While the domestic stock markets have seen a lot of correction triggers in current year 2018 — ranging from the introduction of LTCG and the more recent auditor resignations, valuations are still not mouth watering for making fresh investments, says investment advisor Jatin Khemani. Given that even the smaller companies are now being deeply researched by a wider investment community, it has become difficult to find undervalued scrips, he says.
In the run up to the upcoming general elections in 2019, Jatin Khemani expects the stock markets to be range-bound even as the government’s focus shifts to populist measures from development and policy reforms. In an exclusive interview to Sushruth Sunder of FE Online, Jatin Khemani, founder of Stalwart Advisors, a Delhi-based independent equity research firm, shares insights about the near-term stock market outlook, the recent RBI rate hike, and where he sees value in the current stock market. Here are edited excerpts.
What is your near-to-medium term view on the stock market outlook?
We have had a fantastic run up over the last few years. Especially 2017 was a spectacular year in terms of returns. However, as we entered 2018, valuations were stretched and markets probably were looking for a reason to correct. It got plenty of them, starting with re-introduction of LTCG, followed by series of auditor resignations and alleged fraud in companies like Vakrangee and Manpasand making it to headlines & dampening the sentiment. Then there was the stock classification rejig by SEBI for Mutual Funds wherein a lot of small & mid cap stocks held by so called ‘large-cap’ mutual funds had to be sold in order to comply with new regulations.
This correction has taken out a lot of froth however the valuations are still not mouth-watering. Next 12 months are mostly going to be about the 2019 elections with government’s focus shifting to populist measures from infrastructure development & policy reforms, while investors might stay concerned about the outcome. Though history shows that over longer time frames, there hasn’t been a strong correlation between market returns and any specific government. Over last 30 years, average equity returns have been healthy irrespective of whether we had a clear winner or a coalition, an NDA or a UPA.
While it is always difficult to predict short term market moves, we are not very bullish over next 12 months and expect market to be range bound, barring some stock-specific opportunities which look promising and may yield good returns even in this period.
How will the RBI policy rate hike impact stock markets in your view/ What is the implication of RBI rate hike for investors?
Bond markets are free markets and they react based on demand-supply of money i.e. system liquidity, RBI merely tries to influence it. Fundamentally speaking when interest rates fall, the discount rate used for valuing equity falls, expanding price-earning multiples as more money flows into equity given lower opportunity cost of investing in fixed income. We witnessed this over last decade starting with the financial crisis of 2008. With the situation now turning on its head, ideally we should see contraction in earnings multiple as interest rates rise. The other side of the argument is that what rising interest rates signify is a stronger economy and higher earnings growth which kind of makes it a tussle between multiple contraction and earnings expansion, we would have to see how it pans out.
Where are you finding value in the current stock market?
Despite the correction, it is still not easy to find value in this market. Markets have become very competitive with information widely available and even smaller companies being deeply researched. Having said that, we find value in power sector as a contrarian bet. It is one of the very few pockets which continues to struggle and available at an attractive valuation. There are select capital goods companies, power generation and distribution companies which are interesting to look at. With the new air pollution norms for Coal-fired thermal power plants to be implemented by 2022, there is a Rs 1 lac crore opportunity opening up for companies that manufacture pollution control equipment like FGD, ESP and SCR. In renewable energy, we are bullish on revival of Wind Energy and are participating in industry’s volume growth via an ancillary company. We find value in select real estate developers as well, though this is a longer term call. With RERA and series of government incentives we expect the industry to pick up and expect organized/branded players to be a big beneficiary as and when demand rebounds.
What advice would you give to stock market retail investors?
Some of the Indian promoters/managements have become extremely smart, even the micro cap companies (less than Rs 500 Cr. market cap) have professional investor relations (IR) firm guiding managements to say exactly what investors want to hear. Most investors and analysts take that on face value. Most brokerage reports use management guidance to forecast which is inherently a flawed way.
- As investors we should do series of channel checks and other primary research to validate what management says.
- Avoid dubious managements who talk about their company’s share price, who are present in similar business via private companies transacting with listed company (disclosed in ‘Related Party Transactions’ in Annual Report).
- Prefer owner-operators with substantial skin-in-the-game (ownership).
- Focus on Balance Sheet and Cash Flows much more than Profit & Loss, if there is any merit in what management says it would definitely reflect in financial statements.
Jatin Khemani, CFA is the founder of Stalwart Advisors, a Delhi-based independent equity research firm. The model portfolio is diversified across roughly 20 companies with a conviction-based allocation.
This interview was originally published on 28 June 2018 on www.financialexpress.com