If you want to do active stock picking, here's how you should do it, says Nilesh Shah, MD of Kotak AMC.
Noted ex-fund manager Nilesh Shah, now MD of Kotak Mahindra Asset Management Company, believes most investors are better off doing systematic investment plans (SIPs) into fund schemes.
But he says that if you still want to do active stock picking, here's how you should do it.
Here's Shah's check-list: go with companies that throw off a lot of free cash flow and do not need frequent equity dilution, those that put a premium on sound governance and whose business models cannot be easily replicated.
In an interview with CNBC-TV18, Shah also talked about his near to medium term outlook on the markets, saying that a confluence of good news was helping equities.
He also discussed his views on several sectors, including IT and pharma. While pharma could be invested in from a three year view, he said IT companies could win by investing into their future.
Below is the verbatim transcript of Nilesh Shah’s interview to Anuj Singhal & Sonia Shenoy on CNBC-TV18.
Anuj: Your theory is that today is the best time to start in systematic investment plan (SIP) but from retail investor’s point of view some of them have participated in this market let us give them credit where it is due but a lot of them have missed out as well what is the next strategy?
A: The strategy remains the same; in a triveni sangam if I can call it we have mixture of flows right now. Sentiments are improving and fundamentals will eventually improve. Flow wise you have seen the power of liquidity. There are more buyers than sellers between mutual funds, foreign institutional investors (FIIs), insurance companies, retail and high networth individuals (HNIs) investors, pension funds and new pension scheme.
The buying of Indian equity this year will be anywhere between Rs 1,75,000 crore to 2,25,000 crore. The supply of paper is going to come from government’s divestment and Initial public offering (IPOs) which might just range between Rs 1,20,000 crore to Rs 1,50,000 crore. So, unless until one of the large holders of Indian equity which could be promoters which could be FIIs turn out to be net seller this demand supply equation will continue to support prices.
The sentiments are improving because of passage of goods and services tax (GST) bill, because of good monsoon, because of 7th pay commission, because of some work done by the government, because of some improvement in global economy. Net-net entrepreneurs as well as investors are feeling more bullish about economy and market.
Finally, we are looking at earnings growth to recover which has been missing for last eight quarters. However, now with monsoon coming and interest rates coming down, liquidity improving there is reasonable good chance that earnings also will recover eventually. In this kind of scenario obviously, prices remains ahead of fundamental and if investors come via SIP route that will be the best option for them.
Anuj: Are we making the mistake of going by the past earning and I am just looking at the FY17 earnings and saying this market has become a bit expensive. Could this market go through an expansionary phase something that we saw in early 2000 as well?
A: If I want give the argument that this market is not very expensive or this market is still fair valued that will driven by the fact that they expected trajectory of interest rate is on the downward side. Globally, as well as locally interest rates will continue to decline which means the price to equity (P/E) ratio has to expand which means not only you will benefit from the earnings growth which comes because of the lower interest cost at the borrower level, it will also come through valuation re-rating as the overall risk free rated comes down.
The second thing is related to overall profit kitty. Normally profits have averaged somewhere around 6 percent of our gross domestic product (GDP). Today because of the downward cycle it is averaging somewhere between 4 to 4.50 percent of GDP. Even if we average it at about 6 percent it means there could be 33 percent rise in the profit from here and hence today’s valuation doesn’t look fair value plus but looks more like fair value. So, there are equal arguments for supporting the valuation at today levels. Who knows where the prices will settle, but the fact remains that we are seeing a conflicts of liquidity, sentiment and fundamentals which is a deadly combination for investors return.
Sonia: Your motto has always been to buy and hold on to a fundamentally solid stocks and it brings me to two stocks that you have always told us about Asian Paints and Eicher Motors both are sitting at new highs today. The example that you keep giving us if you rather bought an Asian Paints share rather than paint your house you could have bought a mansion today and similarly if many years back you would have bought into Eicher Motors shares rather than a bike you could have perhaps bought yourselves BMW or an Audi today. What is the evergreen stock of tomorrow? Where do you see the themes that can make you a lot of value say over next 10 years?
A: It is very difficult for us to give stock specific comment. Let me give you some of the characteristics of stocks which will create value for shareholders. Any stock which is generating free cashflow and which doesn’t require dilution of capital I think they are big compounder. We have seen stocks like Motherson Sumi or Sundaram Finance which has never come out for capital market rates. MRF also will fall in that category. So, anyone who is very stingy with your capital who doesn’t come to you for capital more often has a better chance of creating wealth compared to let us someone who is regular visitor to capital market.
The second thing which has happened in Indian market inline with global market is the premium for governance, premium for valuation. If your balance sheet is made depending upon the real fundamentals and not made to order to accountants then certainly that balance sheet will always carry more value.The premium for governance will continue to grow in the days to come, so focus on companies where premium on governance is very high.
