Everybody is saying valuations are expensive, and the markets are due for a correction but look at the ability of the market to shrug off bad news, what it did on election day, the Budget day, and what it has done post that black Monday 10 days ago.
Samir Arora: Correct. One of course is flows, but it would look out of place if we were doing it independent of the world. So, basically, the mothership which is the US is also doing the same, not related to the budget or elections, but in general reacting to any bad phases and so it has recovered so well, Japan has recovered. But the FII flows have been quite negative and I think that is because these tax hikes have become untenable. Just to give you one number, the MSCI India Index in dollar terms is up over 17 percent year to date, whereas a $10 billion index is up 13%. So, over time, this is going to hurt and there will be some loss of FII investments in India.On one hand is this concern about F&O participation, and valuations, and on the other hand, flows that are predictable, which are easy to understand and stable. Which side do you think has a greater argument right now?
Samir Arora: There is a little twist there as well. Now we are in the mutual fund industry, we keep being shown very high SIP flows. Compared to that, our flows felt very meagre but then we realised that actual flows are only half of that. I do not know why collectively as an industry and as a country we are deliberately putting out half the information and the other half is in the footnote, that the actual net flows are not Rs 20,000 crore or more per month, they are only Rs 10,000 crore. For some reason, we are only talking about gross flows. All this talk about that we don’t need FII flows, our domestic flows are enough, is not right. The SIP numbers are good, but they are not what you think are.
Then why is this market holding on? If net flows are not that high?
Samir Arora: They are still good and they are quite regular, so that way it is steady and good. And as I said, if we say we are not bothered, then one day it may bother too much as we have seen in the past. I am always in the camp where I have stopped being outright bullish on anything. I suffered a lot for that in 2008 thinking that we are God’s gift to the stock market or to mankind or whatever. It doesn’t happen that way. But when it is doing well, we are all participating. But some control and restraint are necessary.
Secondly, we cannot let go of pockets of flow by just believing that we are getting Rs 20,000 crore a month, so how can anybody stop? When things go bad, they will become very bad if we ignore one big pool of money and more than that, ignore valuations and ignore bad news beyond a point. So one has to balance it. We have done it. I am sure fund managers are doing it. We can see some correction in midcaps and smallcaps. Yesterday I saw a Motilal Oswal report that the midcap earnings are up some 5% in this first quarter and for smallcaps, they are down or vice versa. So if there is no balance now, it will happen later with a vengeance. You cannot escape all those things over time. It does not mean today we are feeling good or bad, but I still feel bad that we are not appreciating what these tax rates are doing to global flows into India or will do.
By the way, now we ourselves are both a mutual fund and FII. So beyond a point, it is not me telling my book and all that because our mutual fund flows are doing whatever they can do considering our size, but I am just saying as an India observer for 30 years that please call five serious fund managers, do not call custodians and do not call these trustees who do not care. Call fund management companies and ask them what these taxes mean.
Let us also understand that rule book that you guys go by; you are identifying what not to buy in a market first up before you take the plunge and decide what to buy, so what makes that list, if you could walk us through it?
Samir Arora: We figured out over time that if you look at a one- to three-year period, the number of stocks that do better than the index is approximately half, and the stocks that do worse than the index are approximately half. It is very different from what people have a feeling that only 10-20% of stocks create wealth and outperform the market. That is what happens over 10 and 20 years when you may find that only two banks did very well, which is Kotak and HDFC Bank and 10 did badly or five tech companies did well and 100 started.
But just because of an arithmetic angle, which is that the index is an average return of 500 stocks, half do better and half do worse. So, the first thing is to reduce the probability of doing badly or in some sense to improve the probability of getting winners, we have figured out that it is easier to know what is bad than to know what is good. To know something is bad, you need even only one factor enough. For example, if I say that a stock is very expensive, that is normally enough to say we are not buying it. But if you say a stock is not expensive, then somebody might say, so what is the value of that? How is the management or how? If I say that the management according to me has a very bad history of corporate governance, normally you need not ask me what is the business, because if you agree with me that what I am saying is right and that is enough. So, we found that it is easier to reject because rejection can be done with one or two factors, whereas to say positively that it is good stock, you will say, but what about management? Then, I will say management is okay. What about history? Then you say, what about strategy? But if I say one of those things is bad, then that is enough to reject.
So that is why we started with the rejection some 10-15 years ago. These eight factors are there, which are history, industry, theme, valuations, corporate governance, next two-three-year financials, etc. And on that basis, we are first rejecting if it does not fit even one of these factors and that is why we have sold many of these companies which on every angle are good, except that they get rejected on very high valuations and what they are because I have been talking about them for two-three years and broadly we have been right on those stocks.
So that is the way. For the rest, you can see my presentation pinned on my Twitter account or go to our YouTube channel.
A small part of broader markets is correcting, the index is just 5% lower. But in small and midcaps, silent stealth correction is already happening and these are the stocks mostly owned in India by big HNIs or even retail. The narrative is we are staring at tough next 12 months because there are no big triggers out there, earnings are not really wow and we could be heading to a correction. So, what is the right strategy to book out?
Samir Arora: Even now we try to buy midcaps and smallcaps; it is not a complete stop. Not guaranteed but we want very high confidence, 20% earnings growth, revenue growth, for which we are willing to pay a bit more. But in general, it is difficult, difficult to find companies growing 20% on aggregate.
Therefore, if the earnings do not grow 20%, your stock prices cannot grow 20%, like they have done in the past because in the past it has been a combination of earnings growth plus some re-rating, re-valuing because of flows or interest. Now you want that to continue. Now, you will say, HDFC Bank, which is your top holding, does not grow 20%. I agree.
So, we have these two kinds of stocks where we feel that the confidence is high and we will make reasonable money. Then I am talking about these new ideas if you want to buy them; otherwise, we will buy just more of the same and that is the only way to do it because the overall aggregate market is not going to grow 20% anymore and neither will the stock prices grow 20% anymore now you have to grow with the earnings, because the rating part is more or less over.
Will that hold true of PSUs also? PSU stocks at best will grow at 15-20%. I am talking about earnings here because these are single-digit or early double-digit margin businesses. If the economy is growing at 12-13% nominal GDP, then these businesses will grow at 15% to 18%.
Samir Arora: True. I have said in the past, on Budget day or whatever, on these railway stocks. At that time, we used to believe that Vande Bharat will come and these guys will sell food and stuff and after a few days we realised that now the Vande Bharat orders were being cancelled because the government has rightly or at least based on feedback from this thing thought that they should rather invest money on tracks and security and safety and maybe on non-air conditioned coaches and trains and things like that.
So, all these things changed. When the expectations are very high, disappointment also is very high if it does not happen. So, now PSU as a general theme – that part is over. Now, if you like a company, you buy it at whatever 10-15-20% growth rate, but this idea that thematically PSUs will outperform normal private companies because of whatever is happening, that part is over. That does not mean they are bad.
By the way, I have one difference with the world also, that many people say the market is fairly valued or a stock is fairly valued. I do not mind fairly valued things. I do not think all your life you can get undervalued things. If you get fairly valued things, that means you are only going to make returns out of the earnings growth. So, earnings growth, if it is good, say 15-ish percent in this environment, then that is not bad.
We are trying for 20% growth, for new ideas, but it is very difficult. However, fairly valued is also okay.