Question
We’ve had a very painful period for the equity markets, almost two-and-a-half years now. Are we now entering a period of opportunity?
Answer:
Absolutely. See, the key to equities is how the economy is doing and how the underlying business is doing. I don’t think there is any room for pessimism or for complaints or concerns around that. The economy is growing between 7% and 8%. Corporate profit growth is extremely strong. Even the outside-India challenges that we were facing, many of them are now turning favourable, or at least less unfavourable, and multiples have corrected. So, I would look at India and Indian markets with a lot of optimism and positivity.
Question
The conversations that we’ve been having since last Samvat have seen a fair amount of time correction. You’ve said there is a case for a breakout on the upside. You also spoke about the famous liquid oxygen theory — domestic institutional investors holding the market afloat. But despite all of that, there has been severe underperformance, and FII selling has made the liquid oxygen theory look a little jittery, with the 10% cut that we’ve seen in the frontline and some large names as well. What will it take for FIIs to come back, and secondly, for how long can we sustain?
Answer:
We need to distinguish between the economy and the markets. Markets are, in the long term, driven by the economy and the underlying businesses, and not the other way around. The economy has done exceedingly well. What was not working for India, if you look at the external side, was an unfortunate coincidence of four adverse factors at the same time, all playing out at the same time. You had an increase in repatriation of FDI because our markets were expensive, so a lot of PE exits took place. We did not have an AI play, so FIIs sold India $60 billion. Gold imports spiked massively, and finally, you had oil prices. Now, all of these seem to be turning, and I think we should not be pessimistic about India just because foreigners have been selling. If you look at the markets over the last 10 years, the net inflows by foreigners are close to zero. Yet, your markets have compounded in double digits. So, I see no reason why these markets should not, over time, break out on the upside.
Question
Do you have the confidence to call a market bottom when you say it’s not the time to be pessimistic right now? Or do you have the confidence to take an aggressive equity call — that from here on, this is the right entry point and you can make big money if you enter?
Answer:
Equities give you big money, but not quick money. They will give you big money, but with time. I am comfortable saying that the index, over the next three to five years, should deliver mid-double-digit returns. Whether we have made a bottom or not, I think the challenges are not with the economy. The challenges are global factors, which make a short-term impact on the markets. For example, if the war flares up again, will crude go to $130 or $150? We don’t know. Will US 10-year yields go back up again? We don’t know. So, I think these are factors which bring uncertainty to the markets. The basic nature of equities is that it is not a linear asset class. It will not deliver linear returns; it delivers bunched-up returns. But the good news is that if you look at the last 25 years, every time the markets have consolidated for two or three years, they have caught up. These returns will not be denied; they can be delayed. But I think, at this point in time, there is a good chance that we are unlikely to touch the bottom of the past.
Question
So, basically, if you are expecting a double-digit return on the index over the next three years, it will have to come from some of the heavyweights. A lot of them have underperformed, whether it is large IT, large banking — private banks in particular — or even Reliance, which has been fairly stagnant notwithstanding its recent outperformance. What do you think would lead the markets higher from here?
Answer:
I think it should be a fairly broad-based rally. When I look at the Nifty, barring one or two very specific names, maybe around retail, I don’t see overvaluation in any space. The extent of undervaluation could be different. It could be 10%, it could be 30%. But I think, by and large, the Nifty is undervalued. So, I would expect fairly broad-based market participation. Even consumer stocks, after almost 10 years, are looking at sensible valuations, which were very expensive.
Question
Sensible in what context? If you are looking at PE, they are obviously at a premium. But if you are looking at price-to-earnings growth, growth hasn’t been coming. Is it just the underperformance and the time correction that makes them attractive?
Answer:
See, this sector was trading at 70, 80, 100 P/E multiples. If you leave out one or two stocks, it is now trading between 30 and 40 times, which I think is fairly reasonable. If a business has low cyclicality, low volatility, and even to deliver 8-10% growth, it does not need incremental capital, then the fair P/E of that business can be reasonably high. So, if you look at these businesses in light of these two factors, I think the current multiples appear to be reasonable. You can’t make a lot of money, in my opinion, but I would not say they are overvalued.
Question
If there was incremental capital to be allocated in large caps, in what proportion would you put it in different sectors?
