Build a core portfolio
With the economy on a sound footing, stock markets are poised to increase your wealth over the long haul. Where should you look for growth?
In the good old days, most od-timers used to invest in the 'Blue Chips', i.e., in companies that were very big in size and strong financially, and with large stock market values. People relied on the stability of these big companies and their steady increase in profitability. Most of their investments have paid off. Their holdings have increased manifold, and dividends have compounded handsomely.
Even today, there's reason to embrace long-term optimism in equity investments. Morgan Stanley India released a strategy report "India Strategy-Road to 50k" outlining how and when the Sensex could reach 50,000. "Corporate earnings are increasing and balance sheets are in good shape. Companies have huge cash reserves and a large number of them are under-geared," points out Ridham Desai, Managing Director, Morgan Stanley India Securities Private Limited, co-author of the report. It states that the BSE Sensex could take almost 13 years to reach the 50,000 mark from its current level. "If the assumptions are optimistic, the period to 50K shrinks to under 10 years," the report adds.
"For investors in today's market, there is not much option but to think long term," says Nilesh Shah, Chief Investment Officer, Pruicici Mutual Fund. In his opinion, long term means a three-five year time frame, though Shah is quick to clarify that this varies with the objective. "If a person is 35 years old today, long term for him could be 60 years," adds Shah
Rakesh Jhunjhunwala/Chairman/Rare Enterprises
"For the Sensex, 50,000 mark in 13 years appears pessimistic"
ON INVESTING: It's a factor of earnings and valuation. The market is looking good and I do not think P/E multiples are necessarily unsustainable
ON THE SENSEX: This will depend on earnings, which, in turn, will depend on economic development and interest rates. To me, for the Sensex, 50,000 mark in 13 years appears pessimistic
ON LONG TERM: It's important to have a long-term view. I look at long term as at least 3-7 years
ON STRATEGY: Always invest in the business model of any company. For me the reason for optimism is earnings growth drivers
It is interesting to go back a little into the past-around a decade-to make a few comparisons. Take a sector like automobiles, for instance. An investor who had put in his money on a stock like Maruti is not as well placed as one who had invested in Hindustan Motors. In a sector like it, an investment in Infosys has yielded far greater returns than that of Silverline
Technologies or Pentamedia. Over the last few years, out of 88 companies with a market capitalisation of over Rs 500 crore then, all but five have yielded positive returns. Some of the names are familiar household names (see The Wealth Creators). Their business models changed as these companies scaled up in size. Citing the case of a changing market, Shah points out that Tata Steel in the mid-90s was trading as a Tata Group company. "It trades as a steel company today," he says.
Checklist for the Long Run
Corporate earnings are increasing and balance sheets are in good shape
For investors, longer the horizon, the lower the volatility
Look for global cues. India is highly correlated to the global markets and is affected by it
Investors need to spend quality time in identifying and studying companies
Ensure you invest in a sustainable business model of growing companies
Spread your eggs over a basket of stocks to spread the risks of equity investments
But, remember, the market is unpredictable in the short run. "Yes, investment in equities is sometimes fraught with uncertainty. I always take a long-term view and that is anywhere between three-seven years," says well-known investor Rakesh Jhunjhunwala. He is quick to add that there is definitely a level of comfort in today's markets. "2015 could be a horizon for the investor, though the question to be asked is 'when I will need the money?'," he thinks.
For now, India is linked to the global market. "The Indian markets are highly correlated to the global markets and to that extent, India is affected by what takes place globally. Also, our dependence on portfolio flows is quite huge," says Desai of Morgan Stanley. In other words, even a small reduction in portfolio flows coming into India could have a pretty serious impact on the domestic stock markets. But more new investors will increase the levels of interest in the markets as well. Large contributions from this will come from households. "Over the next 10-12 years, there could be inflows as large as $200 billion from households into equities," predicts Desai.
Where will the growth for companies come from? Morgan Stanley's report points out that for India's top 30 companies (these are those that constitute the BSE Sensex), revenue growth will exceed GDP growth. In that context, the growth story over the next few years could well continue to be the big story investors are looking for.
But how should you cherry pick in a market like this? That could well be the easiest question to ask but the most difficult one to answer. The trick lies in identifying companies with robust business models. "There are a couple of factors that need to be looked at. The investor will have to look at areas like the quality of management and the possibility of wealth being shared with the stakeholders," says Shah. That, of course, is easier said than done as it requires investors to spend quality time in identifying and studying companies.
Those tracking the business are unanimously of the opinion that the story often is in deciding the soundness of a company over a long period. "The strategy is to invest in the business model of a company," says Jhunjhunwala. Clearly, a couple of questions need to be asked about any company and Shah puts it down to just two basic ones. "An investor will need to answer if a company will be in existence after 10 years. Secondly, he will need to see if it will make more profit in 10 years than it does today," he states.
Occasionally, nasty surprises could spoil the party and investors need to watch out for them. "Returns from the stock markets are never secular. They are either front-ended or back-ended," warns Shah. Again, for an investor looking for stocks for the long haul, patience is the key.
That apart, the issue is what stocks or sectors could be potential blue chips. "Over the next 13 years, I am very bullish on agriculture. There are major plus points like large upsides from here, investments going up and increasing levels of transparency in farming," says Desai. With the story in this sector barely unfolding, there seems to be some serious play that is waiting to unfold in agriculture. According to Desai, infrastructure too is interesting though it is expensive. "The consumption story too is looking good and in the short term, offshoring looks the most attractive," he maintains.
Morgan Stanley thinks there are a couple of key advantages in India's favour that are the key long-term value drivers for equities. Among them are India's macro story, the demographic advantage and a robust capital market infrastructure. Desai, himself, is of the opinion that Indian companies are largely under-invested and there is a lot more that can be done.
The Indian structural story for the long haul remains intact. The fiscal situation is improving, there's a steady demographic change that is driving demands for goods and services. Companies are increasing productivity and improving the efficiency of capital. Infrastructure spending is picking up, and that is the key driver of a sustained growth in the economy.
Therefore, favour the large cap companies in the next decade over other companies. They are a play on outsourcing, infrastructure and consumer demographic changes taking place in the economy.
Companies like Reliance Industries are investing in new businesses in the retail space, whereas Larsen & Toubro is growing in scale and size that is unparalleled in the construction and engineering space. Infosys has already proven itself in the offshoring business model evolving from just a vendor supplying code to value-added services such as consultancy. Look for core industries where India has a sustainable advantage over the long-term (see 10 stocks for 2020).
Spread your eggs over a basket of stocks to spread the risks of equity investments. Over time, there could be newer blue chips in the market. All you need is patience to weather the unpredictable nature of the markets. And you'll be fairly surprised that achieving satisfactory results in the market was a lot easier
Build a core portfolio