July 2019 Newsletter – Negative Sentiments

Market Outlook

As we write the July 2019 Newsletter, the sentiment on the street is negative. Investors do not want to put their money in small-caps or even mid-caps. Whoever is still sticking to equities is now talking about investing in Bajaj Finance or other large caps that are at 52-week highs. Just a simple trend analysis of the term Multibagger on Google will show you this graph:

Multibagger Search Trends

Even multibaggers have fallen out of trend now. Look at the peak of 2017 and compare it to the scenario now. Investors want to invest in Index funds, large caps and want to stay away from small & mid-caps. The mid-cap forward PE tracked by institutional analysts usually trades at a discount of 5% to 10% to the Nifty’s forward PE. This discount is now above 20%, a level seen when the market sentiments are depressed. The valuation gap between the indices will eventually reduce. Another indicator of the depressed sentiments is the dull IPO market:

Dull IPO Markets

Ground Sentiment

We have been speaking to businesses on the ground. Bearing traders are saying that business is down by up to 70% this year, car dealers are saying that unsold inventory has been inching up. However, restaurants have been rejoicing the newfound business through delivery apps like Swiggy & Zomato. Soft drink companies have seen a spurt in the demand for diet / sugar free variants of their beverages and the more people are enrolling for wellness programs of startups like Cult.fit. We feel that traditional businesses, especially those that took place in cash to evade taxes have taken a hit from which they will not be able to recover.

When we look the numbers being posted by listed companies, we see shrinking margins, slower growth and higher inventory days. This is reflected in the stock prices which are sinking day in, day out. What is encouraging is that the SIP book of the mutual fund industry now stands at ~ Rs 8,000 Crores per month which is an all-time high. Usually, the retail investor runs away from the market after a year like 2018. However, considering that the large cap funds and indices haven’t really seen a bloodbath yet, the regular mutual fund investor must have shifted from small & mid-caps to large caps.

The above table shows the trend in growth of Midcap earnings (ex-financials).

We will stick to companies that meet most of the below criteria:

  • Growing their revenues at 15% p.a. and higher
  • Maintaining / Improving margins
  • Have a history of earning a ROCE higher than Cost of Capital
  • Debt-free or low debt levels
  • Have low reliance on external debt to expand
  • Cash generating companies
  • At cheap/fair valuations
  • Regular dividend paying companies
  • Offer high margin of safety

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