We have just seen the fund raising trailer in the second half of 2017 and in 2018 at least in the first half till the market completely cools down, it will continue and the maket will rise, says Raamdeo Agrawal , MD & CO-Founder, MOFSL in an interview with ET Now. Agrawal says big movers are all led by earnings and have done well even when the economy has faltered.
2017 has not been a bad year…
Go back to all the gurus and hear what they had said at the beginning of 2017 and everybody must have been wrong! Last year, at this point of time, we are reeling from the demonetisation effect, there was a sense of slight pessimism. Even I was a little pessimistic. In fact, we did not buy for 15 days of the flow and then we started buying. So, I must have been very sceptical at the beginning of the year last year. Whenever you are sceptical, you have a wonderful year and now everybody is thinking that it is going to be a wonderful 2018 and what is out there, nobody knows.
Is it time to get sceptical?
I would be. The valuations have gone so stretched. You get high valuation in one segment of the market like in 2000 where all the technology stocks were going berserk and then in 2007, all the realty stocks were going berserk. This time, it is very widespread anything doing small, mid, large, is quite fancy priced hoping that a big blast in the earnings are coming. But optimism is quite widespread. A structural shift in the buying for equities is happening. This is very different time and that is the fun of the stock market — every day is a new day.
But for someone who has studied markets and who understand cycles, you know it better than most that in market nothing changes. History keeps on repeating itself. We may use different nomenclatures, different scenarios, we may talk about different sectors but ultimately it is a boom and a bust cycle that markets have to follow?
Again an unprecedented boom is going on, on the back of probably local flows. How long will it continue because I am coming from my native place Raipur and there again the mood is the same. The only asset class where people are putting in money is equity. Even a city like Raipur does not believe so much in buying equities. The culture is not that deep but it is going to be very widespread and I see the momentum continuing.
In December also, the flow was very good. On the back of that, my sense is ultimately valuation will be driven by the fundamentals of the company itself. If the company is not making money, you can push it by 20-30% but very quickly it will come back to the old levels. We have to be at least having the companies which are going to be earning more, which are growing or which are grossly under priced. Now, the definition of under priced is very different than what it was a year back. Earlier, if companies were growing at 25% ROE, I would not have borrowed it for more than say 22 or 23 PE multiple, keeping 10-15% PE multiple from my end. Now if I get 25% ROA, 25% growth even at 27-28% I would think that I am getting a very reasonable deal and betting on the longevity.
Now, the whole game has become the game of betting on the longevity. What is going to happen is that the returns will depend on how brilliant you are as a fund manager or even how lucky you. The return in the next two to three years will be very muted and I would not be surprised if it is flattish but as you go beyond two or three years, markets cannot value what is going to happen because the capex cycle is yet to happen. Hopefully, it should start next year. And how severe, how intense the capex cycle will be, will determine the earnings growth. These things are all in the future. One has to be very cautious in what one is buying. They should not buy junk. Now what is happening is only junk is left to be looking reasonably priced and when that happens, people sell their good stocks and buy the junk and finally it topples and you are left holding the junk. That should not happen.
It is that time of the year where our mailboxes are full of forecasts 2018 how will things move, which could be the best sector, which could be the best theme. If I take the clock back in the beginning of 2017, no one told us that bitcoin would be a 10x, real estate index would give you 100% return and Reliance would give you a return of 60% plus. Would trying to forecast 2018 be very difficult?
Please take it for granted that nobody can forecast and yet we spend so much of time on that. It is a complete meaningless exercise and yet we are buying the future. The beauty is what price you are paying is not for the past or present, you are paying this price for the future. When you look at the big markets and it becomes very difficult but when it comes to company level, some sanity prevails when you try to understand the business, try to understand the management. Then, the recent trends in terms of how the profitability has shaped up, what kind of entry barriers they have in their businesses, what kind of growth you expect. It is all probability, Future is not about 100%. Nobody can say 100% yehi hoga. The issue is that when you see anything happening with the a probability, that is where you bet and in investing nothing can be done without the price at right place . When you see a high probability event of certain companies and the stock available at reasonable price, which the markets has probably ignored, that is where you have to strike.
In the last two and a half years, we have had two comforts — political comfort and macro comfort. Hopefully, political comfort is here to stay for next couple of years but the macro comfort is missing, inflation is going higher.
While saying that political comfort has been for a couple of years, we have been stable for 60 years. I am not a political pundit. We have to look from a stock market point of view. In 60 years, we have seen all sorts of things, we have seen assassination of Prime Minister, we have seen change of the government from a fully dominated one party ruling to crazy coalitions. In fact, in last 30 years, in bulk of the time, we have had the craziest possible political set up and yet markets are up 340 times. So politics in India does not matter really. So keep that particular variable out of it being a provider of huge volatility.
That is an opportunity.