Answer:
As I said, nothing is looking overvalued to me. Banks, insurance companies, utilities, oil and gas, even IT, pharmaceuticals, automobiles and FMCG — I would buy a bit of all.
Question
And amongst these, are there any pockets that you’d like to highlight as deeply undervalued right now? As you said, some of them may be 30% undervalued.
Answer:
I would say some of the leading private banks would fit that description.
Question
Your style, other than being a value buyer and contra investor, has always been to identify trends before the broader market spots them. Sitting here now, what are the big trends where there is going to be a structural reset and which could emerge as a big theme over the next five years?
Answer:
We need to distinguish between the economy and the markets. As far as the economy is concerned, I think growth in manufacturing and growth in capex should outpace the rest of the economic growth. For the first time in my career, I am seeing all stars align for manufacturing to do well — whether it is the presence of entrepreneurs, capabilities, skilled people, supportive government, supportive buyers who want to de-risk, and very supportive capital markets. We should not underestimate the power of capital markets in driving a business. If a business can be valued at 40, 60, 80 or 100 P/E, the investor may or may not make money, but it is great for the business to scale up because you are able to raise easy capital, quick capital, big capital, and at very attractive prices.
Question
Name some manufacturing ideas that you like.
Answer:
It is fairly broad-based. What we are also seeing is, for the first time, innovative companies. It is not just metal processing or plastic processing — there are companies with IP, decent R&D capabilities, which are innovators. So, I think manufacturing as a theme looks good. But when it comes to capital markets, capital markets appreciate this, and these stocks are very expensive. So, one has to be careful. While there is a long runway for growth, one needs to do good work and make sure that you are not buying a great business at the wrong prices.
Question
In the small- and mid-cap space, in particular, since you found large caps attractive, there are a couple of niches that you mentioned. Is there anything particular that you picked out over the last six or seven months that you believe is likely to compound, despite the overvaluation that we’ve seen in that pack on the whole?
Answer:
I don’t think I can speak about individual names, but as a category, small and mid-caps are expensive. If you break up the returns across categories from, let’s say, minus 50% to plus 1,000%, it is very interesting. We mapped this data for large caps and small and mid-caps (SMIDs). It is only in the more than 1,000% returns over the last few years that small caps have done better than large caps. In every other category of returns, large caps have done better, or they are at par with the proportion of companies in that category versus SMIDs. When we looked deeper, we found that it is basically two or three turnaround cases — companies that were making losses of ₹50 crore or ₹100 crore three years back and are now making ₹100 crore in profit. So, they have gone up 10 times or 20 times. But among the bulk of the other companies, there were 16 companies and 13 of them, or the majority of them, were in the power space — power equipment, transformer oils, conductors, etc. What has happened is that AI has definitely positively impacted power businesses and the suppliers to that business. So, I think it is wrong to say that small and mid-caps have done well. Certain themes have done well. Power is one theme, CDMO can be another, and EMS can be a third. I think it is very isolated, and I have experienced time and again that popular narratives may be correct as far as the business goes, but they end up disappointing over the medium to long term. So, I would be fairly cautious about taking a category-wise or theme-wise approach to investing in small caps.
Question
That’s a phenomenal insight — that the proportion of gains in mid-, small- and large-caps has been largely the same, barring the 1,000% gainers, which have also been a narrow set of themes. You don’t believe that is the right way to invest over the longer period. Now, since you spoke about artificial intelligence, IT is the big corollary to that, where we have seen a decline in all these IT names. Do you find value here?
Answer:
See, the stock prices have declined, but not the businesses. That is a simple insight. Even in the past one or two years of peak deflation by AI, these businesses have not degrown. So, what does this tell us about these businesses? Their relevance for the consumer is intact. Every business — global businesses, Indian businesses, large, mid and small — all of them are growing. Of course, growth rates are low. The larger companies are growing 1%, 2% or 3%. The smaller and mid-sized ones are growing 4%, 6% or 8%. But if AI was disruptive, then businesses should have degrown, which has not happened. So, as we discussed in the context of consumer companies, businesses with low growth rates but which do not need capital to grow deserve a reasonable multiple. In that context, I don’t think these businesses are overvalued.
Question
So, IT is trading at fair valuation, according to you, at this juncture?
