Will you see more stocks to Buy in the coming months? - The 5 Minute WrapUp by Equitymaster
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Will you see more stocks to Buy in the coming months?

Aug 19, 2015

In this issue:
» Inbound M&A deals rise in 2015 so far
» Loan books of private sector banks deteriorate
» ...and more!

In a normal world, the stock market would be a useful barometer of the health of an economy. Indeed, a growing economy would boost corporate profits. And stock prices would mirror rising earnings. In other words, stock markets would move in tandem with economic growth.

However, in the US, with the Fed's easy money policies and interest rates near zero, return-starved investors have made a beeline for stocks. Never mind the fact that stock prices are outpacing corporate earnings.

This wouldn't happen in a normal world. But the US hasn't been normal since 2008.

How about India?

Thankfully, the RBI hasn't jumped on the money printing bandwagon, and its prudent polices have been almost universally lauded.

And yet, the gap between corporate earnings and the stock market exists - and is growing - in India as well.

Let's look at earnings. For the last many quarters, they have been tepid. The investment cycle is yet to turn. Rate cuts through banks have been gradual. Erratic monsoons have hit rural consumption. And key reforms have faced logjams, which has hampered big investment projects.

The only silver lining has been the fall in commodity prices. For a country that largely imports, this has certainly helped many companies' input costs. But it hasn't been enough to bolster growth, and the government's 8% GDP growth target for the fiscal year appears a tad ambitious.

And yet, the stock markets paint a different picture.

Unrealistic growth expectations have pushed the valuations of most Indian companies to beyond expensive. True, we've had a slew of corrections since the start of 2015, but they haven't been enough to bring prices within our comfort zone. While quality companies do abound, value investors will have a hard time buying at these levels.

Should we expect more corrections in the coming months?

It's hard to say. Developments in China have complicated matters. The dragon nation has slowed, and stock markets have tanked. And last week, in a desperate attempt to bolster the economy, the People's Bank of China devalued the Yuan. Clearly, things aren't going too well in China, and investors are pulling money out of the country fast.

This, along with the ongoing problems in the eurozone, has kept India on many investors' radar. That means a wider price-to-earnings gap could remain a reality in India for months to come. Now, these global factors are beyond the control of the government, so the only way to close the gap is for corporate earnings to get a much-needed shot in the arm. For that to happen, we need a revival of the investment cycle, a bolstering of irrigation, and progress in reforms such as land acquisition and labour laws (to name just a few). And this will take time.

Meanwhile, if the value investor is unable to find good bargains, it is a good idea to stay in cash. When the earnings cycle picks up, opportunities will come along. Investing in stocks at any price does not create wealth. The key here is patience.

Have you been able to spot good bargains in the stock markets recently? Let us know your comments or share your views in the Equitymaster Club.

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One proof of gauging the level of interest shown by foreign investors in India is though M&A deals. Indeed, as reported in an article in the Mint, inbound M&A deals are on track to hit a four year high in 2015. This typically involves stake purchases by foreign investors in local companies or Indian-owned foreign assets. Take a look at these numbers. Between January and July in 2015, 70 inbound M&A transactions worth almost US$ 10.2 bn were signed up. In all of 2014, the number of deals stood at 165, valued at US$ 11.2 bn.

So what is driving this development? A lot of international large companies have been sitting on a huge pile of cash and are looking to invest this productively. The reign of the erstwhile UPA government saw a considerable slowdown in investments as the economic and political climate remained uncertain. But with hopes pinned on the Modi government turning things around, a lot of this pent up demand for investments is getting unleashed. As highlighted above, what has also helped matters is the slowdown in China and other competing markets. This has then made the Indian market rather attractive even though many of its structural problems have not yet completely gone away.

 Chart of the day
The auto component industry has its fortunes tied to the automobile industry. However, the industry has evolved into an export powerhouse by banking on its exposure to global processes and work culture of top manufacturers in Japan and Europe. The tryst with global players started way back in 1980s when manufacturers such as Motherson Sumi, JBM Group, Amtek Group, Sona Group started supplying components to Maruti Suzuki (erstwhile Maruti Udyog). Later with the entry of other car companies such as Hyundai, Honda, Ford in 1990s, there has been a further adoption of global best practices translating into better quality. Additionally strong manufacturing capabilities have ensured that auto component exports have become more cost competitive in global markets.

