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The 'Balance Sheet Investing' Way to Sensex 40,000

Sep 23, 2016

In this issue:
» Cash rich PSUs line up for buybacks
» Impact of new Accounting Standards.
» Labour reforms in the offing
» ...and more!
00:00
Tanushree Banerjee, Co-Head of Research

The BSE Small-Cap Index has hit its 2008 highs. Companies have raised more funds through initial public offerings in 2016 than they have in the last five years. And the earnings trend of several companies point to better quarters ahead. In this environment, throwing darts to pick stocks may not be such a bad idea! But putting a little more thought into will only stack the odds further in your favour.

We started talking about Sensex 40,000 when no one wanted to think of buying stocks. The premise for our optimism then was twofold. The market was ignoring the possibility of margins reverting to the mean. And the valuations heavily discounted the earnings upside in some of the best bluechips. It was just an earnings revelation waiting to happen.

Six months later, the turnaround in earnings is visible. Apart from profits, investors are vying for stocks that offer the potential for bigger topline growth. That's why we're seeing companies with compelling earnings growth stories getting richly valued. Hunting for low PE stocks in such a market could leave you disappointed.

For those wanting to get off the beaten track, it is time to consider 'balance sheet investing'. When markets are fairly valued, as they are now, even small concerns could be an excuse for big correction. And looking back to 2008, it is not the profit and loss statement but the balance sheet that can offer the cues.

Have a look at the top 50 gainers over the past year. Nearly two-thirds of these companies have leveraged balance sheets. Many have poor credit ratings that are set to get worse in the coming months. For a lot of them, the debt on their books is will be their undoing.

However, some businesses will hold steady even when the market sentiments turn negative. Their balance sheet strength will help them ride the wave to Sensex 40,000 despite ebbs along the way. And buying the businesses based on the tenacity of the balance sheet will keep valuation downsides minimal.

When 'balance sheet investing', look for companies...

  • That are ready to sweat out their assets
  • That could add capacity with negligible debt
  • With surplus cash and investments on their books
  • With low working capital requirements
  • With sufficient shareholder capital

Just a few good finds with such balance sheet criteria can set you up for reasonable upside even in the most difficult times.

If this strategy makes sense to you, go ahead and download our special report on Sensex 40,000.

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

02:30 Chart of the day

A share buyback typically indicates promoters' efforts to enhance intrinsic value of the stock. But the promoter group we are referring has other motivations to opt for the buyback program. We are referring to government, which is looking for better ways to milk its stakes in the companies.

Historically, various plans of government's stake sales (disinvestment) had hit a stone wall. In 2015-16, the government had set a record target of raising Rs 695 bn through disinvestment, but only managed Rs 321 bn. To avoid a repeat of last year, it is exploring a new strategy. It is expecting the cash PSUs to use the cash in buybacks.

A total of 34 central public sector enterprises (CPSEs) hold about Rs.1.8 trillion in cash and equivalents. This cash pile is expected to come in handy as the government pushes some of these firms to consider share buybacks.

Big Buybacks of the Public Sector Units


03:15

India Inc, has started implementing new accounting standards - Ind AS. With the new accounting norms many companies saw an impact on their financials, as they had to account for taxes and deal with their financial instruments, mainly foreign borrowings, as per the new accounting methodology.

A research report by consulting firm PwC, cited by Economic Times, on 100 listed companies, shows that 55% had a positive impact on their net income for the quarter under Ind AS. Pharma companies stood to benefit the most while infrastructure companies were affected by the new accounting policy. Companies' financial performance do play vital role in investment decisions. However, investors should not get swayed away with the new accounting methodology. Rather, more emphasis should be laid on the moat of the business and sustainable fundamental strength of the company.

04:05

India has a long history of poor labour laws which make the business environment even more challenging. Not only that, archaic labour laws have also been the reason for the downfall of the major Public sector units.

But here is some good news. As reported in Reuters, the government is likely to overhaul labour laws. Now this would not only help to create millions of new jobs. But also make the job market flexible for new employers. Nevertheless, the new norms are likely to put the existing jobs at risk, and tougher for employees to form unions or strike.

Two key bills, covering industrial relations and wages, would be sent to the cabinet this month. The bills would be then presented in parliament's next session, beginning in November.

While the proposal may be game changer, its implementation will be key to improving the employment situation in the country. Having said that, rebellion from trade unions cannot be ruled out.

Speaking about the India's macro issues, Vivek Kaul has been addressing a range of such big issues in his recently launched newsletter, The Vivek Kaul Letter. In this Vivek covers issues like, government's handling of oil prices, the mess in public sector banks, the current state of India's real estate bubble...and a lot more!

Now this a unique kind of newsletter, the first of its kind in an Indian context. It is an effort that will help you to stay on top of big macro trends in India. The ones that could directly impact you and your family.

In fact, as you read this, Vivek has just come out with a video that details all...including how this trend could impact you.

Click here to know more.

04:45

In the meanwhile, after opening the day on a flat note, the Indian stock markets have continued to trade near the dotted line. At the time of writing Barring FMCG & banking stocks, major sectoral indices are witnessing buying interest with stocks from realty, oil & gas leading the pack of gainers. At the time of writing, the BSE Sensex is trading lower by 29 points (down 0.1 %) while the NSE Nifty is trading lower by 8 points (down 0.1%). The BSE Mid Cap index is trading up by 0.6% and BSE Small Cap index is trading higher by 0.7%.

04:50 Investing mantra

"You do things when the opportunities come along. I've had periods in my life when I've had a bundle of ideas come along, and I've had long dry spells. If I get an idea next week, I'll do something. If not, I won't do a damn thing" - Warren Buffett

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

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