Answer:
I think so. It’s a slow-growing, cash-generating business with great capital allocation, globally competitive, and it would be interesting to see whether, as non-tech enterprises adopt AI, it leads to incremental business opportunities for these companies. If that is the case, then ideally, over the next one or two years, growth rates should improve a bit. Should that happen, I think markets can once again get excited about these names.
Question
To some extent, perhaps in the early days, we’ve started seeing some FPI inflows into the market. The sentiment until now was very grim, but now money seems to be coming back. While India is an attractive investment destination by itself, its relative growth versus other markets was absent for the last two-and-a-half years. Now that valuations have corrected, is India more attractive than the alternatives, and have valuations corrected enough?
Answer:
You are absolutely right. The good thing is that India’s economy has not underperformed expectations. India is the world’s fastest-growing economy, growing at 7-8%, and it is delivering that growth with one of the lowest volatilities in growth rates. But what happened was, as AI became popular, memory prices went through the roof. That is why memory-heavy markets like Korea and Taiwan saw earnings go up manifold, and that’s why money probably went out of markets like India into them. But let’s not forget that that’s a deep cyclical business.
Question
Do you have a view on how AI plays out? The Nasdaq is up 150% in the last four years.
Answer:
Let’s not get into the Nasdaq because those are very IP-driven businesses. I don’t have a fair view. But closer to Asia — Korea and Taiwan — memory is a commodity. If prices can go up multiple times, they can also come down because memory capacities will expand. It’s a matter of time — one year, two years or three years. That’s it. It is not an IP-driven business, so it will reverse. You have seen what is happening in Korean markets recently. So, I think when the cycle turns, or if it is about peaking, the linear high growth that India offers will look extremely attractive.
Question
It’s hard to put a time frame on when that inflection happens. Do you think we’re closer to that inflection point? Markets always reprice before the actual event; they’re not going to wait for it.
Answer:
If Korean markets are an indication, then you are already seeing that.
Question
Moore’s law typically says eight years is where either the price halves or the memory doubles. Just since you spoke about flows, the clamour for some sort of tax incentive, in the form of a long-term capital gains (LTCG) cut or making it easier for foreigners to invest in India, is increasing. What camp are you in? You’ve always had bold views.
Answer:
My views may make me unpopular with your viewers. I think the LTCG rates in India are quite adequate. Think of it this way: a salaried middle-class person earning ₹20-30-50 lakh a year is paying 30-40% tax rates. HNIs and ultra-HNIs, on the other hand, would have a bulk of their income in capital gains, one way or the other. So, I think the current rates are very fair. Taxation should be equitable, and I don’t think anyone would invest in a company or the stock market just because there is no tax. Why do you enter a business? Why do you invest anywhere? Because you think there is decent potential for growth in that. So, I think a reasonable tax is quite okay. But I was speaking with Ridham Desai of Morgan Stanley India the other day, and he mentioned that it is not so much a question of taxation in India for foreigners, but that it complicates the processes and procedures for them. I am not an expert on that, but I am sure the government will consider all the pros and cons and come to what is best for the country. I also want to say that Indian capital markets have a very weak correlation between foreign flows and medium- to long-term returns of Indian markets. It is hardly there. The last 10 years are a good example. Yes, month on month, if a lot of money is going out or coming in, markets may move up or down 5%. But I think gone are the days when Indian markets depended meaningfully on foreign capital. Today, you have ₹40,000-50,000 crore coming into the markets every month, and Indian markets have outgrown the impact of foreign flows, and they will outgrow it even more. I am not trying to underestimate the importance of foreign flows because India is a current account deficit country, and all forms of long-term capital are welcome into the country. Just one last point here: we have seen a very sharp correlation between foreign flows and activity in the primary market. In months when foreign flows are coming in, capital raising tends to go up, and when foreign flows are negative, capital raising tends to go down. These are the two sources of supply in the market. The markets have remained broadly flat despite $60 billion of selling in the last two years, and yet, we have raised $100 billion of capital also. So, I think market returns in India will be a function of what growth the economy delivers, what corporate profit growth is, and what valuations are relative to that growth. And I think, one way or the other, whether foreign flows come or do not come, over a three- to five-year period, these markets are good to deliver 12-15% CAGR returns.