In all countries, the market has recovered in the past 16-17 months, whether in India, South Korea or Taiwan. In your opinion, which market has the most potential at the moment?
We have always believed that in the very short term the market is impossible to predict and is little different from a draw. When people say it is very difficult, they characterize the problem badly because very difficult is something that can still be done, but impossible is something that simply cannot be done.
In the long run, markets around the world have tended to generate returns more or less in line with the growth rate of nominal GDP plus dividend yield. India’s nominal GDP growth rate is expected to be low to double digits going forward and our expectations would be similar for the market return in terms of rupees.
What makes India such an exciting market is that it offers the highest alpha generation potential compared to any major equity market in the world. While there are strong opportunities across the full spectrum of market capitalization, India has a diverse mid and small cap segment that is relatively less well researched and therefore more inefficient, thus offering more alpha generation potential. raised.
When you think of the total return of a portfolio, it is a sum of the market return and the outperformance or alpha. While the market performance is more or less the same in all markets, in the case of India the potential to generate higher alpha or outperformance is higher. Since total return is the sum of market returns and outperformance, India offers the potential for higher total return than the developed world and many emerging markets as well.
How risky is it to enter the market or stay in the market at this time?
Equity markets always carry risk, and it’s no different now. The nature and type of risks may vary from time to time. Just because the market is at an all time high doesn’t mean it’s expensive.
Valuations are very important when investing, but in our opinion all valuations should be viewed in relative context. Valuations of Indian stocks correlate with valuations of US stocks, which in turn are a function of US bond rates, among other parameters. This relationship between the equity market and the bond market is very fundamental in nature, since the interest rates used to discount long-term equity cash flows are a function of the long-term bond rates. If we compare the evolution of long-term bond yields and the PE ratio in the United States over the past decades, this provides some interesting information for understanding the increase in multiples of the stock market in the United States and around the world. compared to the last decades.
For example, US 10-year bond yields have been falling steadily since a mid-teens high in the late 1970s, after a decade of high inflation and high inflation expectations. Even in the mid-1990s, the yield on 10-year bonds was 7%, implying that the bond was trading at a multiple of around 14x.
At that time, the S & P500 in the US was trading in the mid teens. Today the bond multiple fell from 14x to 75x (current 10-year bond yield at 1.33%), while the S & P500 PE rose to 20s. I’m not suggesting that S&P should be 75x, but I’m just putting in the context that the stock markets haven’t become expensive relative to other asset classes, especially bond markets, which is the largest class of assets and also the benchmark for all other asset classes.
If for some reason the yields on long-term U.S. bonds reached 3-4% or more, the multiple of the bond would correct from 75x to 25-30x or less, and in such a context it is possible that Global stocks could also come under pressure. We are not suggesting that bond yields are likely to rise more than they are likely to fall, but we are only highlighting what the most obvious risk is for global stocks at any given time, all other things being equal.
Can you tell me a bit about your portfolio? What kinds of stocks do you hold that have existed in the short term and other information about it?
At White Oak, our investment philosophy is that disproportionate returns are achieved over time by investing in large companies at attractive valuations. To be considered excellent, a business must possess the following attributes: (a) have superior returns on additional capital, (b) be scalable, and; (c) be well managed in terms of execution and corporate governance.
Our team is very focused on stock selection. We are not making top-down thematic or sectoral calls, as these are droughts with risks without increasing returns in our opinion. That said, given our philosophy, there are some areas where the team might find more interesting opportunities compared to other areas from a bottom-up perspective. Currently, the team is finding more opportunities in private sector financial services, IT services, specialty chemicals and some consumer discretionary industries.
In private sector financial services, there is this debate about choosing between business-oriented banks and retail banks. What are you leaning on?
In our opinion, it doesn’t matter whether a bank is business-oriented or retail-oriented. In the banking sector, what matters most is whether lending activity is conducted prudently and, in doing so, whether superior returns on assets and on equity are generated on a market-adjusted basis. risk.
If you look at the big private sector banks, perceptions about retail or business have become outdated and irrelevant. Besides understanding the active side, it is very important to focus on the passive side. The strength of the liability franchise often determines which business you can run on the asset side. If you have a low liability deductible then your cost of funds would be higher and to earn a reasonable margin or spread you would have to take riskier loans whether retail or business. The finances held by our team tend to have the best deductible of liability.
Do you recognize cryptocurrencies as an asset class or do you just see them as another fad? Are you invested in it?
We have not invested in cryptocurrencies, personally or for clients. Five years ago, I would have completely dismissed it as a fad. He prospered a lot longer than I thought he would. It makes me wonder if there is anything missing and if more effort is needed to understand the asset class. But from what I know today, which is dangerously little, I still believe that the prices of these cryptocurrencies are determined by speculative activity rather than fundamental value.
What about small caps? Where do you stand on them?
Certain pockets of the market, particularly in the small cap segment, are being driven by the intensification of retail activity. At the risk of generalizing, this seems to be particularly the case when the quality of corporate governance is low. The more volatile a stock and the lower the quality of governance, the greater the interest of retail investors in some of these names.
During the recent IPO boom, we saw loss-making companies like Zomato, Devyani International land on Dalal Street and they generated huge interest from investors. Is this a sign of maturity in the market or a sign of exuberance?
Indian investors are still unfamiliar with the valuation of loss-making initial public offers. It’s very different from the United States, which has a long history of going public with loss-making companies. However, the Indian market is gradually moving to a stage where it can assess and value IPOs that may currently be loss-making.
It must be recognized that just because a business suffers a short-term loss does not mean that it is worthless. For example, now everyone seems to think it’s obvious to invest in FAANG stocks. But the majority of FAANG shares were loss-making when they were listed.
In the United States, over the past 20 years, there have been over 2,000 IPOs. According to a study, nearly 60% of these IPOs were made by loss-making companies. In addition, they recorded an average gain of 18% compared to for-profit companies which recorded a gain of just under 15%. I’m not saying all loss-making IPOs are good investments and investors should jump on them. But the fact that a company is in deficit is not a sufficient reason to ignore or reject it.
So you wouldn’t be afraid to invest in companies like Zomato and Paytm?
Our team assesses every business on its merits and would not reject an opportunity just because it is currently in deficit. The fundamental principle of valuation does not change regardless of current profitability. The value of any business is the present value of future cash flows. What really matters is the potential for long-term cash flow generation; short-term losses make less sense. Therefore, a thoughtful, bottom-up examination of the expected future cash flows of each individual business is of paramount importance rather than a top-down approach of weeding out currently loss-making businesses.
To be more precise, our team has invested in the past and remains open to valuing companies that are loss-making at the time of investment. This is true as long as these companies have the attributes of a great business mentioned above, where our analysis suggests that the current losses are temporary and the generation of long-term cash flow is more than just the current valuation.