The correction has removed quite a bit of froth from mid and small cap space and this is the right time to enter these stocks, says Gaurav Mehta, Fund Manager, Ambit Asset Management, talking to ET Now.
Looks like you are betting big on the small cap space. Given the recent correction that we have seen in both small and midcaps, the valuations are a bit fair and looking attractive at this point of time?
Yes clearly. After the euphoria of calendar year 2017, when all these midcap and small cap stocks were flying high, you have seen a contrast in their performances in last four-five months. As a result, even at the index level, midcap and small cap indices are between 15% and 20% lower than their peaks.
More importantly, several good quality small caps have also corrected much more than that. Going forward, one thing is very clear that there are tangible signs of an economic pickup and that in turn should reflect on the earnings recovery for corporate India.
In a period of recovering earnings and recovery economy, small cap and midcap stocks just by the virtue of high operating leverage and high financial leverage in some cases, should disproportionately benefit with respect to their earnings as well. Net-net, this correction has been a welcome correction. It has removed quite a bit of froth from mid and small cap space. There are several good quality midcap and small cap stocks that run as efficiently as larger blue chip counterparts which have corrected. From a longer term point of view, this is a good entry point into some of these small and midcap stocks.
We are heading into uncertain times. Volatility is going to be the name of the game. Global triggers are at play as well. How are you guys reading the broader markets? Have the overvaluation concerns been taken care of? Is this the right time to rejig portfolio?
I agree that volatility has been high and I expect it to continue to be a part of this game for the next few quarters as well. One reason for the rise in volatility is that global interest rates have been on the rise. And as cost of money becomes more expensive, you will continue to see these bouts of volatility come every now and then because earlier in 2016-2017, because money was so flush and abundant, any small correction was being quickly bought into.
More importantly during those market phases, people were becoming very agnostic with respect to the underlying quality of what they were buying.
So, two things will happen going forward. A) as cost of money becomes dearer, you will see an increase in volatility; and B) as a consequence of this, people will become more discerning with respect to what they buy and quality investing should strongly come back into favour.
Over the last three-four months, during the correction in mid and small cap stocks, it is not just that bad quality stocks have corrected. But several good quality stocks have also corrected. You will need to be bottom-up in this market and you will need to look for small caps and midcaps where A) you are not taking any excessive balance sheet risk and B) more importantly you are staying clear from companies where there is a bit of accounting or governance issues.
If you take care of those two issues, then there is good amount of money to be made by investing in mid and small cap stocks going forward. Corporate earnings and economy both are looking up and as that sort of fructifies going forward, you will see small cap earnings also disproportionately benefit.
Another sector which is looking up a fair bit is the auto space. What is your outlook on the CV space and which are the CV stocks that you are most bullish on?
Our view is that you have just about seen the beginning of the pickup in commercial vehicles space. That is a space that historically has been very sensitive to economic cycles. Last three-four years were a down cycle both from a broader economy point of view and also from a commercial vehicle cycle point of view.
Over the last couple of quarters, you have just about seen a beginning of a recovery. My view would be that commercial vehicle cycle should continue to see a cyclical uplift over the next couple of years at least. More importantly, as the economy and especially logistics becomes streamlined thanks to the advent of GST bill, now its strict implementation because of e-way bill, will increase focus on increased demand for commercial vehicles.
As a consequence, even on a structural basis there are positive tailwinds for the commercial vehicle space. Now with respect to what stocks to play, there are only half a dozen good quality listed plays with respect to the commercial vehicle cycle. Within that also, between OEMs and financiers, we are more tilted towards playing the cycle through financiers for the simple reason that while OEMs will have their tussle with market share gains, etc, commercials are broad bases with respect to their funding of commercial vehicle demand.
As a result, irrespective of who wins the market share tussle, to the extent that the industry is recovering, commercial vehicle financiers should continue to do well. Commercial vehicle financiers should be the preferred way to play the commercial vehicle uptick.