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Indian stock market is still a good place to invest

Losing the share certificates of a stock turned out to be fortuitous for the young Raamdeo Agrawal on his journey to be one of India's most successful equities investors.
It was 1980, when 23-year-old Agrawal first invested in India's stock market. Anticipating its future growth, earnings potential and profitability, he picked up shares of Vysya Bank at almost a throwaway price of Rs25 (Dh2.02). Over the next few years, the stock climbed to Rs2,000, but subsequently fell to Rs300. Thinking it might go down further, he placed a sale order at this price.

To his dismay he found he had lost the share certificates, which were required to complete the transaction. That was the era of pre-electronic trading. So the sale order was cancelled. Eight months elapsed before he got replacement certificates and that too at a cost of Rs50 per share. Rather than selling the shares right then, Agrawal patiently waited.

Finally, he sold the shares at Rs2,000, making good on his initial investment by "simply sitting on the stock and not flipping" as share prices went up and down and up again.

In 1987, Motilal Oswal and Agrawal founded Motilal Oswal Securities Limited (MOSL), today considered one of India's leading diversified financial services firms.

On a short visit to meet clients in Dubai last week, Agrawal, co-founder and managing director of Motilal Oswal Securities Limited, not only shared his investment philosophy but also answered in the positive when asked (as many readers might be wondering) whether there's still an adequate margin of safety to enter the Indian market at the current levels.

He isn't the one to get carried away by the astounding rise of the Indian stock market's Sensitive Index, popularly known as Sensex, in 2009. He reminds that last year's rise of 80 per cent was after a 67 per cent decline the year before. But he feels the annual federal budget presented last month has set the tone for further growth momentum in the economy.

In the last three years, the Sensex's earnings per share (EPS) aggregate has been prevailing at around Rs800-825. He expects this stagnation will end this year.

"In 2010-11, I think it should move up to about Rs1,000 to Rs1,100, depending on what happens to Corus, State Bank of India and, also, what happens to credit growth, etc.

"We are hoping anywhere between 25 and 30 per cent earnings growth. It will take four quarters of earnings growth for that to materialise. So markets will move up as earnings become clearer to the minds of the market men. My sense is we have seen the bottom, pre-budget, unless some black swan event happens.

"Now how much can the market climb up on a 25 per cent earnings growth? My sense is about 15 to 20 per cent."

Uncertainty

He doesn't downplay the continuing uncertainty surrounding global economic recovery and whether the Foreign Institutional Investors (FIIs) will sell or buy.

"They should buy what they bought last year, which was about $14 billion [Dh51.4 billion] to $15 billion. If they do, then we will see the market scaling up," Agrawal adds.

The place of emerging markets amidst the unrelenting globalisation is always a factor to keep in mind, he says.

"India is not moving in isolation to other emerging markets. We are very closely tied to what happens to the entire emerging market, and globally whether emerging markets will be in favour or out of favour."

The second challenge could be more domestic.

"It is important to consider issuance of new papers, whether from the government or the private sector side. When you have too many issues coming together, market tends to soften. So, these are the challenges for the market. My sense is that with a strong earnings growth ahead for the next 12 months, we see markets to be on the positive side from the current levels."

With the Sensex surging from the lows of 7,700 to the current level of 17,000, and its 2009 performance turning out to be one of the best in the world, many investors, still sitting on the sidelines, are not sure whether they have missed the boat. Agrawal strongly believes they have not. He says it all boils down to whether you are in it for investing or speculating.

"If you are talking about holding for one year, it's pure speculation," Agrawal says. "If you are talking about three to five years, that's a decent period. I will be surprised if managed funds don't double in five years. And 15 per cent compound return [on such funds] is a decent return I would say. In no bank deposit you can get such a return anywhere in the world."

What about the current valuation of about 16 times price earnings next year as a criterion for entering the Indian markets now? He feels it's reasonable, given the expected corporate earnings growth in the year ahead.

"We are definitely not at A throwaway price but we are also not at euphoric levels of 20 times or 30 times earnings. In other words, I would say, a $10 stock is now available for $10. It is not available for $8 or $9.

"Markets are very evenly poised and the economy is looking very good for 8 or 9 per cent growth. Corporate profits are going to zoom for the next three, four, five years. So the setting is perfect for a doubling in five years or even less than five years," he says.

Agrawal, who prides himself as a ‘100 per cent' equity investor, has one more piece of advice. An equity investor should have the heart to see prices going down and remaining steady in the face of it. After all, equities are considered one of the riskiest assets to be putting your money in.

