Index is in the different orbit, but stocks are in the different orbit. This dispersion is quite confusing for most investors. Everyone has a question, is it a good time to invest in Equity or one should wait?
The answer is simple. If investor is focused on Earnings, it’s always a good time to start, one must never hurry, and gradually build an investment portfolio, but focus must be on Earnings and not the Price. So, is the case today as well. Markets over last 18 months have been broadly correcting. This is because, Earnings in most sectors have been weak, and prices have been correcting and adjusting accordingly, especially in the auto sector. All in All, consumption demand in the economy is weak all across, and this is more visible in Auto Sector. Current pessimism is a phase of an economic cycle. There is a concept of ‘Wealth Effect’ in economics, and that is what seems to be playing at the moment. Wealth effect is a behavioral economic theory suggesting that people spend more as they perceive that value of their assets are rising and spend less as they perceive the value of their assets are falling. The idea is that consumption spending increases when consumers are made to feel more financially secure and confident about their wealth and this happens when their assets like homes or investment portfolios increase in value. This theory also applies to business spending. Companies tend to increase their hiring levels and capital expenditures in response to rising asset values. So, at the moment, “Wealth Effect” is what is playing Negative. What is needed is couple of real announcements from the government followed by focused stimulus measures. What gives the confidence and a ray of hope at the moment, is that, we have a stable government in place, which has an intention to act. So, it’s a matter of time. Sooner or later, stability measures have to be announced.
Waiting for certainty to emerge could means entering at a higher PE multiple especially when it comes to investing in companies which have stable earnings. So, instead of waiting for certainty to emerge, it’s better to start and gradually build an equity portfolio.
“Investors always pay too much attention to the Index or Stock levels. The focus should instead be on Earnings. Price is nothing but a multiple of Earnings. This is good time for investors to catch and create a portfolio of companies whose earnings are in control and not whose stock prices are low. Investors unfortunately always pay attention to the ‘price’ and miss ‘earnings”
IIFL Multi Cap PMS follows an interesting and insightful mechanism to dissect markets on exactly this mathematics i.e. corporate earnings. This is called SCDV framework, where by the whole of the listed market is divided on the basis of earnings profile of the companies, in following four quadrants.
1. Seculars – PAT and ROE more than 15%
2. Cyclicals – PAT more than 15%, ROE less than 15%
3. Defensives – PAT less than 15%, ROE more than 15%
4. Value Traps – Both PAT and ROE less than 15%
For investors chasing low risk – low return, seculars is the most ideal basket. It comprises of names like HDFC, Kotak, Bajaj, Asian Paints etc. But, if the idea is to strive for more, one needs to discover “those Outliers” in cyclicals, defensives and value traps which show a tendency of moving to seculars. This is where big alpha is made.
IIFL Multi Cap PMS follows a Core and Tactical Allocation where by 40% portfolio sits in Secular basket which becomes “Core” of the portfolio and remaining 50-60% is Tactical allocation between Cyclicals, Defensives and some amount to Value Traps. Core portfolio provides stability and tactical portfolio is where alpha is sought. The belief largely is that companies that are not in secular basket today will not always remain like that. There will be some outliers that over time will make a move to the secular basket in line with the improvement their earnings profile. SCDV seeks to look out for these outliers in Cyclicals, Defensives and Value Traps. This is because when a company’s earnings profile improves, stock analysts rewards it with PE expansion and company thus commands a higher PE multiple. Likewise, there are case of PE contraction in line with fall in earnings profile. So, one cannot just invest in seculars of today and forget. One needs to follow a Core and a Tactical approach with a focus on reducing allocation to companies timely before the PE contraction and regularly discovering companies which could be up for PE expansion in the future.
A few examples of discovery of some of these outliers lately by IIFL Multi Cap PMS
1. ICICI Bank, AXIS Banks were added to the portfolio when there was a pessimism around these banks because of NPAs and corporate governance. However, in line with NPA provisions decreasing, and new management coming, there was a hope for PE expansion. The thought process in identifying ICICI & AXIS as outliers in cyclicals was based on the belief that decrease in NPA provisioning would lead to operating profits getting translated to earnings and change in management would address the corporate governance related perception, which would lead to PE expansion and higher PE multiple. The call worked well. What really triggered the change was “Increase in EBIDTA Margin. So, as earnings profile improved, market identified it with PE expansion.
