NEW DELHI: At 25 times forward price multiples, the domestic stock market is trading above 10-year averages, even as the wait for an earnings recovery has just stretched after more disappointments in Q2 earnings than positive surprises.
But one must not look at profit figures in isolation, as they are nothing but accounting entries. What really matters is cash flow of a company, says Sanjay Ramdas Dongre, Executive Vice-President and Senior Fund Manager at UTI Mutual Fund, India’s sixth largest fund house.
Dongre, who manages Rs 3,200 crore in assets for the fund house, says investors should look out for businesses having high inherent profitability, i.e. return on equity or return on capital employed in the range of 15-18 per cent; as such companies usually provide downside protection in highly volatile market conditions.
In an interview with ETMarkets.com, Dongre said the probability of value strategy working well for an investor is high only when the market begins quoting at a valuation lower than the average of last 10 years. “For a developing country such as India, growth strategy works more often than not,” he said.
He, however, said one should not sell a stock as not as it is delivering earnings growth. “You can never estimate the P/E rerating potential of a stock,” he said, adding that one could invest or stay invested in companies where earnings growth is likely to be high in next two years.
Indian equity investors, Dongre said, have realised Warren Buffett’s key principal: “Be fearful when others are greedy and be greedy when others are fearful.
A surge of retail inflows in the weak market during September-October, he said, was the best thing to happen to the Indian stock market in last three years, he said.
The UTI fund manager, who has over two decades of experience in financial markets, said September quarter earnings were quite similar to those in the previous few quarters, where despite a 20 per cent rise in revenue, profit growth could not cheer the Street, as a jump in raw material prices impacted the operating metrics.
If the general elections next year result in the formation of a minority government, requiring huge outside support, the market would start speculating a decision paralysis resulting in lower GDP growth and, hence, lower earnings growth, Dongre said.
Strategy for small investors
Dongre said since equity has higher volatility compared with other asset classes, the best way to even out such volatility is to invest through systematic investment plans or SIPs.
As corporate earnings pick up over FY18-20, the equity market may register reasonable returns in the medium term. Risk appetite may differ from investor to investor, he said, and recommended 75-100 per cent investment in diversified equity funds and the rest in midcap, thematic or sectoral funds.
Sectors that may surprise
During September quarter, earnings upgrades were seen in corporate-oriented private sector banks while most pharma names saw downgrades.
Dongre said corporate-oriented private sector banks, which have been experiencing stress on loan books for past 24 months, could be moving towards the end of the stress recognition cycle.
Credit cost of such banks may decline, and profitability improve in next 12 months, and thus, shares of these banks could quote at better price-to-book multiples than they are today.
He said NBFCs are facing challenges in a liquidity-constrained environment and banks are gaining the market shares in the loan markets as NBFCs are vacating space in this market. Banks having high Casa shares are best positioned to gain from the opportunity presented by the NBFC crisis, he said.
Dongre is also betting on the cement sector, where lower supply additions and demand revival may lead to a drop in supply–demand gap in the short to medium term, which may improve the sector’s pricing power.
Gas distribution and transmission space could be another area to look at. LNG will have a favourable demand-supply environment. With increasing gas consumption, companies involved in gas supply chain (LNG terminals, gas transmission companies, CGD companies) are expected to be big beneficiaries, he said.
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