Indian small caps most attractive in emerging market space: Shankar Sharma
Mumbai: Shankar Sharma, vice chairman and joint managing director of First Global Securities Pvt. Ltd, finds Indian small-cap stocks most attractive in the emerging market equities landscape. In an interview with Mint on Friday, Sharma talks about valuations and earnings recovery. Edited excerpts:
What is likely to be the theme of the markets for the next one year?
Small caps, small caps and small caps. They are in for a very long bull run, and they are going to be the theme for the next one year. It is though a labour-intensive exercise to pick the right ones, and the bottom-up approach works the best. I don’t think there is any bubble there as yet. They have just cleared their 2008 highs in this calendar year. This doesn’t put them in the bubble territory. Once they double from here that is when we can say they are in a dangerous zone. Midcaps have become really big, so I don’t look at them with the same intensity as small caps anymore.
Where does India stand in your emerging markets investment order?
Indian market is actually two markets – the large cap and the small cap ones. If you are talking of large caps, the order is Brazil, China, Russia and then India. India small caps would be number one on this list.
What is the outlook for markets for Samvat 2074?
I am very optimistic on markets globally, including emerging markets and India. I have been so for some time now. Since February 2016, when emerging markets bottomed out, I have been very bullish on them. They have done phenomenally well. I am very bullish on commodities too, and they have done very well over the last one-and-a-half years
When do you think corporate earnings would recover for India?
Everybody is puzzled by this conundrum of very poor earnings and very strong stock market. In fact, very poor economic growth and very strong stock market.
But to me, there is no conundrum. Earnings are a subset of overall economic growth. Compared to where we should have been, we are markedly lower than where we should be in terms of economic growth. Indian stock market is not a growth story market.
It is a purely a cost of capital market. Markets go up for one of two reasons – one they can go up because of great growth; and second, they can go up despite poor, average or moderate growth as long as the cost of valuing that growth decreases, which means the interest rates. In present value terms, the discount factor used to value future growth was 8.5% and now it is 6.5%.
So you just need to look through the lens of NPV (net present value) and you will see that even poor growth starts looking great when the discount rate is lowered sharply.
You look at real estate, gold, fixed deposits, almost nothing helps you beat inflation at the current rates being offered. When FDs (fixed deposits) offered 10% interest rates some years ago, it was a different ball game. The pie chart of investments has therefore turned in favour of equities in India, as retail savers have simply no viable investment opportunities other than equity.
Does that make valuations stretched going ahead?
Valuations are also a function of interest rates. Arithmetically, valuations expand when interest rates fall. People say valuations are high, but then I ask when did you last see interest rates at these levels? Now again, why are interest rates low, because of slow growth. Also, in this growth scenario, you simply cannot raise interest rates.
When do you think earnings will recover in India?
I don’t think they will recover for quite a while. Based, on evidence that is available, we cannot say earnings will recover any time soon. The disruption due to GST (goods and services tax) will push earnings recovery down by a few quarters.
Do you think the flood in the IPO (initial public offering) market can dry up liquidity from the secondary market?
If at all there will be an impact, it will be positive. When there is a good IPO, the stocks in that sector get a boost. We have seen that in the retail space, airline space and the likes.
You bought a stake in Himachal Futuristic Communications Ltd (HFCL) recently. What attracts you to this stock?
I like companies that people don’t like. People go back to the old, obsolete era of 2000s, when company did some missteps, and paid for it.
Everybody commits mistakes, but we can’t always hold it against them. Why worry about something that happened 17 years back, specially when the company has aggressively made amends, cleaned up its act, repaid large amounts of debt, successfully exited the CDR (corporate debt restructuring) program, has paid a massive amount in recompense to banks, turned the business around. In short, the company has moved on.
We should analyse how proactively a management has dealt with the problems. That’s the key. HFCL gets 10/10 on this front.
It has witnessed strong revenue and profit growth and free cash generation has been strong. And yet, the stock had remained flat for about a decade. I like such situations. Its business outlook looks strong between telecom capex and defence related businesses. It has been instrumental in the aggressive network rollout of Jio.
Which sectors do you like in the small caps space?
I like steel, chemical and infrastructure companies in this space since the last three years. We are not concerned about a company’s past much. We tend to look ahead as to what is in store. You have to have an open mind. A closed mind is the biggest enemy of investment success.
You really need to understand the management, as to how are they resolving problems. Excessive focus on the past blinds you to massive changes in the future. Investing is about bets on the future, not bets on the past.
In the large cap space, which sectors do you like the most? Which sectors do you dislike the most currently?
We like steel. It looks very good as a sector. Insurance is also a good bet, as it is not a leveraged business. I don’t like IT and pharma. Even after being battered, time is still not right to pick them up.