‘We are Clearly a Cou­ple of Years Away from Peak Eq­uity Val­u­a­tions’

The Economic Times - - Companies: Pursuit Of Profit -

S Naren, ex­ec­u­tive di­rec­tor at ICICI Pru­den­tial AMC, be­lieves that as­set al­lo­ca­tion is very im­por­tant as shares race to record highs al­most ev­ery day. The lights are not flash­ing red yet, he says us­ing a traf­fic light anal­ogy. But they are not green either. They are yel­low, which means in­vestors need to look on all sides and in­vest care­fully. In a wide-rang­ing in­ter­view with Prashant Ma­hesh, Naren says peak eq­uity val­u­a­tions will come in the next few years and wor­ries that a rapid rise in earn­ings growth could make val­u­a­tions lose touch with re­al­ity. Edited ex­cerpts:

The mar­ket has been mov­ing up al­most one way from Feb 2016, with the Nifty mov­ing from 7,000 to 10,000. Is the rally over­done? Ac­tu­ally, we try to look at the mar­ket on four pa­ram­e­ters, namely val­u­a­tion, cy­cle, sen­ti­ment and trig­gers. To­day, on val­u­a­tion ba­sis, we are in a sit­u­a­tion where on a price-to-earn­ings (P/E) ba­sis we are costly; on price-to-book (P/B) we are above av­er­age; on mar­ket cap to GDP, we are just above av­er­age and if you look at in­ter­est rates and take the in­verse of in­ter­est rates and earn­ings yields it is slightly above the av­er­age. So on a val­u­a­tion ba­sis mar­kets are not cheap but not ex­tremely ex­pen­sive in our frame­work.

On the sec­ond pa­ram­e­ter, namely cy­cles, we are clearly two years away from the mar­ket top. From a cycli­cal per­spec­tive, the mar­ket is at a top when ca­pac­ity util­i­sa­tion is high, in­ter­est rate cy­cle has turned and there are only chances of rate hikes. On that ba­sis it looks like it will take two years for the capex cy­cle to come and for ca­pac­ity util­i­sa­tion to be higher than where we are.

On the third pa­ram­e­ter, namely sen­ti­ment, you have to be care­ful. For­eign­ers are in­vest­ing and do­mes­tic in­vestors are in­vest­ing with gusto. So sen­ti­ment is the most wor­ry­ing part. In De­cem­ber and Jan­uary, FII flows were neg­a­tive, but now lo­cals and FIIs both are in­vest­ing and lo­cals are in­vest­ing with gusto.

Fi­nally, on the last pa­ram­e­ter, namely trig­ger, I be­lieve till earn­ings come we are safe. The mo­ment earn­ings come, that is the time when you have to be most wor­ried. Earn­ings growth is the big­gest risk to the mar­ket. Bub­bles get formed when you have ex­cel­lent fun­da­men­tals with ir­ra­tional ex­trap­o­la­tion. So what wor­ries me most is earn­ings com­ing quickly. The day it comes, in­vestors will give high mul­ti­ples on high earn­ings and make their big­gest mis­takes.

Where are you al­lo­cat­ing money now? Oil PSUs, power PSUs look very cheap at this point. These are the only few sec­tors trad­ing at 15x trail­ing price-to-earn­ings and with a price-to-book be­low 1.5. Six months back we were bullish on tele­com, but they got re-rated. Some of the cor­po­rate banks are in the process of re-rat­ing. We have had four years of money com­ing in, so there is no cheap bar­gain. We are not in a phase of risk aver­sion.

You are in the fourth year of con­tin­u­ous money in­flow, so pock­ets of deep value do not ex­ist. Three sec­tors have not moved up namely IT, pharma and PSU banks. Each of these ar­eas has its own fun­da­men­tal is­sues in the short term. In case of IT, it is growth; in pharma, it is the US FDA is­sues; and in PSU banks, it is the NPL prob­lems. The one which we like most is pharma, be­cause pharma as per­cent­age of GDP goes up as a coun­try pros­pers, and we also feel the FDA is­sues will be re­solved over the next two years. How­ever, pharma was very cheap in 2007, but not very cheap now com­pared to that time.

SBI cut sav­ings rates on Mon­day. Many of the smaller PSU banks have been hit by NPAs. Can the smaller PSU banks sur­vive? In­dian banks are an un­con­sol­i­dated in­dus­try with a fair amount of com­pe­ti­tion from NBFCs. Chal­lenge ex­ists for all the smaller PSU banks. Since they are sovereign, it is eas­ier to col­lect money. Its only on lend­ing they have to do a good job. They have to cre­ate a good busi­ness model and able to be­come more lo­cal and fo­cus on SMEs as an area and han­dle them well, it could be a good area. The mo­ment the gov­ern­ment sup­ports them and gets them out of this prob­lem of NPLs, there is scope for banks.

Re­tail in­vestors are pour­ing money into eq­ui­ties. ₹ 4,850 crore is flow­ing into eq­ui­ties through SIPs ev­ery month. What has changed? Can the flow in­ten­sify fur­ther? Cor­po­rate profit as a per­cent­age of GDP has come down from 7.1% to 2.9%. We be­lieve this 2.9% will go to 4%, which means a 30% growth. There will be a cycli­cal re­bound in earn­ings. You have high ROE, high PE stocks now in Nifty. To­day eq­uity is in a TINA (there is no al­ter­na­tive) fac­tor. In In­dia, in­vestors have a feel­ing that any­thing that gives less than 8% is low. Hence you have reached a TINA sit­u­a­tion, driv­ing money into eq­ui­ties.

SIPs can go even higher, but it is im­por­tant for us to com­mu­ni­cate to in­vestors, that past re­turns were high and this may not be repli­cated in the fu­ture.

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