"One of the things about investing in India or any part in the world, if you can't take 20 or 30 per cent correction from your purchase price, then you don't belong to the game. You can't get it at the lowest, because at the lowest you are scared. The moment some companies slightly move up, the markets also go up. Then you say that you've missed the bus. So, when do you get in?"

He concedes, however, it is not for everybody to play the market directly.

"It is for you to decide whether you are going into the market on your own or you should take professional help," says Agrawal.

"If you yourself understand what companies are worth investing in, you can very well double your money in a few years. ‘Bigger the better' for the guy who is managing himself. But if you are not competent, irrespective of the size of money you have, you must take professional guidance. It is very complex, and you have to be on top of things."

Even a seasoned stock market investor like Agrawal himself goes wrong sometimes.

In 2000 he sold his Infosys (India's leading IT company) shares at Rs8,000 per share and with the profit, bought shares of a small company (the name of which he would not like to disclose) at Rs400, which immediately slumped to Rs20. It has stayed at the same level since then.

Having digested this experience, the master investor draws this lesson: "Quality [of companies] matters a lot," he says.

Fund managers

As for guidance for those who need it, he means taking the mutual fund route. Without taking names, he says, he has high regard for several of what are available, both in terms of fund managers and funds. But he underscores the point that the investor should carry out his or her own due diligence on them.

"If you go for professional help, you have all these fund managers. Look at their track record, what they have been able to achieve over the past five to 10 years. Smart talk everybody can do it. Go for the tested products. After all, there's quite a plethora of them. Portfolio management services (PMS) and foreign houses offer a lot of exciting equity products, and [there are] brilliant managers in India. You must know the person and fund you have to do the homework."

Coming back to investing directly, he lays down the investment criteria of what makes him think that a stock is worth a second look.

Valuation is absolutely important, but with it, he looks at how much money the company can make in the future, he says.

"One is profit [what it makes now] and the other is profitability. Most of the people don't focus on profitability. Is the business going to need Rs1 billion to earn Rs100 million, or incur Rs100 million to earn Rs100 million. That's the real differentiator between two businesses.

How important is tangible asset backup to minimise the downside risk?

"It depends on the businesses," Agrawal points out. "Some of the businesses are tangible asset based businesses, some of the others are completely brand equity-driven kinds of businesses where real assets are intangible."

He then goes on to explain the two with examples.

Like when you buy a cement company stock, you are looking at the tangible assets. The valuation criteria of such a company is based on enterprise value (which is the total takeover value) per ton. The replacement cost (that is, cost to replace an asset at current prices) must be judged in terms of whether one pays the full price but buys a superior machine or one buys an average machine, but at half the price.

On the brand equity side, for example, companies like Nestlé India and Hero Honda Motors do have factories. But their valuation is not based on tangible assets but their earnings power.

"The kind of brand equity such companies enjoy, the kind of scale they enjoy, the kind of low cost of production they enjoy because of that there's always a certain level of profitability, cash flow and dividend payout ability," he says.

"These companies are looking at some staggering growth potential into the future — and competition is limited for them because they have almost killed all competition on the way to becoming number one or number two. So that's the kind of opportunity you look at, but at a reasonable price, which is available at 13 times or 14 times earnings current year and 12 times next year. So that's how I approach."

Agrawal believes in the philosophy of buy and hold. So when does he sell? Well, he doesn't bother too much about the selling if he feels his buying has been at the right price.

"I suggest to others three to five years, but personally, for myself, I look at 10 to 20 to 25 years. So selling is not on my horizon, but I am not averse to it. Of course, you have got to have those kinds of businesses to hold on to. There are not many of that type, even in the US. You come across a few and you are lucky to buy into them."

Investing mantras of Agrawal

Inspired by Benjamin Graham, the guru of value method of investing, and his most famous follower Warren Buffett:

1. Focus on great growth businesses. Growth is all around, but growth combined with superior business is fountain of wealth creation.

2. Terrific management team the horse is important but the jockey is even more important. A combination of good horse and even better jockey wins the race.

3. Look for large opportunities with few players. When the scaling up of economy will happen in next 10 to 15 years, all the values in that business will converge at one or two places.

4. Buy at reasonable valuations. Avoid bubble valuation, even in best companies.

His top stock picks:

HDFC Bank
State Bank of India
Hero Honda Motors
Bajaj Auto
Nestle India
Maruti Suzuki (later, when the price is right)

Crisis is no hurdle for India

Crisis? What crisis? Indian policymakers are not asking such a complacent question. But India has had a "good crisis". Now its task is to unwind the exceptional support given to the economy and push through the reforms needed to sustain fast and inclusive growth.

