Current 'hot' topic impacting your equity exposure? - The 5 Minute WrapUp by Equitymaster
Investing in India - 5 Minute WrapUp by Equitymaster

Current 'hot' topic impacting your equity exposure? 

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In this issue:
» Cash rich Indian companies are increasing debt.
» India Inc. in the worst financial health in almost a decade.
» OECD: Poor education and labor laws impacting India's growth.
» The restricted branch network of foreign banks.
» and more....

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Given the volatility of the stock markets over the past few years, retail investors have reduced their exposure or have moved away from stock markets in recent times. A part of the reason also maybe due to the front line stocks, represented by the BSE-Sensex, not having moved anywhere, given that the index has been hovering around 20,000 mark for a while now.

In the process, investors' interests and exposure to real estate or fixed income investments - which have been moving higher or do provide short term certainty on returns, has gained traction in recent times.

But... not having any exposure to equities - the asset class that has outperformed all other categories over the long term - is not the way to go, in our opinion. Especially considering the large ticket size and risky nature of real estate investments and the barely inflation covering returns of fixed income securities.

Once in a while we come along the 'hot' topics of the season that go about affecting investor sentiments. The current one being the 'possible outcome of general elections'. Pick up any business daily and a few pages are dedicated towards the happenings and developments in the political scenario of the country. And it would not be wrong in saying that these developments will continue to influence the movement in stocks and sentiments of investors - both foreign and local - till the final results are announced.

Should such developments impact long term investors' investing decisions? We don't think so. Sticking to strong companies which are involved in businesses that are bound to do well irrespective of which party comes into power is a good way to go about things. This is as long as these businesses are acquired at decent valuations.

We would like to point out that such a question was posted by one of the members of our recent initiative - the Equitymaster Club. The question was whether it is risky to invest in equities for new investors or should one wait till the elections.

It is for such interactions that we have set up the Equitymaster Club. It is essentially a platform for long term value investors - new and seasoned - to come together and share their knowledge, ideas and views on all things investing - be it equities, derivatives, financial planning, mutual funds, commodities, amongst other things.

And we must say, we found the responses - by members of the club - to this question to be very interesting!

In our view, a very broad and relevant method to go about gauging the attractiveness of the stock markets is by looking at the valuations of the key indices.

Currently, the BSE-Sensex is trading at a trailing twelve month price to earnings ratio of a little less than 17 times. This is close to the average valuations that the index has traded at over the long term. So, the front line stocks are trading at fair valuations at the moment.

But when one compares the valuations of the rest of the stocks, those represented by indices such as the BSE-500, BSE Mid Cap or BSE Small Cap indices, it does paint a different picture. The current valuations of these indices are lower than what they have been trading at over the long term, which indicates that on a broader scale, stocks are not very expensive. However, it would only make sense for investors to take a bottom up approach when identifying individual stocks from these spaces.

According to you, is it a good time for investors to increase their exposure to equities or should one wait for the outcome of the elections to make their decision? Let us know your comments or share your views in the Equitymaster Club.

01:40  Chart of the day
It was only a while ago that the regulator had imposed restrictions on the expansion network of the foreign banks in India. The RBI had urged the foreign bankers to convert their branches into wholly-owned subsidiaries. It had also promised near-national treatment to the foreign banks if they were to adhere to subsidiarisation clause. This made the foreign lenders contemplate about their Indian presence. However there has been a change of stance of late. The RBI has further tightened the subsidiarisation guidelines. The foreign lenders would be allowed unimpeded branch network provided their home countries permit Indian lenders to open branches without much restrictions. These restrictions have put off the foreign lenders. So much so that the global major Citibank has decided against setting up a subsidiary in India. Moreover issues pertaining to stamp duty and taxation also stand looming. The requirement of significant rural presence acts as a major deterrent too. We believe that the RBI is certainly justified in demanding an equitable treatment for Indian banks overseas. And it is time the banking regulators in the US and Europe too allow more leeway to Indian entities. However, the RBI needs to take into account the business dynamics of the foreign entities while formulating its guidelines.

Foreign banks: Restricted branch network

Investors are, at times, in awe of certain corporate. So much so, that they are only bothered about the returns from the company. As long as that remains intact, they turn a blind eye to any financial wrongdoing. Take the case of cash rich companies like Apple and Google for instance. With about US$ 145 bn in its books, Apple for instance could acquire Facebook, Hewlett-Packard and Yahoo. Put another way, it could buy every office building and retail space in New York, according to New York Times. But even then the company has been adding truckloads of debt on its books. Why so? For debt is considered a burden only when one has to pay a price for it. But when companies are fetching nearly free money, it is often irresistible to not take the same.

Moreover, those familiar with the concept of return on equity (ROE) will know that debt has an important part to pay in shareholder returns. And if debt is available at near zero cost to boost ROE, companies are under shareholder pressure to take additional debt. This is exactly what has been happening to cash rich companies under the influence of the Fed's QE program. What is worrying is that not just companies in the US but also those in India are resorting to the same. Conglomerates in India like Reliance Industries too have raised cheap funds overseas despite sufficient cash on book. And as and when the interest rate cycle turns, the companies will have to offload the debt. That is likely to have a negative impact on their ROEs and in the process impact their valuations.

