Go for tried and tested stocks; corp governance key: Mehta

At an Investor Camp organised by CNBC-TV18, Dipan Mehta, member of the BSE and the NSE chronicled the performance (returns) of various Sensex stocks in the past 25 years.

He emphasised the need research to stocks before investing in them. This will help the investors weed out stocks and enhance the quality of thier portfolio. He outlined the reasons for the good or bad performance of the stocks. Larger chunk of the outperforming stocks had been industries within the technology space, software, pharmaceutical companies which large revenues coming in from exports and that is a natural advantage for them. This, he attributed to the depreciating rupee. Also read: Investors should wait until markets ease a bit: Dipan Mehta Below is the edited transcript of his speech. We did a study to figure out which are the sectors which have outperformed over the past 25 years. We truly believe in long term investing and we have seen that the power of compounding actually plays out when one invest over 5-10-15-25 years or so. The Sensex per se has been around for decades and the average return has been from 14 percent to 17 percent excluding dividends. We took the time-frame of 25 years to see which industries have done really well. It was restricted to the 79 Sensex companies. Since the Sensex was launched, there have been changes from time to time. Although there are only 30 stocks at present, at various points of time companies have entered Sensex and have been deleted from it. So, totally 79 companies exist. We would have covered almost all the industries which were flourishing in the past and the upcoming sunrise industries in this duration. We saw private sector banks increase its market capitalization, technology companies increase their weightages, and industries like steel, paper and shipping reducing their weightages. So, the Sensex has seen the transition from the old to the new economy. The out-performers from 1988 are the software companies. They delivered a compound return of 26 percent. Cement has delivered 25 percent return, pharmaceutical companies 23 percent, fast moving consumer goods (FMCG) companies 23 percent and entertainment 22.35 percent. The only company on the Sensex was Zee Telefilms. The returns from the date of listing of the company or 1988, whichever is available was taken to study. In this situation, people invested in cement as there were no software firms. There were two companies that gave a 25 percent compound return on investing in this; Associated Cement Company (ACC) and Ambuja Cement. Companies like ITC, Hindustan Unilever, Nestle, and Colgate in FMCG sector delivered an average return of 23 percent. Steel, paper, tyres, textile and fertilizers were the underperforming industry. They hardly delivered any returns. If one had any companies of any of these five industries in their portfolio, they would have wanted to get out of it. The portfolio which consisted of software, pharma, FMCG, entertainment sectors would have seen those stocks outperforming by huge margins. Just as the batsman prefers to bat on a bating friendly pitch, why shouldn’t an investor just focus on the five or six sectors which historically, either in India or globally, have delivered the best returns?
 
