Friday, November 1, 2019

Keenly watching the Quality vs value debate

Presently, the collective wisdom in Indian stock market appears divided at least on two issues over the consideration of appropriate equity investment strategy.
The first point of division is over the sustainability of the stock markets at the present levels.
A smaller but influential segment, which primarily includes economists, development bankers and strategists, believes that the macro conditions in Indian economy may not improve materially from the current level at least till FY21. The political and fiscal constraints shall limit the government's ability to stimulate the economy through fiscal incentives and material increase in infrastructure investments. The private investment may not see any significant improvement in the absence of large scale new employment opportunities; occurrence of which looks improbable unless radical reforms in labor and land laws are executed earnestly and immediately. Regardless of the initiation of the resolution process for many large struggling businesses in the core sectors (power, roads, cement, steel, mining etc), the financial stress remains elevated and is percolating to other sectors and households. Under these circumstances expecting any material improvement in corporate earnings would be unreasonable. The recent performance of the Indian equities which is mostly based on PER re-rating may not be sustainable and a correction may set in 2020 itself.
The larger segment, comprising of asset managers, analysts, large investors, and intermediaries, believes that the measures already initiated by the government, e.g., GST, IBC, RERA, corporate tax rate restructuring, etc. shall result in marked improvement in the macro as well as micro environment. Initiatives to encourage foreign investment in manufacturing and the government's thrust on building massive infrastructure shall generate large number of employment and demand for private investment as well consumption. Lower interest rates shall ease the financial stress; and resolution of stressed cases shall bring many valuable idle assets back into the business. This group is quite optimistic about the opportunity being provided by the Sino-US trade conflict, assuming that India shall be able to attract many western conglomerates that may be looking to relocate from China to other friendly jurisdictions. The corporate earnings therefore should see a steady rise from the present levels and may grow upwards of 20% in FY21.
The second and more intensely debated point of disagreement is about the choice between the large cap stocks (quality) vs the mid cap (value & growth) stocks. The debating parties here are mostly analysts and fund managers. The market appears vertically divided on this issue. The number of people arguing from both the sides is almost equal.
The group favoring stocks with expensive valuations but higher visibility of earnings growth, sustainability, quality of balance sheet and product and technology leadership argues that the present strength of these companies shall automatically enable these companies to dominate the market in the future helping these to attain higher and faster growth trajectory. The apparently expensive current valuations are therefore totally justifiable and should not be a matter of concern for the investors.
The other group however finds a bubble in the large cap valuations, as most of these stocks have failed to deliver a growth commensurate with their valuations in past many years. In their view, the assumption of faster and higher growth trajectory therefore is mostly untenable and needs to be rejected. This group sees tremendous value and growth opportunities in the second tier companies which have delivered consistent results in challenging environment.
I am watching this debate keenly. However, so far I have not found any argument compelling enough to inspire a change in my investment strategy.

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