It is budget time again and market is worried that the budget may have that may impact the cash flows of the businesses and investors.
One of the key thing that the Government should ensure is a stable tax regime. Given the global market situation, tinkering with the tax rates in any manner, is not desirable at this point in time and we do believe that the policymakers would share the view. Budgets should be an exercise in continuity and trying to do too many things just creates uncertainty in the minds of the investors of both the real assets and financial assets.
Given our expectation that the budget would be rational, a stable tax regime and the oil bonanza that the country is benefitting from (and even otherwise), markets should start to look at the earnings trajectory and the valuations.
Deep discount valuations have opened up on account of the sharp swings in the global and Indian financial markets. Earnings in India have not grown for a year now primarily on account of inventory losses and stress on corporate banks and commodity businesses. Margins have started to improve. Q2 delivered operating profit margin improvements and while numbers are still coming out, we believe that q3 would also deliver operating profit margins improvement. Earnings, (ex of corporate banks and commodity pack) hence, must be expected to improve very quickly as soon as the underlying commodity prices stabilise.
Given the fact that valuations today are at sub 15X, one-year forward and we are looking at an earnings bounce, we do believe that the current levels of the market offer a good upside to the investors. Free cash flow generating, strongly growing (EPS) businesses should be the focus of investors going forward given the continued uncertainty in the global environment.
If the budget has a stable tax regime and does not increase any tax rate, then the moves in the market would be primarily dictated by the earnings outlook and the global volatility. This volatility is something that may take time to subside.
Here again, lessons from the past have shown that the markets tend to focus on valuations and earnings growth. If one looks at the period before and after the Lehman crisis, in both the periods, markets were positive. The financial freeze that occurred on account of Lehman going under, was what created the sharp downtick which again gave way to uptick in a few months. Markets could not sustain the uptick over the years as the earnings momentum just died down.
Money follows valuations and growth. Today, part of the market which has been able to grow earnings consistently over past few years is a good place to focus because of the high probability that this same part would be able to keep up with the growth momentum and especially since the valuations have also become benign.
(Written by Prateek Agrawal, Business Head and Chief Investment Officer, ASK Investment Managers)