After touching almost 8000-points, the Sensex seems to have taken a breather between 7600-7700 points. Your comments.
In recent times, there is a belief that the market is going up because there is liquidity. But if you look at the fundamentals, the situation is exactly the reverse. The money is coming because the Indian markets are attractive. Let's look at the fundamentals. There is little doubt of corporate profit growth. All the elements of strong growth are in place. There is strong economic growth which seems sustainable. The visibility of economic as well as corporate growth going forward is also longer. We should be seeing at least 15 per cent corporate profit growth a year for the next three-five years for the broader market. India stands apart as a reservoir of growth while most global economies are growing slowly.
The second part is valuation. The one-year-forward price-earnings ratio for the Sensex stocks is about 14.3 times. Remember, the earnings estimates are conservative going by the first quarter results, which have surprised everybody on the positive side. Most people expected the first quarter profit growth between 10-20 per cent, but the profit growth has been almost 30 per cent. If the much-needed boost from the agriculture sector happens, we will be positively surprised. We have started this year with a 6.5 per cent GDP growth forecast, considering that agriculture growth is not going to be much. If agriculture grows, then we will see higher economic growth, which will lead to higher corporate profit growth too. The P/E based on 2006-07 earnings is around 13 times, which is lower than the past 15-year average one-year forward P/E of around 15 times. The 15-year forward P/E range has been between 11 and 28, so we are closer to the bottom of the range than the top. Based on the stronger growth and better visibility, I would think there is a case of a P/E re-rating to 17-18 times as we go forward. So, this is the heart of the argument of attractiveness creating liquidity. A lot of people are seeing it and are coming because of that.
If you go beyond the Sensex companies, this growth is creating opportunities for lots of companies. That is why we have had a resounding rally in mid-caps. When we launched our mid-cap fund in July 2004, our argument was that India will keep growing for a long time and the economy will throw up opportunities for many companies to grow faster and become larger. This is the process of evolution. When you invest in mid-caps for the long-term, you are participating in companies that will become blockbusters of tomorrow. Six years back there were just 25-30 large-cap companies in India whereas today we have 75 large-caps, which will double five years later. Obviously, the medium-sized companies are going to migrate to being large-caps. Though there are a lot of mid-caps which have become overvalued in the frenzy of the last two years, there will be good stocks here.
Considering the 15 per cent growth for three years in the Sensex stocks, and if you add up the other opportunities and the fact that you can still beat the market through active fund management, the prospects are quite bright from an investor's standpoint. Unfortunately, people have wrong expectations from equity investments. They always want to double money in one or two years. That probably is coming to an end in a way. Even if you earn 12-15 per cent from equities, there will not be reason enough to not be invested as all the other alternative investment classes are not giving you that much returns.
If you look at the Indian market for the last 15 years, an average bull market has lasted for 12-15 months. The current bull market started two and a half years ago and, if nothing else, this creates positive sentiment for equities as a class of assets. We have seen money coming from outside India so far and not from within India. There is a lot of money sitting in India, which will move from other asset classes into equities as we go forward. Considering all these factors, we are definitely encouraging investors to look at this market as an opportunity.
You are not worried about the market falling?
No. The market could fall 10 per cent from here but this 10 per cent is 700 points. Volatility is part of the game, and you cannot plan for it. An investor should ask if he is going to make money for the next three years, even at these levels. The answer is a yes. When you reach a level where you feel that you will not make much money is when you start worrying. We are a long way from there right now.
What kind of an investor are you?
I think it is not possible to bracket investors as aggressive or conservative. If aggression means investing in stocks that nobody else is buying, then we are aggressive. If staying away from momentum investing is conservative, then we are conservative. We are disciplined investors and follow a stock-specific approach. Investors look for absolute returns. We too believe that one can generate absolute returns over a period of three-five years irrespective of the markets.
What is your team like?
We are a compact team. As CIO, I overlook the equity and fixed income operations. As Fund Manager, I am responsible for managing all equity funds except Chola Opportunities Fund which is managed by Pradeep Kumar, Fund Manager - Equities. One more team member is an equity research analyst. We know exactly what each of us is expecting from the other two. In Fixed Income, we have Ashish Nigam as our Fixed Income Fund Manager and we also have a dealer.