Today, several auto component players in India derive nearly half of their sales from overseas markets. As per the Automotive Components Manufacturers Association (ACMA), the domestic auto component industry has developed the capability of exporting precision engineering and machine components. This is also reflected in the auto component exports that have grown at a compounded annual growth rate of 22% in the past five years. Even automobile exports have doubled over the same period reaching 3.57 m units in FY15 (Source: SIAM).

Recently, Motherson Sumi bagged a contract of Rs 150 bn from Mercedes Benz to supply components for the latter's future vehicles from 2018. Other luxury car companies such as BMW and Audi have increased domestic procurement for bringing down the cost of their cars. Even General Motors will be investing US$ 1 bn in India to expand its manufacturing capacity and raise the share of local components for the development of 10 new models in the next five years. This goes on to show that the domestic auto components industry has come of age and will play a vital role in realizing Prime Minister Modi's ambitious 'Make in India' program launched last year.

Auto component industry, a global export hub

While the auto component industry has fortified itself from slowdown, troubles for the banking industry do not seem to be far from over. Public sector banks (PSBs) have been bogged down by the pile-up in bad loans. At the end of March 2015, PSBs had net non performing advances (NNPA) ratio of 3.2% compared to 0.9% for private sector banks (PVBs) (Source: Financial Stability Report). So it would appear that PVBs are in a relatively better position. But nothing can be further from truth. The loan books of PVBs such as ICICI Bank, Axis Bank and Yes Bank have deteriorated in recent quarters. The fallout is on account of the aggressive stance followed by these banks to grab market share from the state lenders that account for 70% of total outstanding loans. Rising bad loans, falling profitability and capital adequacy had led PSBs to go slow on credit offtake in the past year.

Therefore, increased exposure by PVBs to distressed sectors such as infrastructure, metal and power has stressed their balance sheets. As per RBI's Financial Stability Report, the gross bad loans ratio of PVBs could rise by two-folds in a worst case scenario. And increased slippages in turn may adversely impact financials of these banks going ahead. Therefore, PVBs may be in relatively better financial health as compared to PSBs but reckless growth strategy can impact their asset quality and financial performance.

After opening in the red, the Indian stock markets gained ground in the subsequent hours as buying activity intensified across index heavyweights. At the time of writing, the BSE-Sensex was trading up by around 160 points. Gains were largely seen in healthcare, IT and auto stocks.

 Today's investing mantra
"We want to be right on something that will work right now, not something that might work in the future." - Warren Buffett.

This edition of The 5 Minute WrapUp is authored by Radhika Pandit (Research Analyst) and Madhu Gupta (Research Analyst).

Today's Premium Edition.

Auto ancillaries - A fertile ground for stock picking?

A look at the long term profitability and track record of India's auto ancillary industry.
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Equitymaster requests your view! Post a comment on "Will you see more stocks to Buy in the coming months?". Click here!

4 Responses to "Will you see more stocks to Buy in the coming months?"

R K Gupta

Aug 20, 2015

I have come across a company called CCL Products Ltd. which is expected to reach 369/- from CMP of ~242/-by FY18. You may wish to study it.

I also wonder to what extent your write up on Companies such as ADI Fine Chem Ltd. (AFL) is useful since you have advised investors to wait for 15% correction from CMP.



Aug 20, 2015

For a long time, I was in 2 minds about investing in BOSCH but price only moved up but never came down. this analysis helped me make up my mind-BOSCH is A good long term bet


Shrinivas Moghe

Aug 19, 2015

Nutraplus, PVR, Suprajit, Ashok leyland, are the stocks, which logically hold good potential. I am not an expert, rather I am a novice to this Bazar. But looking at the prospects of the sectors, in which these companies are operating, I feel so. Besides, they all are leaders in their respective sectors.

Like (1)


Aug 19, 2015

I feel that IT Stocks particularly large cap are fairly valued around 20 to 25 times PE Ratio, considering the depreciation in rupee and further probability of fall due to increase in Fed rate will further make the valuations attractive. This is my personal view.

Thanks with regards

Like (1)
Equitymaster requests your view! Post a comment on "Will you see more stocks to Buy in the coming months?". Click here!
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