When Pranab Mukherjee, the finance minister, presented his budget recently he noted that a year ago, India confronted a double challenge: the global crisis and a poor monsoon. Now, "I can say with confidence that we have weathered these crises well". As the Indian government's Economic Survey put it: "A variety of stimulus packages were put in place in the second half of 2008-09, in the Interim Budget 2009-2010 and, again, three months later, in the main Budget 2009-2010. By the second quarter the economy showed signs of turning; and now, close to the end of the year, India seems to be rapidly returning to the buoyant years preceding 2008." This year it is forecast to grow by 7.2 per cent. If the Indian economy has succeeded in surviving this test with so little damage, even cautious analysts must be more optimistic about the future.

Stimulus has its costs. The central government's fiscal deficit expanded from 2.6 per cent of GDP in 2007-08 to a provisional figure of 5.9 per cent in 2009-09 and an estimate of 6.5 per cent for this year. If one includes the states, the deficit jumped from 4 per cent of GDP in 2007-08, to 8.5 per cent in 2008-09 and a forecast of 9.7 per cent this year. India's nominal GDP grew at an average rate of 14 per cent between 2004-05 and 2009-10. That makes deficits of 10 per cent of GDP quite sustainable. I wish that were equally true of the UK.

Nevertheless, continuation of such deficits is undesirable. Second, the public sector's savings collapsed from 5 per cent of GDP in 2007-08 to 1.4 per cent in 2008-09. This needs to be reversed.

Before the crisis the country's gross savings rate had hit 36 per cent of GDP. Given the country's attractions to long-term foreign capital, that would allow an investment rate of close to 40 per cent of GDP. Such a high rate of investment could deliver 10 per cent growth. It might deliver even more: since India's per capita output (at purchasing power parity) is roughly one-15th of that of the US, the potential for fast growth is huge.

The extent of the optimism became evident during a week spent in India last month. Among the highlights was a conference on a book of essays in honour of Montek Singh Ahluwalia, deputy chairman of the planning commission and, after Prime Minister Manmohan Singh, India's most influential economic policymaker of the last two decades (and a friend of mine for 39 years).

Upbeat tone

I was struck by the upbeat tone of the essay on "macroeconomic performance and policies, 2000-8" by Dr Shankar Acharya, a former chief economic adviser to the Indian government. Acharya is the most sober of competent analysts of the Indian economy. Indeed, the book gives a strong sense of the confidence of the technocratic elite in India's performance and prospects.

Similar confidence is palpable among the business elite. This confidence makes this a radically different India from the one I knew when I was the senior divisional economist for India, at the World Bank, in the mid-1970s. The emergence of an elite consensus on where the country is going is clear to any regular visitor. When entering the Commerce Ministry, bastion of opponents of open markets in the 1970s, I was struck by a poster describing India as the "world's largest free-market democracy".

Another feature is the belief that the pragmatism of India's policies, particularly over global finance and the balance of payments, had proved correct. This was the theme of an essay by Rakesh Mohan, former deputy governor of the Reserve Bank of India.

Fortunately, a country as big as India could sustain fast growth even if the external environment remained less friendly than before. But that would make lifting internal obstacles to growth even more urgent. The external environment also matters, in at least three respects. First, India has followed China in becoming far more open to trade. Indeed, India's ratio of trade in goods and non-factor services to GDP in 2008 was where China's was in 2003. Second, India depends on access to foreign raw materials, particularly energy. So energy price shocks would be very destabilising. Finally, India needs peace.

As a chapter in the Economic Survey on the "Micro-foundations of Growth" argues, even "India's unpardonably large bureaucratic costs are like a valuable resource buried under the ground".

I have little difficulty in imagining that India can sustain growth of close to 10 per cent a year for a long time. Under conservative assumptions, the Indian economy would be bigger than the UK's, in market prices, in a decade and bigger than Japan's in two. I argue in a chapter on "India in the World" that India is following China as a "premature superpower", by which I mean a country with low living standards, but a huge economy.

Exhausted by the burden of its pretensions, the UK should soon offer its seat on the Security Council of the United Nations to its former colony. Its condition would be that France does the same in favour of the European Union. Whether or not such enlightened statesmanship is forthcoming (presumably not), we are moving into the age of continental superpowers. Asia will be home to not one, but two of them.