Sep 15, 2017 11:00 AM IST | Source:

Long-term investors can stay put; 5-10 percent correction possible in interim: Kotak Sec

The market is overvalued but not in a bubble zone, Rusmik Oza, Head-Midcap, Kotak Securities said in an interview to Moneycontrol.

Long-term investors can stay put and face a 5-10 percent correction in the interim, Rusmik Oza, Head-Midcap, Kotak Securities said in an interview to Moneycontrol. As time passes, valuations will start correcting due to likely earnings growth, he added.


Have markets got cold feet near record highs? It came within striking distance of record highs on Nifty but then the momentum fizzled out. However, both small and midcap stocks have hit fresh record highs. Do you think this trend is sustainable and are we on track to hit fresh record highs possibly in September or October?

The sheer flush of domestic inflows into equities is leading to valuations of mid & small caps surpassing everyone’s expectations. If there is no escalation in the geopolitical tension between US and North Korea, then we could see a resumption of FPI flows into large caps.

That, coupled with the consistent domestic flows, can lead to further re-rating in mid & small caps and we can see the Indices at new highs.

Does GDP print of 5.7 percent for the quarter ended June worry you? And will it derail a rally in equity markets?

We are in a phase where forecasting GDP and other broader economic parameters will be slightly challenging. This is because of the implementation of the ongoing GST regime and its immediate negative impact on businesses.

Investors usually look to the future while investing in equities and the thesis is that long term impact of GST will be very positive for the economy in terms of higher tax collections and bringing a lot of unorganised sector into the formal economy.

The expectation is that after few quarters of GST implementation, GDP growth should inch upwards as tax collection goes up.

The market-cap to GDP ratio is trading at its long-term average, but valuations of Indian equities remain rich. The Sensex trades at a 12-month forward P/E of 19.2x, at an 11 percent premium to a long-period average of 17.4x. Sensex P/B of 2.8x is at 4 percent premium to its historical average. How should investors read through this information?

The market-cap to GDP is higher by 10 percent compared to its 10-year average. We need to worry only when the ratio of market-cap to GDP rises above 100 percent.

At current forward PE of 19x of Nifty/Sensex is closer to one standard deviation higher than the 10-years average. This means that markets are overvalued but not in a bubble zone.

When Sensex/Nifty forward PE goes up by 2 Standard deviations (SD), that is 22-23x then we can say the market is in a bubble zone. Given the overvaluation, investors need to be cautious and wait for interim corrections to deploy fresh money.

There could be time-wise correction in the interim for valuations to come down to 10-years average. Long term investors can stay put and face a 5-10 percent correction in the interim. As time passes, valuations will start correcting due to likely earnings growth.

Gold has caught the fancy of investors in 2017 amid rising geopolitical concerns. What are your views?

Gold doesn’t seem to be an investment option for many investors. It can at best be a hedge against any catastrophic event emerging out of the geopolitical tension.

Investors who are seriously concerned and looking for a doomsday-like situation can allocate some portion of their investment into gold.

Top five stocks/sectors you think could produce multibaggers in next 2-3 years?

Difficult to spot multibaggers at this juncture when we have already seen nearly four years of rally in equities. Most of the mid and small caps have been discovered by analysts.

There is a scarcity of stocks that can become multibaggers from this juncture. Investors are taking higher risk in junk kind of stocks to make multibagger returns.

We do not recommend such investments at this juncture. Investors should rather focus on good quality, high earnings growth companies, which can compound at 25-30 percent per annum for the next three years so as to double one’s investment.

What is your call on small and midcap stocks?

Midcaps are placed between the overvaluation and bubble kind of zone. We feel the outperformance of midcaps over large caps may not sustain in future.

Based on Bloomberg consensus estimates, the Forward PE of Mid Cap Index is at 21x vs. 18.3x of the Nifty 50. This is not sustainable in the long run as midcap Index should be trading at par or lower than Nifty 50 Index.

The premium valuations are based on the assumption of ~34 percent earnings CAGR of the mid cap Index as compared to ~20 percent earnings CAGR of Nifty 50 (for the period FY17-FY19E).

The risk of earnings disappointment could be higher in case of midcap Index as compared to Nifty 50. If the midcap forward PE goes up another 10-15 percent immediately then it would get into a bubble zone. If this happens gradually over the next few quarters then earnings growth will lend some support.

Why are FPIs fleeing India? They have already taken close to USD 2 bn from India equity markets in August. Is it temporary or will the trend continue?

FPIs have pulled out money from emerging markets due to the geopolitical tension between the US and North Korea. August saw FPI outflows from other Asian countries like Indonesia, S.Korea, Taiwan, Thailand. The proportion of pullout was slightly higher from India due to earnings disappointment. This could be a temporary phenomenon if the geopolitical situation abates.

What is your call on NBFCs which have caught investors’ attention in the past few months? What is driving the rally and is it sustainable?

NBFCs, in general, are trading at hefty valuations. The basket is trading at 3.9x FY18E Price/BV and ~3.4x FY19E Price/BV. Some of the larger names are trading at 4-5x Fw Price/BV.

Cheap source of funding and ability to lend at higher spreads as compared to the banking sector is helping valuations sustain at higher levels.

Also, as most of the NBFCs are focused on retail lending, NPA problem is manageable as compared to banks. These kind of valuations are not sustainable and we could see both price and time correction in NBFCs going forward.

MF AUM hit historic Rs 20 lakh crore mark in August which talks about retail investors’ participation which only doubled in the last three years. What is the way forward?

Retail participation in Indian equities has a long way to go as there is limited option on other investment avenues. As per few research reports, annual incremental household savings works to USD 400 bn.

Household exposure to equities as of now works to just 4 percent as compared to 12 percent for gold, and 16 percent of bank deposits. Assuming the same proportion of 3-4 percent allocation of incremental savings going into equities, it works out to ~16-18 bn annually.

Post demonetisation, a lot of cash has come into the banking system (i.e. formal economy). Part of this is/has to come into equities over time. Adding these to the regular flow of SIPs we can still expect lot more money coming into Indian equities by local investors.

How should one choose stocks for investing in this market for the long term? Apart from technical factors what are the fundamental factors which one can consider to spot a multibagger bet?

Look for sectors that can do well in the post-GST phase (i.e. sectors where there is a huge potential of movement from unorganised sector to organised sector). Post four years of the rally, focus on quality stocks so that they can withstand any deeper correction.

Fundamental factors to consider are return ratios (focus on companies having over 15 percent RoCE and over 20 percent RoE). There should be reasonable debt/equity ratio of 1x or less than 1x & healthy operating cash flows to sustain future capex.
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