Indian stock markets are not going down in a hurry, intermittent small corrections notwithstanding.
By Manish Jain
The last few days have given a glimpse of the correction that everyone has been waiting for, however, given that the fundamentals are so strong and the liquidity cycle on the upswing, the belief is that the correction will not be long lasting. As they always do, markets shall bounce back before long.
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Be that as it may, Nifty has yielded a return of over 29% YTDCY21 and a stunning 54% in the last one year. From the lows of March ’20, the returns have been an unbelievable 125%. Clearly the run in the market has outpaced the earnings, essentially implying that the multiples have expanded. As they should, retail investors have now started worrying about the rally and the sustainability of the same.
First and foremost, the economy is on an upswing and steady growth should be expected from herein. Earnings for Nifty can easily compound at a 14-15% pace for the next three years. Liquidity is also another key factor, which will continue to play in our favour. Strong demand along with improving capex cycle shall be the other key factors that will play a part in the secular earnings growth. So, one thing is for sure that markets are not going down in a hurry, intermittent small corrections notwithstanding.
So the key question then is, how do we reconcile the valuation? Here are a few tips:
a) Shed the historical baggage: Looking at valuations in a historical context has no meaning. In the last six odd years, we have witnessed a dramatic number of events, which have impeded growth, which is unlikely to be the case going forward. The steady structural growth of the next three years means that the comparison is not like for like. The moot point being that just because something has traded a certain valuation in the past, does not mean it can’t breach that in future.
b) Risk-reward is important: Rather than looking at valuation on a standalone basis (which is what most of us usually tend to do) look at them in respect to the growth offered. A business that grows at 20% sustainably, and another one, which offers 5% can’t be trading at the same valuations. So, looking at holistic risk-reward is very important.
c) Have a forward-looking view: Multiples are derived from DCF and that is a superior valuation methodology. It gives you a forward looking view devoid of any historical bias. The objectivity in analysis increases exponentially. DCF, FCFE, Free Cash flow discounting are some of the key metrics that can be used.
d) Unicorns: This is another important aspect that needs to be taken into account. Currently, there is a spate of IPOs, which are coming in this field. These Unicorns usually don’t have any profitability, but have very expensive valuations. As more of these get listed, the overall business valuations will continue to rise.
So, in conclusion, we all need to unlearn to learn. We need to shed the historical baggage of valuation and have a more forward-looking view. Markets are actually more inexpensive today than in the past, on a PEG basis. Go ahead and invest in the markets. However, as always, scout for the Good & Clean companies.
(Manish Jain, Fund Manager, Ambit Asset Management. Views expressed are the author’s own.)