India's strong economic growth is sustainable and there is little doubt of corporate profit growth. All the elements of strong growth are in place. The visibility of economic as well as corporate growth going forward is also longer. We have started this year with a 6.5% GDP growth forecast, but by now most forecasts suggest 7.5%+ GDP growth this year.
We should be seeing at least 15% corporate profit growth a year for the next three to five years for the broader market. India stands apart as a reservoir of growth while most global economies are growing slowly. So with strong economic growth one will have good corporate profit growth which in turn should lead to superior performance from equities as a class of asset. This is as simple as one can get.
The second part is valuation. The one year- forward price-earnings ratio for the Sensex stocks is about 13 times, which is lower than the past 15-year average one-year forward P/E of around 15 times. The 15-year forward P/E range has been between 11 and 42, so we are closer to the bottom of the range than the top. Based on the stronger growth and better visibility, I would think there is a case of a P/E re-rating to 5-16x times as we go forward.
Economic growth is creating opportunities for lots of companies. That is why we have had a resounding rally in mid-caps. Our argument for midcaps is that India will keep growing for a long time and the economy will throw up opportunities for many companies to grow faster and become larger. This is the process of evolution. When you invest in mid-caps for the long-term, you are participating in companies that will become blockbusters of tomorrow. Six years back there were just 25-30 large-cap companies in India whereas today we have 75 large-caps. May be tomorrow we will have 150 large cap companies in India. Obviously, the medium-sized companies are going to migrate to being large-caps. Though there are a lot of mid-caps which have become overvalued in the frenzy of the last two years, there are still good stocks here.
Returns expectations and retail investors
Considering the 12-15% growth for three years in the Sensex stocks, and if you add up the other opportunities and the fact that you can still beat the market through active fund management, the prospects are quite bright from an investor's standpoint. Unfortunately, people have wrong expectations from equity investments. They always want to double money in one or two years. That probably should come to an end in a way. Even if you earn 12- 15% from equities, there will be reason enough to be invested as all the other alternative investment classes are not giving you that much returns. Sentiment of retail investors will also change as we go forward because the structure of the current bull market is completely different. If you look at the Indian market for the last 15 years, an average bull market has lasted for 12-15 months. But the current bull market has already lasted for more than two and a half years. Further in the past we have always had manipulations/single individuals dominating markets in those short bull runs. But now we have a large number of institutional investors in India. There are 28 mutual funds with more than 125 equity schemes and almost 800 FIIs registered with Sebi. This was not there in earlier bull runs. Thus, unlike the past, a large part of the market - large cap and most mid cap stocks - is not vulnerable to manipulations due to the presence of large institutional players. Only a small part of the market - small cap stocks and penny stocks- are prone to foul play. This is clearly a major development in the structure of the Indian market and will work in favour of retail investors.
We have seen money coming from outside India so far and not from within India. There is a lot of money sitting in India, which will move from other asset classes into equities as we go forward.
Retail investors do not have the time and resources that are required to invest equity stocks directly. Instead, they should use the Mutual Fund route which gives advantages such as professional fund management, liquidity, diversification and lower risk than direct equity investing.
Waiting for corrections and right levels
It is impossible to time the markets. Volatility is part of the game, and you cannot plan for it. An investor should ask if he is going to make money for the next three years, even at the current levels. The answer is a yes. When you reach a level where you feel that you will not make much money is when you start worrying. We are a long way from there right now.
So, investors should not lose much valuable time and opportunity in waiting for a large correction to happen as market timing is always difficult. Investors should instead focus on long term equity investing which has the potential of generating superior returns. This is more relevant now when other alternative investment options yield a return in the range of 5-8% p.a. and do not have the power to beat inflation. Our study on the performance of diversified equity funds shows that the longer an investor's investment horizon, lower is the volatility in returns. And shorter the investment horizon, higher is the volatility in returns.
The author is CIO, Cholamandalam AMC