Why does one invest in industries which delivered poor shareholder returns? One has the choice to avoid industries or invest in industries. _PAGEBREAK_ On market returns in the past 10 years There were two more inclusions from the past 10 years. In that massive infrastructure boom of 2003-2007, capital goods had done really well. Interest rates were low, there was massive upswing in the capex cycle. Companies like Larsen and Turbo, Siemens, ABB, Crompton Greaves, Cummins, did exceedingly well and delivered 29 percent return over a 10-year period till April 2013. Even after the correction over the 10-year period they delivered fantastic returns. The banking sector also saw private sector banks entering which was not the case in 1988. Banks like HDFC, HDFC Bank, ICICI Bank and other private sector banks which were a part of major indices have delivered incredible returns. Castrol, which is more like an FMCG dependent on consumer purchasing also gave good compound returns. The underperformers remain more or less the same - Paper, steel, textile, tyres, and fertilizer. On incomes in last five years Last five years 2008-2013 has been the most challenging times for the Indian capital market. There too, Castrol has been one of the better performers. Average returns by FMCG 23 were percent, Zee Telefilms 17 percent, pharma companies led by Sun Pharma and Dr Reddy’s give 15.83 percent. We are not taking weightage returns over the here because the investor does not follow the weightages of any index. Cement despite all its various challenges in the real estate sector, infrastructure has delivered at 10.31 percent return. The worst returns list remains the same. Probably, there are not many industries which have underperformed as badly. On stock-selection What are the conclusions? If I were an investor looking to buy stocks for 5, 10, 15, and 25 years, it would include the one with good return prospects mentioned earlier. There is enough choice, liquidity and debt within these industries. They can absorb billions of dollars of investments. They were targeted by the institutional investors too. With a temperament and a long-term outlook these are the industries that one should be targeting. Of course there are exceptions as well. In software, we have had Mahindra Satyam. Several other midcap software companies also destroyed shareholder value. Within banks, State Bank of India (SBI) has not performed and some private sector banks have not performed well. In pharma companies, the multinational corporations (MNCs) have not performed well. By and large you should just focus on sectors which have delivered consistent returns and way above the Sensex averages. These companies are asset light. They have high Return on Investment (ROI) and Return on Equity (ROE), good corporate governance standards and most importantly secular growth. This means that year-after-year 5-10-15-20 percent top-line does come to deliver. There could be one or two bad years, but the Compound Annual Growth Rate (CAGR) of these companies have been consistently. But that is not the case with these (underperforming) companies. They are cyclical in nature. They expand only by making acquisitions or adding capacity and are highly capital intensive. There is hardly any entry barrier over here. They compete with imports at various points of time. On the whole, these businesses are ordinary type and have hardly any value addition being done. There are no brands, or technology which also explains the reasons on returns from these industries being sub-par. Tata Steel has delivered better returns but Steel Authority of India (SAIL), Mukand and even Zenith was a part of the Sensex. An average of these for the past five years gives 27 percent negative return. Realty sector got 19 percent negative return. _PAGEBREAK_ Reasons for outperformers The likes of FMCG and Castrol sell things which have rising domestic consumption. We consume more soap, toothpaste, even automobiles than steel. So the growth in has been higher than over the past 5-10-15 years. The pharma and the software companies have benefitted from exports. A large function of its exports has to do with the currency too. The value of rupee in 1988 was 14/USD. Currently, it is 58/USD. 10 years back it was 45; it was 45-46 five years ago. There has been a consistent depreciation of the rupee. We are now touching 60/USD and we do not know where it would end up. So industries within the technology space, software, pharmaceutical companies have large revenues coming in from exports and that in itself is a natural advantage for them. Even some ones in which the growth is not that great, in September quarters of these companies, despite flat or negative volume growth, such companies will deliver excellent rupee numbers. At the end of the day, we are Indian investors investing in Indian rupee. Although, the FIIs may fret about dollar sales and dollar earnings per share, in Indian rupees these companies would deliver very good returns at least in the next two-three quarters if the rupee depreciates. On government intervention on industries Most of the industries here are well organised. There are decent monopolies over there and be it software, cement, pharma; have good industry practices, transparency, good corporate governance standards and minimal government interference. There is hardly any requirement for government permissions or policies. That is not the case for the underperforming, high capital intensive industries. In India interest rates have always been high. We are a capital starved country. Whatever cyclical situation that goes down to 6-7 percent; at the end of the day, the interest rates are typically double digits. Unlike, Europe or US one can get funding at 2 or 3 percent even for the bluest of blue chip companies. At 10-12 percent of borrowing rate, how does one expect to make money if actual return on investment is in the range of 15-16 percent? Therefore, we have to go for companies with zero debt, which, as a result, will have no interest cost. So, they perform well. Of course, industries like real estate, telecom, fertilizers, oil and gas have a lot of government interference. The government dictates all aspects of production, distribution, sales, pricing. And it need not look at whether all their policies and suggestions or various laws are favourable for minority shareholders or not. For the oil marketing companies (OMCs) – just because the government wants to control inflation, the minority shareholders of the oil PSUs suffer with lower profits. We have to recognize this that this is not going to change in the near future. So, why do we invest in companies where there is lot of government interference, frequent policy changes? Avoid them. There have been points of time when these industries do exceedingly well. But is one really equipped to take advantage of these short-term booms. I don’t think so. These are best completely avoided it. _PAGEBREAK_ On dealing with market volatility These days we have a lot of discussion, argument, debate about various asset classes than what in the last five or 10 years. Investor has the choice to put money in fixed income, equity, gold, real estate, art or wine. People know that equity delivers a good return. Historically, it has been known and they have seen around them that Sensex’s rally has delivered fabulous return. But there are two major problems with investing in equity. The first is that, equities are volatile. Sensex goes from 15,000 to 21,000 and then back to 8,000 and then back to 20,000. Individual stocks are even more volatile. It is not that the volatility escapes the FMCG, technology or the pharma stocks. This is a peculiarity of this particular asset class and one has to live with it. One should have a long-term approach to tackle this volatility. Cycles eventually will play out once the boom cycle will be followed by a bust cycle. End of the day when one invest for 10 years, 15 years, 20 years, 25 years, then why not buy real estate, gold or invest in fixed deposit? The notion that ‘I am going to be in equities for 10-15-20 years and give it to the next generation’ will help in not worrying on volatility. Investors would have an idea on the behaviour of the stock over a long time. Stock selection is also important. If anybody invested in land, real estate one will get some appreciation but the value of the property does not become zero. Same is the case with fixed investments, fixed deposits, bonds, government securities and gold. Gold has undergone lot of volatility but if one sees, gold never becomes zero. Companies’ stock can become zero. This is no denying the fact.