What is your investment process?
We have a different process for large-caps and mid-caps. In large-caps, we break up the stocks into sectors, and then rank the stocks in terms of how much gap there is between the share price and the share value. For example, we have targets of P/E ratio or price-book value, or EV/EBITDA (enterprise value to earnings before interest, tax, depreciation and amortisation), or discounted cash flow based valuation. We get the upside in a stock from these numbers. This way we have a list of stocks that will do well in descending order for every sector. We decide whether to be overweight or underweight in a stock and based on the rankings, pick one or more stocks.
In mid-caps, we have a different process. We would like to put our energies into identifying stocks that will become much larger companies because of opportunities, progress and growth. We do not like to invest in mid-caps that are doing well because the business cycle is positive. We have five filters, and only if a stock passes one of these filters will it enter the portfolio.
The third filter is to pick stocks that are leaders in their own businesses and are large-caps of their own sectors. When growth happens, these companies will consolidate their position and become large-cap companies. One example here is Blue Dart, the courier company, which is a leader by far. The fourth filter is stocks that are proxies to large-caps, in the sense that they are from the same industry and because they are mid-sized companies, there is a discount in valuation. The company's fundamentals do not merit the discount. When we buy a company like this, we invest in a proxy to a large-cap plus we get the benefit of improved valuation. We bought Shree Cements through this filter. It was a hugely profitable cement company and was available at 40-50 per cent discount to the rest of the industry. The fifth filter is picking globally competitive mid-cap companies, which are doing big things outside India. Since these companies are looking at a wider canvas than India only, there is a prospect that as they become more successful in their strategy, they can become much larger corporations. The examples here are Micro Inks and Crompton Greaves. We religiously stuck to these filters in picking all our stocks.
In any company, there are three-four critical variables that can make or mar the valuation of this company, and once you get a hang of them, more than half the work is done. We also take support from broker research, especially when we do not want to reinvent the wheel. In mid-caps we create our own earnings models for the stocks.
How do you assess the correct valuation?
Valuation is a relative term. You may be willing to pay 25 times for a company whereas I will be willing to pay 10 times. Our team discusses the sectoral worksheets regularly, where we do our comparison. Then, we double-check the valuation by reverse analysis. If a stock has a P/E ratio of X or a discounted cash flow (DCF) value of Y, what does it imply? If the DCF is the same as the market price, what does it imply in terms of growth going forward? We use these double checks to ensure that we don't fall in the wrong traps in terms of overpaying or underpaying for a company.
No, it is very different. We were the first AMC to launch this fund, so let me tell you how we thought of it. We kept getting questions from investors that both mid-caps and large-caps are good to invest, how much exposure should I have in each type? We realised that a segmentation was happening and investors wanted a large-cap exposure and a mid-cap exposure. It was no longer a case of equity exposure like earlier when they would ask what should be their asset allocation between debt and equity.
When we were doing our research in December 2004, we took all the diversified equity funds and created one consolidated portfolio and we found that 75-80 per cent of that portfolio was large-cap companies. On the other hand, mid-cap funds were almost entirely invested in mid-cap stocks. We decided to launch the multi-cap fund with the premise that 40-45 per cent of the corpus would generally be invested in large-caps and mid-caps each and 5-10 per cent in small caps. Then we said that this is the basic nature of the product and investors can create their portfolios, depending upon their expectation and risk ability. We have also seen clear periods in the market, which favour either mid-caps or large-caps. So, we can swing our portfolio by 25-30 per cent towards one capitalisation type to benefit from market trends.
Can you talk about each of your equity products?
Chola Growth is a large-cap blue chip fund. Our Midcap Fund invests 100 per cent of its corpus in mid-caps. Our Multi-cap Fund uses the swing factor that I mentioned earlier. Chola Global Advantage invests in companies that have or are expected to have at least 20 per cent of their turnover from outside India in the next three years. The premise is that our economy can grow at 7-8 per cent only if we have significant exports. Chola Opportunities Fund is a concentrated equity fund where we take bets in two-three sectors. The equity portion of our Monthly Income Plan has been ranging between 15 per cent and 20 per cent, and is invested in large-cap companies.
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