Is a fall from the cliff around the corner for domestic stocks?
I really do not know how to predict market move, but clearly this is one market which has taken everyone by surprise by staging a sharp recovery. We think from the overweight equity position at about 7,000 to 9,000 on Nifty, now it is time to be ‘neutral weight’ equity. Valuations have got stretched and this is time to be neither ‘underweight’ nor ‘overweight’ equity. It is time to maintain that position which you can afford to keep for the long term and where some amount of volatility that you can bear.
For the last two or three years, analysts have gone wrong in predicting the earnings cycles. So is that the biggest risk right now?
The best way to invest yesterday and today and probably tomorrow as well is to invest in good businesses run by good managers available at good prices. It’s very easy to say, but very difficult to execute. What I will recommend to investors is that buy quality companies where you believe the managers will work for you, and not cheat you, and try to build a margin of safety in prices. Today, if you value companies on FY21 earnings, in most cases you will find them trading at lifetime high valuations. But that is because FY21 profits have disappeared. You are buying companies not for FY21 profit, but far beyond. So try to buy those companies where you believe growth will be higher, which will survive the current downturn and their margins over a period of time will normalise.
At Kotak Mutual Fund I have requested my team members to ensure that our portfolios pass through the following filters: one, our portfolio companies should have less leverage, because we believe leverage will become lethal in the days to come, and impact shareholder value far more. Secondly, our portfolio companies should have as lower breakeven as possible in terms of operating cost. They should not have very high fixed overheads, they should have cost structures that will allow them to survive a downturn. Thirdly, we are looking to invest in companies that are top three or four in their respective sectors. There is no point in investing in companies that follow. Besides, we apply the common filter of companies and governance which we believe will work for minority shareholders. Very simple things but very difficult to do when you see penny stocks rally in the short term.
Midcaps and smallcaps have begun a recovery and perhaps fast catching up with the largecap universe. Are you saying you are not convinced about the rally across the broader universe?
It all depends. It’s stock specific. The days of sector-specific rally are probably behind us. One could see a scenario where a portfolio of quality stocks across largecaps, midcaps and smallcaps can still outperform the market. The focus has to be in buying companies that are less leveraged, have lower operating cost and have leadership positions or ability to innovate to survive the downturn. The Covid-19 crisis is a long haul. It is not going to go away in one or two quarters. Companies will take time to come back to normalcy and they have to cut costs aggressively in order to survive the downturn. So, we would not be able to judge across an entire sector. One will have to pick up her own stocks on a bottom-up basis depending on how they are cutting costs and how they are innovating to survive the downturn.
In the near term, what is the sense that you are getting about IT and pharma?
It is always very difficult to predict the near term, because flows can remain stronger than fundamentals. There is a famous saying in the market: “markets can remain irrational longer than you can remain solvent.” My feeling is that at least in the near term the momentum on IT and pharma is likely to continue. People are worried about other parts of the economy, especially on investments, infrastructure, engineering and capital goods sides. They will look towards the safety of IT, pharma and FMCG kind of sectors. Most IT and pharma companies have lesser leverage. They also have slightly robust cash on the balance sheets, which will help them survive the downturn. More importantly, both the sectors are poised for some growth pickup in the days to come, courtesy Covid-19 disruptions. So the momentum is in their favour, but my recommendation is to buy quality stocks, keep a watch on valuation and let the momentum not mislead you.