Here's One More Reason to Believe in Sensex 40,000 - The 5 Minute WrapUp by Equitymaster
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Here's One More Reason to Believe in Sensex 40,000

Sep 14, 2016
In this issue:
» Directors take most of the pay
» Every Tata company will have to earn its right to grow
» ...and more!
00:00
Madhu Gupta, Research analyst

India has weathered the onslaught of global recession pretty well.

In a slowing world economy, India continues to grow the fastest, even racing ahead of China.

But India has been battling its own set of problems.

The huge pile-up of bad loans in the banking system and a slowdown in the investment climate in the country have been hindering the demand revival.

Although corporate sales growth remains in the low single digits, earnings growth has revived smartly from the historical lows in FY15. Indeed, the earnings surge is becoming more and more evident, and Mr Market seems - dare we say - jovial.

Bumper rainfall powering rural incomes, higher government salaries from the 7th Pay Commission, and the much awaited Goods and Services Tax reforms are propelling the markets.

Little wonder the BSE Sensex is trading at a trailing PE multiple of 21 times - a bit more than the long-term average of 18 times.

Does this mean that markets are overheated?

We believe that, while the earnings upside has a long way to go, some stocks are pricing in too much too soon.

Having said that, in terms of corporate fundamentals, India remains a bright spot amid all the world gloom.

And this fact has been reinforced by foreign companies operating in India. Foreign promoters have steadily raised their ownership of companies in India over the last three years, increasing their stakes from 40.5% to 51.6%.

We all know that share buybacks are the best way to exhibit confidence in a company's business performance. And foreign companies seem to have a lot of confidence in India's growth prospects.

With hardly any growth in their home countries coupled with access to cheap funds in a low interest-rate environment, foreign companies find India an attractive destination to earn higher yields on earnings.

No wonder multinational companies such as Unilever and Nestle have steadily raised their stakes in their Indian subsidiaries in the last few years.

Even as foreign investors remain bullish about the resilience of the Indian economy and its ability to deliver returns, our own calculations show India Inc's earnings upside has the potential to pocket some handsome returns for those who ride the wave.

Here's what Co-Head of Research Rahul Shah wrote about the very real possibility of a 70% upside in the Sensex:

  • The aggregate data we have pulled for Nifty companies suggests that profit margins were at a ten-year low at the end of FY15. Even if they were to rise to the average of the last ten years, not immediately, but three years out, the upside would close to 70%.

    Put differently, markets will go up 70% over the next three years if profit margins revert to the mean.

And every time the market corrects, it's an opportunity to benefit even more from the likely upside.

The time is ripe. Download our special report - Sensex 40,000: 4 Stocks to Profit from the Coming Stock Market Wave.

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------------------------------

03:01 Chart of the day

One of the amendments made to the Companies Act is that firms are required to disclose the payout ratio for directors. This is essentially the ratio of the directors' pay to the median employee salary.

Directors are responsible for charting the direction of the company and taking key decisions to ensure growth of the business and profitability of operations. So it only follows that they get paid the best. But the bone of contention is - by how much?

As reported in the Business Standard, an analysis of 168 directors of 19 Sensex companies that have reported data showed that 47 directors earned at least 50 times what a typical employee took home.

The chart below shows the top five companies where this divide is way too high. Is such a high ratio justified?

Mr Narayana Murthy had last year mentioned that the salary between the top executive and the median salary of the employees should not be more than 15 times. In that context, directors are being paid too much.

Of course, a lot also depends on how well the business is doing. And this too over a longer term horizon. Has the management built a sustainable business that has the potential to grow going forward? Is that why the directors and top management are being paid top dollar?

These are some of the things that need to be kept in mind when looking at companies. The real test is to see how the scenario pans out when the business is facing rough weather. Are the directors then still ensuring that they take home a hefty pay package? If yes, then it becomes a corporate governance issue.

Directors Take Most of the Pay


04:02

The Tata Group is a highly respected business house in the corporate world. But not all Tata businesses are on the same footing. Some are simply better than the others. This can be gauged by looking at the financials, the strength of the business model and the industry it operates in.

In this regard, the Chairman of the Group, Mr Cyrus Mistry has stated that every company in the Tata Group would have to earn its right to grow. This means that each will have to focus on building strong operational cash flows and look at their capital structures.

In this context, it would do well to go back a bit into the Group's history. Mr Ratan Tata gets credit for transforming the company. He became the chairman of the Group in 1991. At the time, India was grappling with the draconian License Raj system and the Group's focus was largely India.

Post the License Raj era, Mr Tata went about streamlining the businesses. Around 2000, he decided to focus on a few industries, including automobiles, steel, power, beverages, hotels, IT, and chemicals.

But Mr Tata harboured loftier ambitions; he wanted Tata to become a global powerhouse. And that is when the acquisition spree began.

Between 1995-2003, the Tata companies made, on average, one purchase a year. In 2004, they made six. And in 2005-06, more than 20. Along with the increase in acquisitions, the company's scale increased.

But not all these acquisitions have turned out well. For instance, Tata Motors' acquisition of Jaguar Land Rover (JLR) has been a success. But the same cannot be said of Tata Steel's acquisition of Corus. Indeed, recently, Tata Steel was compelled to sell off its UK operations are it consistently reported losses in the past.

So it will be interesting to see the kind of direction that Cyrus Mistry will give to the Group and whether he will be successful in ensuring that each of the businesses become strong cash flow generators and value creators.

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, Indian indices had a rather volatile day as they oscillated to either side of yesterday's close. Stocks from the IT and metals sectors witnessed maximum selling pressure. At the time of writing, the BSE Sensex was trading down 31 points and the NSE Nifty was trading down 5 points. However, the BSE Mid Cap and the BSE Small Cap bucked the trend and were trading up by 1% each.

04:56 Today's investment mantra

"The future is never clear and you pay a very high price for a cheery consensus. Uncertainty actually is the friend of the buyer of long-term values." - Warren Buffett

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

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Equitymaster requests your view! Post a comment on "Here's One More Reason to Believe in Sensex 40,000". Click here!

2 Responses to "Here's One More Reason to Believe in Sensex 40,000"

Y D

Sep 17, 2016

Agree. Equitymaster also wants to profit from us by use of GREED & FEAR.
They want to sell to optimists via Sensex @ 40,000. For pessimists, they have Hormegeddon.
Ultimately one of them will turn TRUE and they will say - see our prediction came true.

Like (2)

kumar

Sep 15, 2016

i remember the dialogue in an old hindi movie!! padosan. "Ek pe rehena" 1 head Equity master tries to convince 40000 and another in the form of vievk paul trying to convince 10000 for sensex.

Can you please make up your mind or, are you trying to be on the fence and shout when either of the event happens.

If that is the case then you are no different from TV analyst

Like (4)
  
Equitymaster requests your view! Post a comment on "Here's One More Reason to Believe in Sensex 40,000". Click here!
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