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The Small-Cap Story Is Not Over Yet - Here's Why...

Sep 9, 2016

In this issue:
» PSU banks continue to lose their edge against private players
» TCS continues to remain Tata Group's backbone
» ...and more
00:00
Radhika Pandit, Managing Editor of ValuePro

Post the 2008 financial crisis, central bankers in the developed world have continued to pump money into the system. As is apparent, this hasn't really done anything to bolster real growth in their economies. It has only inflated the prices of asset classes everywhere.

Marc Faber says this relentless money printing exercise is not going to stop anytime soon. The balance sheet of the major central banks increased sixteen times between 1998 and 2015. And not much seems to be preventing it from going up another 20 or 100 times. According to Faber, money printing is an unlimited action - until the system breaks down.

This money printing also explains the massive disconnect between the underlying economies and stock markets across the globe. In a normal world, stock prices are driven by real GDP growth and rises in corporate earnings. In this artificial world created by central banks, real growth is negligible. Yet stock prices are still rising because of excess liquidity.

Where does India fit into all this? India has one big edge over the developed countries - a tremendous potential for growth. Faber believes India needs to get its act together if it wants to grow at 5% per annum on a consistent basis. The key here is consistency. India has been growing at more than 5%, but erratically. During the reign of the erstwhile UPA government, growth came down considerably.

If India has to grow faster and that too consistently, then it needs to do away with its deeply entrenched bureaucracy and usher in reforms. A lot is expected from the Modi government on this front.

So the growth potential is there. But what about valuations? As is the case abroad, Indian markets are not exactly cheap. As Faber has rightly pointed out, a lot of the consumer goods companies in India are trading at PE multiples of around 40-50 times earnings. That is not cheap by a long shot, however good the growth prospects are.

Now, that does not mean there aren't opportunities. A lot of the big companies are very well researched and form part of many index funds. So at today's valuations, it may not always be possible to find cheap large caps.

But Faber believes many smaller companies remain undervalued and provide strong opportunities to build wealth.

How true is this? I put this question to my colleague, Richa Agrawal. Richa heads our small-cap recommendation service, Hidden Treasure. Here's Richa:

  • The small-cap index touched a lifetime high in September. It is up 34% from the lows at the end of February. As per an article in Livemint and data compiled by Bloomberg, the S&P BSE Small-Cap Index is valued at a 62% premium over the MSCI Emerging Markets Small-Cap Index. Overall, the risk-reward ratio of small caps is looking less favourable.

Richa is not saying there are no opportunities in the small-cap space at all. She strongly believes in following a stock-specific approach while selecting companies from this space. Which means small-cap investors should never compromise on two factors - fundamentals and valuations.

In fact, Richa and her team just recommended a stock yesterday. It is a good business that the team had been tracking for quite some time. There was no question about the strength of the fundamentals of the business. But up to now, the team was not comfortable recommending it because of the expensive valuations. But the stock has corrected about 20% from its peak earlier this year, and the Hidden Treasure team pounced on the opportunity to recommend the stock.

03:01 Chart of the day

During December 2008, Equitymaster conducted an investor survey, asking readers 'Whom do you prefer placing your bank deposits with?' 52.4% opted for PSU banks. The reason being that the depositors considered government owned banks to be safer than their private sector and foreign counterparts.

A lot has changed since then.

Fast forward to June 2016. The choices are shifting.

Who do you Prefer Placing Your Bank Deposits With?


Slow credit offtake and sliding asset quality are not the only issues which the public sector banks are battling. Rapid slowing in deposit growth for these banks is another challenge.

Going by today's chart, excluding the State Bank of India group, there has been a rapid deceleration in deposit growth for these banks. Further, an article in Mint states that revival in the public sector banks deposits look bleak. This is because on one hand, private players are attracting more deposits. Furthermore, 18 new niche banks will set up their shop over the next several months. This will put up a tough fight for deposits.

04:12

If one were to look at the Tata Group's market cap, Tata Consultancy Services (TCS) takes the major chunk. This is despite the price correction seen recently in the scrip.

Share in Tata Group's Market Cap (%)


Slowing demand from global clients, coupled with economic uncertainty around Britain's decision to depart the European Union have put pressure on Indian IT services firms. And, stock price of TCS, Asia's most valuable software company, has been witnessing sharp price correction since the last few quarters. So far for the week, the stock is down by 8%.

Tata is one of the most respected business names not just in India but the world. Thus, will it not make sense to look into the company's long term growth prospects? And if the valuations look ripe, does it not make sense to put money into the stock? Well, this is something only time will tell.

What more, our ValuePro team, over a series of articles, has analysed which of the Tata Group companies are ValuePro worthy (these are the ones Warren Buffett would consider buying) and which do not make the cut.

04:45

In the meanwhile, after opening the day weak, the Indian indices registered further losses and continued to trade in the negative territory. Sectoral indices are trading weak with stocks from the auto, metal and realty sector witnessing maximum selling pressure. At the time of writing BSE Sensex was trading down 220 points (down 0.8%) and the NSE Nifty was trading down 70 points (down 0.8%). The BSE Mid Cap index was trading down by 0.7%, while the BSE Small Cap index was trading down 0.4%.

04:56 Today's investment mantra

"When a management with a reputation for brilliance tackles a business with a reputation for bad economics, it is usually the reputation of the business that remains intact." - Warren Buffett

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

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