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The 8th of November 2016 will be a historic day for India. Prime Minister Narendra Modi's master stroke of demonetizing the Rs 500 and Rs 1,000 currency notes is bigger than most reforms that we had envisaged. This is aimed to flush out black money. This announcement has a wide reaching on the Indian economy with several sectors will be under pressure. There are businesses that will struggle to adapt to the new business paradigm. Sectors such as real estate, Infrastructure and Jewelry that use more of black money will take a big knock. Similarly, sectors like construction material, travel and tourism, unorganised trade and services will see the significant pain in the near term.
The move is aimed at curbing corruption and the flow of black money in India. In the words of Mr Modi-
As per us, the above development is a step in the right direction. The move would help India fight its battle against corruption and black money. The black money would re-enter the banking channel and every penny will be accounted for. Bringing money into the banking system would mean paying taxes on the unaccounted money earlier. Finally, this would help the government in realizing tax revenues, which could then be used for the welfare of the Indian economy.
In conclusion, taking a broad brush, big picture approach, the move to ban 500 and 1000 denomination notes is certainly a move in the right direction. Along with the GST roll out, it will certainly give a big fillip to the India growth story.
The development can be a big positive for Indian stock markets in the long-term. There are two ways the stock markets can benefit. One, from the very improvement in fundamentals the move would lead to. Second, from the possibility of more money moving into stocks as black money investment channels dry up.
So the question then comes as should one go out and buy every stock one can lay his hands on?
In our view, the above move should not have any marked change in your investment approach. The principles of stock selection still remain the same: buying fundamentally strong companies, run by a competent management team and available at reasonable valuations.
As we mentioned in a recent 5 Minute WrapUp, investors who bought stocks during the 1991-92 liberalization wave with complete disregard to valuations had to contend with absolutely no returns for the large part of the next 12 years.
Here's what we wrote:
In their excitement, all calculations had gone out the window. Investors were willing to pay just about anything to get their hands on stocks. And when that happens, disaster - almost always - is just around the corner.
So irrespective of whether it is the famous reforms of 1992, GST, demonetization, the one question that needs to be always asked is whether one is paying too much for the stock with respect to its intrinsic value.
For even though the company may turn out to do very well, or the economy may have some great years ahead of it, when you pay too much, even a good stock can quickly turn into a bad investment.
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