Sep 16, 2005|
The cat and mouse race...
Everyone has gone wrong! Especially in the last six to eight months when it comes to predicting where the stock markets are headed. Whoever predicted that the 'index would fall' or 'further rise is likely to be limited' has been 'surprised' big time and what is even 'surprising' is that it has continued every day till now. While we do not predict levels, we have been advising caution for a long time when it comes to valuation levels.
In some cases, we have been correct (especially valuations) and in some, we have grossly gone wrong with our view on the stock markets and select sectors. And we do not regret the same because it is a matter of momentum (read liquidity). We have been strong advocates of the fact that faster rise in interest rates, especially in the US, is likely to arrest the magnitude of foreign money flow into the country. But the buck does not seem to stop! There have been arguments about the interest rates in the US crossing a threshold limit after which fund flows will slow down. But money continues to flow into the market. So, do we have to re-look our view on valuations?
The answer is a strong NO, for the following reasons.
Given the fact that fundamentals i.e. industry structure, competition, profitability and finally earnings do not change just because the stock markets is bullish, valuations of stocks and sector need not be upgraded to make stocks a BUY. We continue to believe that irrespective of stock market cycle, commodity stocks (steel, aluminium, cement, auto, fertilisers, banks) should trade at around long-term GDP growth rates or thereabouts. Of course, needless to say because of individual strengths/weaknesses, some companies may command a premium/discount. Bottomline, we are not upgrading valuations, just because the market is hot.
We also believe that earnings growth of corporates is unlikely to sustain the growth witnessed in the last five to six years. To put things in perspective, between FY00 to FY04, the net profit of Quantum Universe (around 250 companies) grew at 21.1% CAGR whereas sales grew by 11.4%. This was partly on account of EBDITA outpacing topline growth (14.9%) and interest cost remaining stagnant (1.1% CAGR). Net fixed assets during this period also grew at a very slow rate of 6.4% CAGR, thus indicating the fact that corporates were 'busy' utilising existing capacities more efficiently. We believe that capex cycle well in sight, interest and depreciation charges will rise faster, whereas the benefit of the capex is unlikely to filter in the next one to two years (even four years in the case of some steel companies). So, just assuming that earnings growth will be robust at 20% per annum for index companies is fraught with risk.
The last and the most critical factor, in our view, that is driving the stock market is liquidity i.e. interest level in India among foreign portfolio investors. While it is difficult to say when they will start 'panicking', in our view, macro signs are ominous. While higher crude prices are common to all economies (developed and developing), the magnitude of impact is likely to be at a varying level. As a developing and growing nation, the recent fiscal deficit numbers do point out to the fact that the government is unlikely to meet its deficit reduction targets. Some like education cess is being used to manage deficits (we understand this based on our interaction with corporates). Watch out for inflation numbers going forward.
Bottomline, if one is planning to make fresh investment in stock markets, keep out! If one is already sitting on a pile of profits, it is prudent to book atleast half of it to benefit from future buying opportunity. If one is already invested and looking for new stories, 'read between the lines'! As a sample, there is a big difference between a 'Buy' and 'Outperformer' on a stock (which constantly keeps running in the tickers of business channels).
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