in 2006. Plus or minus?
Bharat Shah: No. I don't know honestly. And I don't even care to know. Because I believe that there is a moneymaking opportunity for the next 10 or 15 years.
Ramesh Damani: Ok. Bharatbhai, thanks. We now turn to Sukumar.
R Sukumar: I think the market is being driven by the fact that India was totally undiscovered and there is money coming in and I think this is the tip of the iceberg. It's going to be much much bigger and when you really look at the demographics and the implication it has on the savings rate and the type of money that people can put into the market over the next 20 or 30 years, the amount can be mind-boggling.
The money that is coming into the equity market is obviously increasing. My rough estimate is that there is about $1 trillion with the households currently.
So every one percentage point shift could mean about $10 billion of flows into the markets. And if you assume it's going to be a 10 per centage point shift, we are looking at $100 billion. And FIIs in the last 11 years haven't put in $100 billion. So, I think from a pure demand perspective, it's going to be pretty mind-boggling over a period of time.
Ramesh Damani: Any wish list from the finance minister for this budget?
R Sukumar: The FM has to capitalize on the momentum, which has mainly come from the manufacturing sector, which is 30 per cent of the economy growing at 5 per cent. So, infrastructure spending, improving the bottlenecks will keep that sector going. The other issue is that you have to keep inflation within control for which I think the fiscal discipline is very important.
Ramesh Damani: Aren't you worried about oil?
R Sukumar: I think it's definitely a short to medium term worry.
Ramesh Damani: Short to medium term or long-term? I mean oil could be in a structural bull market too. Could take it to $120 a barrel.
R Sukumar: Yeah. I think depends upon what you are defining as long term. If you're looking at 10 years, I would think that it would be less of a concern because oil at high prices will lead to innovation. One simple fact, you know, in US you have the Ford Explorer which is a pure gasoline version and one which is a hybrid version.
The hybrid version consumes half the gasoline but you have to pay $10,000 more. And the government doesn't want to do something to incentivize that thing but wants to go to Iraq to bring the price of oil down.
But if they can address some of these issues, obviously the demand can alter very significantly. And also using natural gas as transport fuel can alter the situation. But net net, I think in the long term, innovation will ensure that oil price is not going to impact the economy too badly. But from short to medium perspective, innovation is not going to help.
Ramesh Damani: Net, net Sukumar, 2006 -- up or down?
R Sukumar: We are in the business where we are saying don't come to the market unless you're looking at 5 and 10 years. So to speak about 2006 I think is plain unethical. But if you look at 2006, I don't see the foreign inflows increasing dramatically.
From a domestic point of view there is scope to increase and we are seeing some signs of increasing. So I think both are positive. The worry is clearly that the supply pipeline is building faster and there is a lot of incentive for a lot of promoters who don't really create value to raise capital at this point of time. Whether it happens or not I think is the issue.
Ramesh Damani: OK. Thanks Sukumar. Tell us Madhu how do you pick stocks?
Madhu Kela: When we choose stocks, the first thing which we look at is what is the size of the external opportunity in which the company is operating. Second is whether you see a management which is hungry enough to produce which can make your one rupee, two rupees or not.
Whether they have fire in the belly. Third is the longevity and the competitiveness of the business itself. And finally as lot of distinguished guests have already spoken, we look at what price are we getting into. Because you know buying a great company expensive is no fun.
Ramesh Damani: You seem to be very bullish on the real estate sector.
Madhu Kela: I am very optimistic. One, when I look at the overall market cap of real estate companies in relation to what the overall market cap of the India is, it's disproportionately low.
Second, you know as Rakesh said that crooks become honest when they become wealthy. And the markets have proven many a times that too much emphasis on that honest management may help you talk good but it doesn't help you generate good returns.
So you have to look at managements which can deliver. And look at the size of the economy and look at the size ofreal estate development which has happened.
Look at -- you know Hong Kong is a $200 billion economy, Singapore is $125 billion economy -- when you go into these countries, look at the kind of real estate development which has happened.
And look at -- we are going to be $1 trillion economy in the next couple of years and the state of real estate development in our country. And that is what I meant when I said we look at external opportunity. The opportunity looks staggering. Now, our job is to find that hungry promoter and buy it at the right value. And sit tight.
Ramesh Damani: Madhu, you work for a group which fairly or unfairly has a reputation of being very close to New Delhi. So what's coming in this year's budget?
Madhu Kela: I wish! But I have my own wishlist for the budget. I think the pace of infrastructure development in our country is what is really worrying me a lot. The pace of the whole infrastructure unbundling has to happen much much faster than what we have seen. And secondly I would imagine that they would do something about the agriculture sector in general.