The third thing is the business model, is it a model which can be replicated by others without too much of a trouble or is it a business model which is difficult for replication and hence you can be reasonably sure of sustenance of your profit. So, businesses which display this characteristic, good governances, less competition, less need of capital this are characteristics which will hold good for 5 -10 to 15-20 years.
Sonia: How does the new listing fit into this category? RBL Bank we are expecting the listing anytime soon. Agreed that there is a lot of competition now in the sector but some of the other check boxes do get ticked in terms of a strong business model, high pedigree of the management and good governance so far at least. Is this a stock that perhaps can create wealth for investors?
A: If you see in the banking space, we have virtually two breakups the private sector banks the public sector banks. The private sector banks started somewhere in the mid 90’s in a real sense, there were many private sector banks in existence before that but they were really small. However, mid 90’s they got new licences from Reserve Bank of India (RBI) and then the story began. Today they own a roughly about 25 percent of Indian banking balance sheet and 75 percent is owned by public sector banks.
In incremental credit deposit the private sector bank ratio is almost half-half. So, it clearly shows that they are gaining market share from public sector banks and public sector banks are getting constrained by capital, by administrative freedom to run the business and so on and so forth. So, in that context private sector banks have a lesser competitive disadvantage vis-a-vis public sector banks and which is reflected in their year-on-year growth in businesses.
If we see almost all the private sector banks barring very few exceptions they all have created tremendous wealth for shareholders. From the IPO price of almost all private sector banks today they are up minimum 50-100 times. So, if you have a long-term horizon then certainly, private sector banks will continue to create wealth for you.
Anuj: The other big leg of the market, IT stocks, is the market again giving an opportunity to enter into say Infosys or Tata Consultancy Services (TCS) or do you think that this sectors glory days are now truly over and this is now a commoditise play?
A: This is a sector which is going through a churn. There was a time when basically providing hands and legs to the clients assured you of business and because your hands, legs and bodies where available at a very competitive price you were in a position to make handsome profit. The margins of most of the IT companies if we exclude their cash on balance sheet it is still reasonably high. The question is coming from a growth point of view. This year the recruitment in IT sector will be lower than last year. It might be very moderate for many of the large companies.
It clearly shows that the whole model of providing bodies to do the work is getting disrupted through technological improvements including artificial intelligence. Now market is sure that we will reward growth in IT sector, but they are not sure which company will be in a position to deliver growth. There are opportunities on digital side. There are opportunities on product side. There are opportunities on even as mundane things like Pokemon Go. As long as market is not convinced that Indian IT company can create a Pokemon Go they are unlikely to get valuation.
It is not that Indian companies are sitting duck they are already making changes, some people are going into consulting, in fact most people are aggressively investing into digital. We will probably see some amount of under performance in IT sector and IT stocks for a while. Those companies which will be able to invest for future in terms of digital, in terms of products, in terms of gaming or anything like that market will reward them. It is time to be stock specific but there is some amount of under performance in the IT sector in the near term.
Anuj: What is the next big sunrise sector, you have been talking about non banking financial companies (NBFCs), cement has created so much wealth, all the domestic sectors have created a lot of wealth for shareholders or investors over the last two years. What is the next one that is always the big question?
A: If you are taking a three year view according to me pharma sector provides a great opportunity. Most of the Indian pharma companies are today available at 30-50 percent discount to their previous high valuation, not the price but the valuation. This has happened because of the various notices which they have received from USFDA. Now probably cycle is coming to an end; these factories will starts getting approvals, they will file the products with the USFDA for launch in US market. They will be eventually getting approvals to launch those generic products which will give them the growth as well the profitability.
On the domestic side anyway pharma companies are doing well. India most below USD 15 per capita GDP to above USD 1,500 per capita GDP people are spending more money on healthcare, wellness and stuff like that. So, there is traction on the domestic side. There will be traction on the global markets side over a period of time. We are seeing a shift in the pharma industry from chemical based drugs to probably bio-similar kind of drugs.
So, companies which are investing for future in bio-similar kind of thing I think combination of this will provide a growth in this sector and opportunity in this sectors for investors to multiply their wealth. So, to me pharma sector with a three year horizon provides an opportunity. It doesn’t mean that you and invest in pharma stocks today. It means that you invest it over next 6 to 12 months. It doesn’t mean that you go and pick up only one pharma stocks saying that this going to be winner.
You never know how things will shape up in future, so build a portfolio of pharma stocks some large caps, some midcaps, some small cap, some focused on US generic, some focused in domestic markets, some focused in ancillary sectors like hospital and diagnostic and so on and so forth. This portfolio should be able to outperform market over next three years.
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