Yes, that is an opportunity but on the whole I have seen it does not really matter because of this or because of that, a stock is doing well or not. The global macro, local macro factors you must keep into account when you look at the company.
When I ask anyone on my show what could be the biggest risk for 2018, the immediate answer is global. So let us not go about talk about global uncertainty because we do not know about that, the day they occur we talk about it. But local, what to your mind could surprise us and also disappoint us?
One is the oil price. That seems to be going out of hand. More you want it to go down, more it is going up. The current account deficit and hence again the same problem, pressure on rupee, pressure on current account deficit all that kind of equation. The equations of 2008 onwards that brought Raghuram Rajan here and he stabilised things. Fortunately, the oil price was also very stable. So, times could be challenging on the oil front that is one. It looks to be one immediate factor and how we tackle it is imprtant.
But remember, when oil prices go up, the Middle Eastern economy, the oil producing countries which were suffering so far, they get confidence and some of them are our large export destinations. The global economy overall does very well. Right now, the global economy is booming. This will further fuel the global economy and that will allow a lot of exports and our capacity utilisation can go up. It can bring another kind of impetus also.
So higher oil prices are going to hurt us because we are net importers but it will also bring prosperity in trading and global exports. Otherwise, the rest of the things are manageable and it is all company specific.
Ultimately markets they will map earnings and earnings will reflect economy and the way to understand economy is that you look at all the high frequency data points — what is happening to car sales, truck sales, air traffic, variety of data points. What is your understanding of the high frequency indicators, what are they pointing and where is the economy headed?
See there are two parts. One is consumption part of it and second is the investment part of the economy. Every business cycle brings that capex cycle when you make a nuclear plant or a steel plant. A three million tonne steel plant costs about say $3 billion. Now that 15-20 thousand crores expenditure for you is capex, but for rest of the economy it is the revenue and that is where the change in the revenue trajectory happens. If something is growing at 10%, say cement is growing at 5% and suddenly 20-30 roads or something comes up which is a capex in the economy and then cement demand goes up by 12-15%, earnings explode. This is because there is fixed cost and hence a lot of operating leverage, financial leverage and then the companies start doing well. That phase has not happened in the last three-four years and that is a very large opportunity.
Now to the extent we have seen there is no business cycle which ends without having a blast in the capex and that capex cycle should be starting next year. Always it is convenient to say second half of next year but I think next year should be a better year for the capex and 2019-20, it would go full blast. I hope it starts in the first half of 2018 itself and that can change the trajectory of the earnings.
Markets have already moved up in anticipation of strong earnings and somewhere it has been frustrating that earnings have not come also. When real earnings will come in, would investors say look we knew this was coming, we already had bought stocks in anticipation of the earning and the upside could get limited, You could have a situation where earnings actually start picking up but stock prices may not fall and may stagnate?
It depends on the stocks. How much has the market been discounted and how much are they surprised? There will be stocks where market has over anticipated, over expected and built in the price. There it will be muted or it may even correct and in some places, the market was completely ignorant because earnings estimate is a very crazy thing. Apart from the top line growth, say cement grows by 10%. But it is not necessary that every company grow by 10%. If a company has put upon a five million tonne, another five million tonne, it will grow at 100%, maybe even 300% because the operating leverage and financial leverage both will come to play. But if the demand does not come by 10% or 12%, then this guy is in deep trouble because he has put up the capacity and there is no demand. Whenever this kind of upsurge in capex comes and it is a prolonged capex, there will be lot of surprises and more on the positive side and that is why my sense is that the earnings blast which is yet to come for five-six years. Whenever it comes, it will not come at 15-20%, will come at more like at aggregate level 30-40%, 50%…
And that is what could surprise markets and lead to a PE multiple and a stock expansion phase?
Yes. Life goes on but we are already at one time GDP, at Rs 151-lakh-crore market cap. We are a little close to our GDP levels. Currently our GDP will be about Rs 160 lakh crore or so. The market is at Rs 151 lakh crore and it is so good thing that markets are not overstretched on the aggregate valuation. Our GDP is growing at about 10-11% so that much scope is there but if there is a fundamentally very rapid expansion in capex and it is very prolonged because this time the inflation control thanks to Mr Rajan and MPC and all is so tight that we may have slow recovery but it can be very prolonged recovery.
The script of how markets have moved in 2016 and 2017, was largely dominated by government policies and liquidities. Sometimes it was demonetisation, sometimes it was GST rollout. But can I say that for 2018 and beyond the script of how markets would move could be a function of earnings?
Yes I mean it is actually overdue, earnings should have dominated much earlier. See the stocks which have done well have been dominant earnings companies. There will always be exceptions but big movers are all led by the earnings because while we are saying that aggregate earnings have not grown, it does not mean that there is not 100, 250 companies which have not grown, in fact there are companies which have grown like a big time, 100%, 200% and all. There are companies which have done well say like entire capital market segment, all the three-four companies we have, all of that, in a situation when the economy has actually not done well. So there are segments of the markets which have done very well but as the capex starts, what will happen is there will be large segments of the market which will simultaneously do well and so a lot many more people will make money.