2. Merck Limited turned out to be an outlier in pharma, as it was quoting 20-21 PE i.e. 40% – 50% discount to MNC peers which trade at 30 – 40 PE. It was found, company had done Capex in last couple of years, which had suppressed the EBDITA margins, which was at 14-15%. Parent of Merck was selling India OTC business to P&G, which in India has 4 times bigger sales force as compared to Merck Limited. There was a possibility of Increased Capacity of Merck Ltd getting benefited by Bigger Distribution capacity of P & G. So, it was likely that ROE would expand, and hence, company would command higher PE multiples. The call worked well. What really triggered the change was “Increase in EBIDTA Margin from 14%-15% to 22%-24%. Basically as earnings profile improved, market identified it with PE expansion.
3. Aavas Financiers was bought when its IPO got listed. It was at the same time when, IL & FS default was unfolded. Aavas being an NBFC, was witnessing selling. All companies in NBFCs were looking weak, but everything cannot be painted with same ideology. Aavas which is backed by AU bank, was quoting at 2 times less price to book. It had earnings growth of 35% – 40% plus, operates in the niche market of affordable housing. There is a huge demand for small home loans in small towns. NPAs which is main issue for housing finance was extremely low for Aavas. The call worked well. Stock doubled in less than 1 year.
4. SBI was added at 185 and then at 230 when it was in a Value Trap. Whole philosophy was that SBI has the maximum NPA provisioning in the country and when NCLT money would be recovered, there would be improvement in earnings profile, and being the largest bank was not only available at a cheap price, but was expected to show improvements in earnings profile.
5. Ultra Tech, a large cap stock in cement was added in Jan, 2019 when there was a belief that large caps are trading at expensive valuations, and stock actually delivered 30% in 8 months. The call worked well.
6. RBL Bank was held in portfolio for 2.5 years. Allocation was 4%. First exit of around 2% was made at 640. The day the recent quarter numbers was announced, it was sensed that the guidance is negative and stock was thus, completely exited around 550. At present the stock trades as 375.
7. Biocon was bought couple of years back. Beginning of July’19, allocation was 2.5%. There was a molecule launch expected which was supposed to benefit Biocon. We were holding Biocon for some time and were positive on it, but, 15 days before the launch of molecule by Biocon, its competitors in US launched the same molecule. When there is already a competition in the market, it leads to significant erosion of 25-30% in the products’ price. We thus, sensed a concern that were going to play negative on the forward price to earnings, and thus exited the day this news came in US markets, and post exit the stocks has gone down further 15% to 20%.
Aniruddha Sarkar, Fund Manager IIFL Multi Cap PMS adds “Entry in the stock is not what differentiates, it’s the Exit that differentiates”. “Being agile in today’s market is very important. There are funds that have been holding Page and Eicher, but holding a stock till eternity is not our approach. We do not get attached to stocks and follow 40% core and 60% tactical”.
Since inception, in last 4.5 years, IIFL Multi Cap PMS has thus delivered 18% IRR. During the same time Nifty has delivered 8% IRR, and BSE Top 200 has delivered approx.10% IRR.
In Last 1 Year, till 31st July’19, when terrain has been tough for all, IIFL Multi Cap PMS has delivered approx. 9.71%, vs Nifty’s returns of -2.71% and broader markets showing deep correction.
Simply put, IIFL Multi cap PMS follows Earnings, Earnings and only Earnings, it avoids value traps, stays away from corporate governance issues, and sticks to SCDV framework. This PMS offers an STP option as well, which helps investors to stagger their investments.
Thus, if the focus on Earnings, and one is Expert in discovering Outliers on the basis of changes in the Earnings profile of companies, index level doesn’t really matter much, what matters is Earnings.
We at PMS AIF World (www.pmsaifworld.com) do an unparalleled research, and suitability analysis. We recognize IIFL Multi Cap PMS as one of the right investment products for informed investors.
Disclaimer: Investments are subject to market risk. This write up is issued by PMS-AIF and is produced for information purposes only. Information and opinion contained in this document are published only for the assistance of the recipient. It is neither a solicitation to sell nor shall it form the basis. Or be relied upon in connection with any contract or commitment whatsoever or be taken as investment advice.