High economic growth need not equal high earnings

By Morningstar |  02-12-16 | 

Anoop Bhaskar, Head of Equities at IDFC AMC, shared his views as a panelist on the 'Stock Market in 2017: How Are Your Portfolios Positioned?' panel at the Morningstar Investment Conference.

Regarding foreign flows into the Indian markets, 2015 started with a bang before FIIs withdrew a lot of money. Domestic investors pumped in money. Is that some sort of flow level decoupling that you are seeing?

I think it is more part of a cyclical function.

Look at real estate. After 10 good years it had a slowdown. But most investors would favour it the most. So, we have one asset class which is not doing well.

Low inflation and hope for a good recovery in the economy usually is good for equity.

So these two factors would have contributed to the flows that we have seen.

For it to be a structural change, I would keep my fingers crossed. I would claim that we've crossed that bridge and this is going to be permanent.

Real estate still remains one asset class in India where you can take leverage and it's allowed by the Government of India to lever up. And therefore, it's always good for investors to have that in a portfolio.

Unfortunately, you can't do SIPs in real estate. Once you make a commitment for real estate, it is for a large amount of your capital. That comes at the cost of equity or the case of other financial assets.

Regarding earnings growth, –quarter-on-quarter we've been waiting for that sort of kicker to come in. But we keep hearing that it's probably expected six months down the line. When do you really think that turnaround is going to come in?

The last two years have been odd.

The country has had GDP growth of 7-7.5% but no earnings growth has come with it. A myth is that high economic growth equals high earnings. We have to revisit that. When you have high nominal GDP growth then you can have high earnings growth; not when you have high real GDP growth.

We still don't have clarity on what caused it –you can't have a slowdown when you're growing at 7.5%.

Probably 2010 to 2014 was a period when the view was that we will have 8-9% growth and 14-15% nominal GDP growth for a decade or so and that is how we had planned our investments. The world has changed since then. We realized a bit late. All our investments, whether on the banking or corporate side, have been largely done during that phase when growth was a given. And we have not been able to resolve those issues even today.

So how do you resolve a stuck metals project? Some move was made on that front by coming out with a minimum price for imports which has given a breather to steel companies, but there are other metals which are still facing competition. Time will be taken to resolve those issues.  The banking balance sheet side repair that has to take place could lead to more sluggish growth than what we believe – Indians feel they have a right to a GDP growth rate of 8%. We don’t have those blocks in place. We have to be more moderate in our consideration for growth.

Because we are in a phase of low cost of capital, we will have these high valuations for a slightly longer period of time. So rather than get bogged down by just seeing the P/Es of today versus P/Es of 15 years back, when the cost of capital was very different, you have to see where earnings growth in the whole world is and how Indian earnings look compared to that.

The U.S. trades at 18 times, has had no growth in profit from absolute profit growth. The full profit growth has come from the share buybacks that they have done. So absolute profit of their main index - S&P 500, has remained flat for three years in row. It is only by continuously buying back shares that there is growth in EPS on that index.

In that context, a growth rate of earnings of 8-12% in India will not look bad. It is just that we are more fixated on the P/E levels at which we are trading and not seeing what the earnings growth in the rest of the world is. We have to lower our earnings growth expectation and accept slight P/E valuation going forward, which means that the markets will be more volatile because when you have low earnings and high valuations, it become more risky by itself.

How are you trading the mid-cap space currently?

IDFC Sterling is a classical mid- and small-cap fund, so it has its relevant ups and downs. This is probably the most competitive category.

In this fund, we are benchmark agnostic. In the last six months, financials as a sector has done very well and we've not been there as much. Our fund is more focused on industrial recovery which has taken more time than what was earlier expected.

In the mid-cap space, there has been this move of quality and growth which has done very well. That's a fairly crowded trade at this stage where valuations are far higher and they have far exceeded the kind of growth those companies can deliver. So, we've consciously steered away from that segment to a large extent.

What about Premier?

IDFC Premier invests in best-of-class companies across market caps. Its benchmark is BSE 500. In the past, it invested more in mid and small-caps because the returns were much higher. But in terms of its mandate, it's a fund which can go across all markets caps. The underlying theme being is to look at companies that are best-in-class, which have got the best operating parameters and in sectors where we believe there is good growth potential over the near term which is the next one to three years.

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