If you can't come with at least a 5-yr horizon, stay away: Bharat Shah

Interview withExecutive Director, ASK Group

Having seen the stock markets for thirty-five years up close, Bharat Shah, Executive Director, ASK Group has encountered many up and down cycles, but is never distracted by them. At a reasonable price, companies with high returns on capital always reward shareholders in the long run. In an interview with Clifford Alvares, Shah shares his insights on the market and what investors can do now. 

 

Investors are worried that the stock market has become volatile and it is dissuading them from staying invested in the markets. What do you think they should do?

 

I would completely ignore the day to day volatility of the markets. It's neither important nor worth worrying about. On a short-term basis all stock markets move up or down. For the long term, opportunities continue to be available. One can compound growth for a long time even in this market. There has been a divergence in indices. But at the same time there are plenty and stocks that are available at high returns on capital employed. The market is very discriminating in terms of segregating quality and the good companies from the average ones.  So I will focus on the opportunities rather than worry about where the market is going.

 

But aren't the PE ratios of companies with high returns on capital a bit too steep. Do they justify entering even now?

 

That is perfectly alright. Why would such businesses be available at a PE of 14 or 15. I am perfectly comfortable with a PE of 25. There is a long-term potential growth of 15-20 percent available in many of these companies if you take into account the large opportunity that they have in front of them. These businesses will never be available at a cheap rate. I would put it this way, on a measure of PE some of them might look expensive, but on a long-term secular high growth trajectory in my opinion some of them are available at reasonable valuations. One pays a high PE for the longevity of business and certainty of prices. 

 

The economy is going through a challenging time as growth is slowing. In such an environment can companies continue to deliver on capital efficiency? 

 

There are macro-economic challenges due to the high fiscal deficit, which is a source of worry. It is affecting inflation and is not allowing interest rates to come down. Capital formation has slowed down and investment-to-GDP ratio has come down. Clearly in such an environment there's a challenge on capital efficiency which has declined. We are putting in more capital for the same level of output, and clearly that is worrying.  Manufacturing sector is going through challenging times and so are many other companies. But I would continue to focus on companies that have a strong competitive characters and have high levels of capital efficiency. 

 

The market seems to be increasingly discerning about quality. What about look at mid- and small-cap stocks where some of the stocks have fallen significantly? 

 

The polarisation between quality and not-so-quality has become much more sharper. But it's a misconception to say that all the stocks in the mid-cap space are not doing well. If the growth opportunities are real, balance sheets are clean, stocks do well. One has to look at returns on capital and future growth opportunities even in the mid-cap space. 

 

Apart from consumer related areas, where do you think opportunities are available for investors? 

 

In the rural side, there's a greater cash flow and rising levels of income. Consumption and demand patterns are undergoing a change and businesses which capitalise on rural opportunities, and there are good investments here. Capital goods and infrastructure related areas have seen a significant reduction in valuation because their order books have come down, and these are some pockets that investors can look at now. I would build a blend of good domestic and international companies from pure exporters in IT and pharma and keep a caliberated weightage on good quality banks and non-banking finance companies with strong franchies.  Some auto component firms are world class companies. Agri-related and farm support systems have some good companies one can look at. There are even non-banking finance firms with outstanding capital efficiency with virtually no bad assets. In this market, there's still plenty to choose from. 

 

Investors more often these days don't look beyond one or two quarters. How can one keep a long-term focus these days?

 

Two or three quarters is impossible to forecast. Even if you can do that, they are not relevant. One has to be able to understand businesses, management quality and future growth prospects and then invest in these companies for very long time. If you can't come into the market with a five- or 10-year horizon, stay away from the market.