Very early, I learnt a piece of wisdom from you that when there is a bear market, buybacks always mark the market bottom and fundraisings always coincide with the market top if I look at the data of 2017, it has been a crazy round of fundraising, QIPs, government divestment, IPOs, a new sector called insurance got created and it has a market cap of two lakh crore. Is this a telltale sign that if not now, but a market top is coming soon?
The good thing is that it is a self-check mechanism and it also shows that our capital markets are very healthy. The moment you try to push the valuation to say 24-25 all sorts of sellers come, whether it is foreigners, governments, promoters. Everybody is willing to sell so the supply is there and that is why you see the IPOs, QIPs and sizes of secondary raisings. India does not need many more new companies. It is always healthy to have new companies but right now, the existing number of players are very large, they must bring the scale, they must go global, they must consolidate. A QIP is very quick and it goes to the institutional investors so even SEBI is pretty open about that.
My sense is 2018 will be the year of– we have just seen the trailer in the second half of 2017 and in 2018 at least in the first half till the market completely cools down — there will be a massive amount of raising and the market will climb the wall of supplies. As the supply keeps coming, as you raise it from say 10400 to 10600, 11000, the supply line will become even bigger. So koi bolta hai ki some wise man says ki jab bazaar badhta hai to shares asmaan se aata hai. So it will come, it will come from all over.
You have always tried to identify sectors or themes where there is value migration or businesses which are at an earnings inflection point. Where do you think there is a serious scope for value migration and which are the companies, sectors or themes which are on a cusp of a earnings recovery?
As far as the biggest value migration is concerned, the migration from public sector banks to private sector is still on and a lot is yet to happen. We think that so much has happened in the last 10 years but if there is no effective revival of PSU banks very quickly, then probably the migration could be faster because the preparation from the private sector side is massive. Look at the amount of money being raised at the drop of a hat by each and every bank. The entire HDFC group is proposing a few billion dollars of raising and that gives them enough capital to underwrite risk and they will be able to underwrite a very large amount of loans. They will give a tough competition to the other side because they are very efficiently operated and now they will have the scale also.
I am trying to understand what do you think is at an inflection point in terms of themes, sectors?
While doing this year's wealth creation study, we understood the longevity. What happens is that you buy something at one buck it goes to three, you think enough is enough and after that it goes up by 100 times, 200 times. A lot of these private sector NBFCs, housing finance companies, banks they have done very well but many more years of goodness probably could be in store. One has to be very careful in just booking the profit and getting out and finding new ideas.
Your old ideas which are doing well could be the ones you should stay with. That is one aspect of it. But second theme is the newer sectors. People love to have new names, new sectors so the cyclicals could be the ones. Third, IT and pharma, particularly pharma which is actually globally non seasonal, is a very secular kind of a business. It has suffered in the last one or two years because of regulatory issues, permissions and a lot of competition but my sense is that India might be actually becoming stronger in pharma than ever before. These sectors are worth watching, when what to buy that is anybody's call but they are very large and very profitable well run sectors and companies are very good, new companies are also coming up there so they look to be very opportune sides.
What to your mind has been the most enjoyable moment for you personally in 2017 –the fact that you officially became a billionaire or the fact that you have completed 10 years of your fund with very strong market beating returns?
The most enjoyable one is always when I managed a breakthrough in wealth creation studies because you get actual new gyan and that is what we will use every day. It makes me feel very nice from inside that now I have another tool which I can use to not only protect the current performance but also further improve upon it so that my clients can have fun. That is always the moment whenever we have a breakthrough in the wealth creation study. This year we talked about longevity, the gap growth advantage period. It is a completely new concept that we have given.
You know one of my favourite wealth creation studies was three years ago when the title of the wealth creation study said, in stock markets you should have conviction to see, wisdom to buy and patience to wait. That is one of my favourite quotes which I often borrow on air as well and I always give credit to your wealth creation study. But QGLP now it has become a symbol of how a fund manager should really evolve the entire thought process. How much of QGLP thought process is influenced by Guru Buffett and how much of that is original?
I would say foundation is 100% Buffettian and I think the 2007 annual report of his page 6 and 7 was the foundation of this but actually in our sustained wealth creation studies in 2013 or 2014, we broke through and said the quality is important but quality will not allow you to go down but we are not there not to go down, we are there to move forward. So quality will allow you not to go down or it will protect you from going down but growth is what is going to take you forward. And the rate of growth will decide at what pace you will go forward. Buffett gave me the Q. The G is our addition.
Now this is an ongoing process, the growth being further longevity and growth types.
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