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Here's what you need to know about Megatrend 2.0

May 5, 2015

In this issue:
» Are you distracted by the all noise in the markets?
» Huge debt pile hampers Indian Infrastructure
» What does the latest PMI data show?
» A value investing lesson from the late Parag Parikh
» ...and more!


00:00
"From irrational expectations to rational optimism" quotes a newspaper headline as an 'expert' view on market sentiment. You need to be a literature scholar and not just an investor to understand what that exactly means. For me, such jargons and expert view mean as much as the daily dose of breaking news bombarded by enthusiastic news anchors. However, as investors and long term ones at that, it is important to re-evaluate your investment thesis every once in a while.

Now, when it comes to bottom up stock picking, every investor should have a clearly thought out reason to buy a stock. Buffett never buys anything unless he can write down his reasons for buying a company on a piece of paper. So if the reason for buying a stock is the strong brands it owns, a short term blip in profits cannot be the reason to doubt your investment. However if bank that you have bought for good asset quality starts accumulating NPAs it is definitely a good reason to sell the stock.

Similarly you need to re-evaluate macro investment themes from time to time. For if you are buying stocks based on certain trends in a sector, being oblivious to the opportunities and challenges can thwart your returns.

Now, most of you may recall that I wrote about India's second innings in an economic Megatrend in 2014. This can be called Megatrend 2.0 because it is the second phase of the Megatrend that India witnessed since 1991 for almost a decade. The fact that the Megatrends impact corporate profits in a big way is something that I wanted to highlight.

So if you are an investor with economic Megatrends as the key thesis of your investment, you may want to know whether and how well the trends are playing out.

First of all you need to understand that these trends are very long term in nature and do not impact corporate profits on a quarterly basis. So relating the latest quarter's or fiscal's performance with the presence or absence of a Megatrend is not the way to go about it. The March 2015 quarter performance of India Inc is definitely not encouraging enough. But that does not mean the broad rationale for your investments should change. That is because none of the trends have matured enough to make a meaningful impact on corporate profits. And even while the Megatrends are playing out companies will go though the cyclicality that the business models are subject to. So you need to invest in stocks that can eventually ride the tide and take advantage of the economic tailwinds.

And even as I write, The India Letter team is busy scheduling meetings with companies that are making some clear headway in one of the seven signals of Megatrend 2.0. The record private sector capacity addition in power, Rs 15 trillion deals for OEMs in defense, approvals and allocation of Rs 60 bn for smart cities and transformation in retailing are the more recent updates of the trends that the team is following closely. And as long as the long term fundamentals and management of the company merit the Megatrend bet, the short term performance will not change our views.

Are you changing your portfolio based on the March quarter results of companies you own? Let us know your comments or share your views in the Equitymaster Club.

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02:15
Megatrend or not, it is definitely not going to be a joyride for companies waiting to capitalize on India growth story. Take the case of infrastructure players for instance. The fact that a higher GDP growth rate would warrant more infrastructure investment cannot alone be the game changer for infra companies. They need to do a lot more to improve the state of their balance sheets as well. Already with a huge pile of debt on their books, the biggest Indian infra firms are finding it tough to execute growth plans. As per Wall Street Journal, Indian companies that build big infrastructure projects owe more than Rs 3 trillion to banks and debtors. The total amount of debt for Indian infrastructure companies is at its highest in more than a decade. And this in turn is affecting the overall economy because banks, fearing the loans won't be repaid, are reluctant to lend more to such companies. Thus as an investor you need to be very careful about the kind of company you are investing in, irrespective of macro trends playing out in the sector.

03:05
  Chart of the day
The Megatrends will certainly provide a long term boost to the economy. However, investors must be prepared for some hiccups along the way. The obvious example right now is manufacturing. While the government's 'Make in India' drive is a big long term positive, the current situation is not. While project approvals have more or less come through, the sector is groaning under a huge pile of debt. As corporates pay down debt, it is completely natural for inventories to be quickly liquidated. The evidence is clear on this front.

PMI data shows slowdown in Manufacturing

The chart clearly reflects the pressure felt by manufacturers at the factory level. The Purchasing Managers Index (PMI) is a leading indicator of economic activity. A reading above 50 indicates expansion while a reading below 50 indicates contraction. The slowdown in manufacturing is evident. We believe this trend may persist in the short term. However, as long as the government sticks to its reform agenda, the future is bright for the manufacturing sector. In the short term, the markets could present good opportunities for long term investors to pick up stocks in this space.

04:05
Yesterday had brought the sad news of the demise of Parag Parikh. He was one of India's leading Value investors. He passed away in a car accident while en route to Berkshire Hathaway's shareholder meeting in Omaha USA. There is much that investors can learn from this gentleman. The discipline to stick to the principles of value investing in the middle of a raging bull market would be the most important one we believe.

In a way, value investing is boring. Investors sometimes need to wait before the value of their stocks is recognized by the market. This can be difficult in a bull market when high growth stocks are in favor. This is why it's useful to know 'the law of the farm'. It means that you cannot sow something today and reap tomorrow. In other words, markets reward patience over activity. All kinds of stocks can go up in the short run. However, only the ones with fundamentally sound business behind them will create long term wealth. Mr. Parikh strongly believed in the 'law of the farm' and we believe you should too.

04:40
Meanwhile, the Indian stock markets were trading flat. The BSE-Sensex was trading down 22 points (0.1%) at the time of writing. Banking and consumer durables stocks were leading the losers. The midcap and small cap indices were outperforming with gains between 0.6 and 0.1%. Most Asian indices ended in the red. European indices have opened on a positive note.

04:50
 Today's investing mantra
"Behind every stock is a company. Find out what it is doing." - Peter Lynch

This edition of The 5 Minute WrapUp is authored by Tanushree Banerjee.

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2 Responses to "Here's what you need to know about Megatrend 2.0"

Joisa

May 6, 2015

Make in India is not going to succeed unless the Govt controls the import of cheap/ substandard materials from countries like China and those having bilateral treaties. Even cheaper credit by the banks is not going to help as it is not the only factor deciding viability . The dumping of chemicals, steel etc will kill Indian industries. Top management posts are lying vacant in PSU, PSBs etc. Nobody wants to take dicisions. PM is on a continuous foreign jaunt, whether China will change it's colours?. Even hardcore Modi supporters may find it difficult justify the actions. May be big Corporates and IMF, BCG,WORLD Bank people etc may be happy

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Savio

May 5, 2015

I am not too surprised reading Tanushree's post.

I used to be a journalist many years ago. I was on the Business Desk and press conferences were mostly at plush hotels and in the evening. The philosophy was "relax" while you work. :)

I recall I once returned to the office at around 11 pm after the conference. I was the only sober reporter and that is why I was able to get to the office on my two-wheeler. :)

I filed the story that got published the next day. Guess what! My friends from the other newspapers were angry because they were pulled up for not running the story the same day.

My lesson: When there are obvious conflicts of interest, you got to be very careful. From the finance perspective, we need to be very careful what brokerages recommend (read buy/sell calls a dime a dozen) because they are rewarded for our (senseless?) activity. And as Mr Buffet says, we are rewarded only for being right!

So be sober in your finance career and stay the course.

PS: Very sorry to hear about Mr Parikh's demise. I was one of the early investors in his mutual fund and learned a lot from his videos and books.

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