Ambit Capital recently published a report titled The India Story Changes – Profiting from a Changing India, which looked into issues that ail India, how the country is changing and how investors can profit from companies identified using its "greatness" framework.
The key points the report makes are:
- Although "value" investing has outperformed "growth" over the past decade in India, neither style is generating consistent returns now. The market is not cheap enough to make "value" investing easy. The fading of India's growth prospects makes "growth" a dicey affair.
- Political power has fragmented in India and this is hitting companies whose main competitive advantage is connectivity to such power bases.
- The cost of capital in India is now structurally high (the highest in Asia) and will remain so (thereby triggering a rerating of cash generators).
- Competition is rising in India as MNCs expand in a range of sectors. This, plus a reduction in asset turnover, is resulting a in structural reduction in corporate India's return ratios.
- Aspirational consumption remains robust and is a potent source of outperformance for companies which can feed off this demand.
- Accounting quality remains variable across sectors; hence companies whose accounting quality is improving tend to outperform.
- Investors need to exit the old India story (cash-consumptive, capital-hungry companies which rely on the government to get things done) and focus on well-managed, cash-generative companies which feed off aspirational demand. Ambit's "greatness" framework identifies such companies.
We conducted an email interview with Saurabh Mukherjee, Head of Equities, Ambit Capital, to get more insights on the report and the thinking behind it. Here is the conversation.
In your report, The "India Story" Changes, you make the assertion that value investing (a 10-year annualized outperformance of 2.7% versus the benchmark) has outperformed growth investing (outperformance of 0.5%)--though in the past few years, you note neither has delivered results of discerning difference. How do you define value versus growth investing and what are the key trends you have observed in the past 10 years and the reasons you could attribute to those trends?
We define "value" to be the cheapest 20% of stocks in a market on price-to-book. We define "growth" to be the most expensive 20% of stocks in a market on price-to-book.
The key trends to note include the superior performance of "value" stocks in the initial part of the past decade when India was relatively inexpensive market and foreign institutional investors had not yet become big investors in India.
Then in the closing stages of the decade (FY10 and FY11) with economic growing at 8%, "growth" stocks outperformed.
Recently, however, neither of these styles has yielded consistent returns as the market is too expensive for "value" investing to work and economic growth is too weak for "growth" investing to work.
What has outperformed, however, are well managed, cash-generative firms with clean accounts, good corporate governance and low/no dependence on political connections.
In the report, you also lay out a general theme to categorize the firms of the old "India story" and the new one. A typical profile for the old-story companies could be companies that depend on political connections to get work done, those in capital-intensive sectors, perhaps debt-heavy along with questionable accounting practices while the new "India story" companies are consumer-focused firms that generate healthy cash flows. However, the stock performances of the former companies have generally lagged the latter's, these past few years. So how much of the theme is already in the market's price given the valuation differences between the two camps?
The old "India story" companies still constitute almost 35% of the BSE 100. These companies are in sectors such as banks, power, infra, construction, real estate and aviation.
You only have to look at the rally that banks such as SBI and Axis Bank enjoyed from January through to March to realise that there are a number of investors in the market who haven't woken up to the new realities facing the country.
As these investors appreciate the risks embedded in large cap stocks such as SBI and Axis, they are likely to migrate to our "Good & Clean" stocks thereby fuelling a re-rating of these names.
You have outlined a "greatness" framework where you categorize companies as 'mediocre', 'good but not great' and 'great'. Can you explain the attributes of the "great" companies and on what basis would you think are valuations for such firms still cheap in the Indian market?
Fortunately the 'great' firms are still available at reasonable valuations--many of them are trading at forward earnings multiple which are in the low to mid teens (which is broadly in line with the overall market multiple).
In fact, on EV/EBITDA basis, the great firms are actually cheaper than the overall market.
More importantly, we have a much greater degree of comfort in these 'great' firms maintaining and improving their book values, earnings and EBITDA levels, which unfortunately cannot be said of a normal Indian firm with nasty downside surprises becoming fairly common these days, thus rendering all valuation exercises meaningless.
To read the full report and to view Ambit's top buy and sell ideas, download the PDF.