Value in contra plays, find businesses that are down but not out: Samit Vartak of Sage One

While a majority of the companies fall in the first category, one needs to look at a third category, where companies are going through a bad cycle and valuations are cheap.

Investors must consider contra plays that offer good businesses going through a rough patch, as that is the only way to find value in the current market, said Samit Vartak, Founding Partner and CIO, of Sage One.

Vartak divides mid-cap stocks into various categories. One is where both growth and valuations are high, and the second is where growth is high but valuations are extremely attractive.

Also watch: Midcaps & Smallcaps: Where can investors look for the next opportunities? | SageOne's Samit Vartak

It’s sensible to buy the first category stocks with higher valuations, said Vartak. He explained that if those companies have the potential to double their earnings in three years, valuations on those stocks would very rarely correct.

While a majority of the companies fall in the first category, one needs to look at a third category, where companies are going through a bad cycle and valuations are cheap.

“These are contra plays. Most of the contra plays are on the export side, whether it is textiles or even chemicals,” he explains. For example, in the chemical space, in the recent few quarters, earnings have fallen 25-30 percent. Compared to their own historical valuation, they’re not really attractive, Vartak says, but at least their earnings and margins have been impacted.

“In this case, I feel that there is a high possibility that earnings might expand not just in terms of topline growth, but also in terms of margin expansion,” he adds.

Also read: Samit Vartak loves smallcaps for firm balance sheet, better earning and prudent strategy

For an investor, it is a very dangerous thing to enter at a high PE multiple and high margin levels, because there is a double whammy possible -- earnings and PE multiples may contract at the same time.

With the third pocket, if one studies the cycles of different industries, not only at the industry level but also at the company level, one could find out when things are at their worst. And when the industry bounces back, having a 10-20 percent allocation to those themes in the portfolio can get a re-rating in multiples, open up huge growth, and create significant alpha, he says.

Disclaimer: The views and investment tips expressed by investment experts on Moneycontrol.com are their own and not those of the website or its management. Moneycontrol.com advises users to check with certified experts before taking any investment decisions.