Ramesh Damani: What are the themes that you think will work this way in the market?
Madhu Kela: The companies which are benefiting out a domestic economy expansion and are benefiting out of domestic consumption will continue to do well. The other thing which I have been quite positive over last 2-3 years and continue to remain positive on the outsourcing opportunities minus IT.
Pharmaceuticals, auto ancillaries, there are lot of sectors which are opening up -- and most ideal placed companies are wherever you have 60-70 per cent turnover coming from the domestic side of the business and 30-40 per cent turnover coming from the export side of the business. And the size of the export opportunity looks very large.
Ramesh Damani: OK. Madhu, thanks.
Last, but of course, not the least we turn to Prashant Jain. Can you explain your investment philosophy?
Prashant Jain: I think we'll all say the same thing but anyway... we like good businesses. I think we are a growing economy so we look for growth potential. Ideally the business must generate free cash flows. I think good business with some comparative advantage.
Sustainability is extremely important. At least I try and avoid investing in businesses with low sustainability. Then I think management is important. We have realized that managements do change over time. And that's why we don't look too much at the past actions.
Many people have made mistakes but I think that competence to run a businesses is very important. And finally I think the price what you are paying. And we always remain effectively diversified. Even if we are running a portfolio with 20-25 stocks, we are effectively diversified across key economic variables. So that is how you attempt to limit the impact of any mistakes that you make.
Ramesh Damani: Does oil prices, the satndoff ith Iran problem or even the even bird flu worry you? Do you take that into your metrics?
Prashant Jain: See, when we look at risks, we look at two things. One is event risks which impact the sentiment of equities globally or locally. And second is events or factors which will impact the earnings growth or the economic growth of country.
To be honest with you, we don't see many risks which will reduce or impact the economic growth in this country on a sustainable basis. I mean to put things in perspective if you go back 20 years oil used to sell for may be Rs 10 to a litre. Today it is Rs 45 to a litre. So clearly it has not impacted economic growth.
I think oil impacts us two ways. One is it increases inflation world over, but it does not put our companies at a comparative disadvantage to others. Because cost of production is the same.
And second is it reduces consumer surplus. Which again I don't think is very relevant in the Indian context because such a high savings rate and such a high growth in income. And that is why oil even if it spikes, it may impact the sentimental equities, but I don't think it will have a lasting impact on corporate profits or economic growth over even a 2-3 year period.
So, I don't see too many events which will reduce the economic growth potential in this country. But sentiment could suffer. I mean if I think if something happens in Iran or Iraq or generally sentiment towards equities worldwide turns bearish.
I think today we are far more globally integrated, we see huge amount of capital inflows. So I think if the sentiment towards equities deteriorates, we will suffer. But I don't see any concern as far as economic growth is concerned.
Madhu Kela: Can I just add here?
Ramesh Damani: Sure, Madhu.
Madhu Kela: I think you have a look at the sum total of investing in your favor. You can't look at oil in isolation. Because if you looked at oil in isolation, you would have been worried even at $50 and would have been sitting on cash.
The reality is markets have moved up 50 per cent and oil has also moved up by $20. So as long as the sum total of investing remains in your favor, oil in isolation will not be a big worry.
Ramesh Damani: Prashant, Moneymaking is easy is a bull market -- evryone can make money. Does that frighten you as a fund manager?
Prashant Jain: I think the way I look at the markets is that what has happened in the last two or three years is that PEs were very low and because of deleveraging, improving cost efficiencies, falling cost of borrowings, the profit growth has been disproportionate. And as Indian stock markets have been discovered by the locals and the PEs are now quite reasonable.
I think going forward we will see profit growth is slowing down, number one. And number two, the profit growth will not be uniform all across sectors. But regarding stock prices moving by 20-30 per cent in a month or in a matter of weeks, I think it is always like that.
You may hold a stock for three years but in 10 per cent of the days, it will give you bulk of the returns. So I am not particularly worried about Siemens going up by x percent on a particular day. But one thing what I am sensing is in the market is that the premium for quality has certainly shrunk. And as an investor or a manager, what I'm trying to do at least is to focus more on the quality. And I think, big money is over.
Capitalideasonline.com has published a book authored by Chetan Parikh, Naveen Agarwal and Utpal Sheth called India's Money Monarchs.
The book contains in-depth interviews with leading Indian investors and fund managers bringing out their investment philosophy and success factors. It provides useful insights into investing in general and the peculiarities while investing in Indian markets in particular. A useful read for serious investors.