We have a question for you. What, according to you, is the biggest threat to the economic stability of India? Is it high inflation? Or is it budgetary and current account deficits? Here is something shocking. If the International Monetary Fund's latest annual assessment (as reported by Mint) of the Indian economy is to be believed, the biggest threat for India is excessive corporate leverage. In other words, the balance sheets of Indian companies and banks are sitting on a huge debt pile. Indian companies are in the worst financial health in almost a decade. In fact, the IMF goes on to point out that Indian companies are way more leveraged than other emerging markets. Indian companies rely on foreign funding for about 20% of their debt finance. It must be noted that the debt risks are concentrated in certain sectors such as construction and infrastructure. As such, investors must exercise prudence while investing in these sectors. The same would hold true for investors looking to invest in the recently beaten down banking sector stocks given that they have a significant exposure to such sectors that are dong through tough phases at the moment.

The India growth story has taken a backseat in the last 2-3 years. Infrastructure bottlenecks are the primary reason why growth has been suffering. OECD too has echoed concerns on India's infrastructure mess. Apart from that, it also cited poor labor laws and education quality as primary hindrances for slowing growth. Well, there might be nothing new in what OECD has said.

India's infrastructure growth has been suffering due to policy paralysis. Though we have Right to Education (RTE) in place, the quality of education is poor. We need more of an inclusive model for education. Further, overly stringent labor laws have hindered job creation in the formal market. All these factors have seen GDP growth falling to the 5-6% mark. As such, the OECD has rightly highlighted these concerns.

So, what needs to be done to revive growth? Obviously find a solution to these issues. However, the nature of coalition government prevents this from happening especially when it comes to enacting reforms in the infrastructure space. We all know the kind of resistance incumbent government had to face while passing the bill on FDI in multi brand retail. However, the entire blame of infrastructure mess cannot be put on the coalition nature of democracy. The government in itself has shown very little will when it comes to speeding up infrastructure investments. Excessive bureaucracy in getting project clearances and corruption are main impediments to infrastructure growth. Unless government works towards this regard, growth is bound to continue to suffer.

Barring few, global stock markets mostly rose during the week gone by. The US markets, however, remained weak on account of poor housing data that raised concerns about the American economy. Also, the severe climatic conditions weighed down the economic growth, thereby leading to subdued activity across US indices. Moreover, the cues of scale down in monetary stimulus restricted the momentum in US benchmark indices. While the benchmark S&P 500 index closed weaker towards the end of week gone by, it is expected to remain tepid in the forthcoming week too.

Barring Germany, the European markets delivered a strong performance in the week gone by. The major indices of the UK and France were up by 2.6% and 0.9% respectively. The French index is expected to remain buoyant as the investors are counting on the potential economic growth of the country. Moreover, the Ukraine political fiasco kept the European ministers busy during the week. That said, the European Union eyeing the G20 growth target would continue to maintain positive sentiments across European indices. The Asian markets stood strong in the week gone by. However, China's benchmark index stood lower as the fears pertaining to the durability of the China economic recovery continue to weigh high.

The Indian equity markets ended the week on a firm note. Persistent capital inflows from the foreign funds coupled with positive global cues maintained the Indian markets' buoyancy throughout the week. Moreover, the Finance Minister's positive commentary in the interim budget brought cheers to the equity markets. The Indian economy is expected to recover at least 5.2% growth in second half of 2013-14 from 4.6% in the first half, as cited by the finance minister.

Performance during the week ended February 21st, 2014

04:56  Weekend investing mantra
"Nearly everyone interested in common stocks wants to be told by someone else what he thinks the market is going to do. The demand being there, it must be supplied."- Benjamin Graham
Today being a Saturday, there is no Premium edition being published. But you can always read our most recent issue here...
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2 Responses to "Current 'hot' topic impacting your equity exposure?"


Mar 1, 2014

I strongly feel that one should wait till the elections are over. Reasons-
1) BJP and congress may not get a full majority.
2) If Aam admi party come to power, they have to fulfill their agenda first. It will be like comunist style. Everything will be subsidised; but from where they can finance these subsidies? There may be confusion until they correct; atleast for few months.


R C Sarangi

Feb 22, 2014

My considered opinion is that this is the best time for investors to increase their exposure. The post election scenario emerging are three. The first is that UPA will come back. In this case they will try to mend their ways to appear more pro industry and rein on corrupt practices. Second scenario is that NDA will come which no doubt will be pro industry. Only third scenario of a fractured third front emerging will hurt industry and economic outlook. Hence higher exposure has advantage of 66%. I wish the political outcome was so simple, but in any case there appears a large possibility of better economic outlook after election and investors should have no doubt of Sensex reaching 23000 by end of the calendar year.

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