Let us talk about this export led push. A variety of export oriented companies are talking about buoyant outlooks and good demand. How are you playing this export-oriented push which is coming to India?
Post the pandemic recovery that we have seen after the second Covid wave, there has been very good recovery in exports. A lot of global parameters are showing that we are moving towards normalisation and the efforts that have gone in for the past few years are showing results there.
The government introduced a lot of production linked incentives for import substitution to promote export for our key industries. The world is looking to source from India as part of a China plus one strategy. A lot of multinationals want to set up new businesses or increase their businesses in India. I see a good pick up in the capex cycle on the export side, a good demand and a buoyant environment there and we are coming back to handling some of the supply issues that were disrupted in the last few months.
As we are coming back, things are getting better. Even the corporates that I speak to have indicated that they are very positive about the outlook. Almost all the sectors which are exporting are showing good signs and this time it will be good demand pull plus the incentives given by the government which will show up in the profitable growth for these sectors.
There’s a debate going on whether the real economy and Dalal Street are moving in tandem. Naysayers are seeing things are not good on ground but the market is a discounting machine for the future. What do you expect the earnings would be for the next couple of quarters for your portfolio companies?
While on a longer term, we see a good correlation between GDP growth and the markets growth purely because a lot of sectors which contribute to the GDP are also contributing to the earnings in a big way, especially if it is a banking or financial services company. That’s why we see over a decade or so, markets have a good correlation with GDP. However, if you look at breaking it up into year-wise movement, that is not the case.
Also within the sectors that are moving, there are certain heavyweights which move in a particular type of economy. For example, during the second wave, we saw pressure coming in banking and financial services which brought the market some correction or a flattish movement for a few months. The other sectors continued to do well. For example, IT or chemicals and some of the infra companies started doing well. So, I do not think we should try to connect exactly one to one with markets and with the Nifty.
The second part, which is also an important difference, is there is a large unorganised sector in the country and they have not completely recovered. So, I am not surprised that when we speak to people on the ground, we do not see that complete recovery or growth vis-à-vis say what they had in 2019. But the improvement is definitely there and within the organised sector, I think there is a very sharp improvement as a lot of market share has moved from unorganised businesses to organised. That is where the difference comes. Markets have moved logically from here. One has to be a little more cautious because a lot of sectors, a lot of stocks have moved into reasonable or fair valuation zones. One has to be very selective from here on in the themes and in the kind of stock picking that we are doing.
Let us flip the coin a bit. Which are the areas of the market which have started to look frothy to you and where the earning stories are getting discounted and where given a chance of further rally, you may be keen on taking some profits off the table?
I have tried to generalise these segments but unfortunately it is very selective even within the sectors. For example, it is true consumer companies have very high valuations but many of these franchises are so strong and their business models are very strong. They are throwing so much cash and they have such fantastic return ratios that they deserve a higher rating than the average market.
However, there are certain stocks within these sectors where valuations have moved up significantly. We try to do a certain kind of reverse. We see what kind of growth rates will be required for them to sustain these valuations and in the case of a few of these companies, expectations will be much higher in the future. That is where the valuation problem comes in. Valuation actually reflects that people have very high expectations about that company.
Now people who are coming in with really long term views, will still see returns from these companies but the compounding will be slower. If one buys these at the right valuations, a great business can become a great investment and that is where one needs to be selective.
There are certain pockets, certain IPOs listed at such a high premium to their peer group but they get corrected over a period of time. People should look out for where they can get the best compounding of returns when they are investing instead of giving in to the fear of missing out (FOMO). That is where valuation matters a lot.
How convinced are you of the robustness or the sturdiness of the earnings qualities of your portfolio companies or corporate India in general? We have seen a couple of quarters of healthy earnings already. Does the runway look as good four to eight quarters from here on?
When valuations are low, surprises become your friend. So whenever there is an earnings surprise in positive, stock prices move significantly. When valuations are low and there is a negative earnings surprise, the stocks do not fall much because the expectations are generally very low. When the valuations are high, then surprises become important in a way because a negative surprise means there is a sharp correction and the positive surprise means there is not much up move in those.
We have seen very good earnings upgrades in the last four to five quarters and we have reached a level where in case of earnings surprises, the market can probably take a time correction or maybe a short correction downwards also. So I am not worried about earnings growth or broad based economic recovery. But when we are already pricing in FY23 and then want to look for FY24 valuations, either one has to be patient or be ready for a correction and has to be aware that a negative surprise can lead to a sharp down move.