January 2016: Quality is…What quality does

The Indian stock market took a sharp knock this month – the Nifty was down 4.8% and our portfolios also participated in the fall. For the financial year (Apr’15 – Jan’16), the Nifty is down 10.9% and our portfolios have done much better than the markets.

In today’s world, currency has become the great leveler, driving large changes globally – the number of currencies which have halved in the last 18 months, against the dollar, is now ceasing to be a joke. The second largest currency block in the world, i.e. the Euro is itself down 30% against the dollar – the Indian rupee has held up well in this storm, partly driven by the sharp fall in prices of commodities like oil & gold, which India imports heavily. India is also likely to emerge as an attractive investment destination going forward given its healthy macro-economic fundamentals and world leading growth.

Some market commentators are suggesting that we could be visiting a 2008 like situation again in the world economy and markets, thanks to what is happening in China – we believe that there are some crucial differences between 2008 and now. First and foremost is the fact that, valuations are reasonable now, compared to the extreme levels seen in 2007 – large falls in a market are usually preceded by over-valuation, over-leverage and over-bought conditions. None of these three conditions were satisfied in the current market move, at least from the broad indices point of view. There have been several instances of some small and mid-caps trading at stretched valuations. The froth, if any this time around, is mostly centered in that space – high quality large caps remain reasonably priced.

The other subject much discussed these days is the volatility in the market – we depict volatility in a rather simplistic manner which is the 52 week high divided by 52 week low minus 1. The historical median volatility of the Nifty is 56%. As per this measure, CY2015 was the least volatile ever, in the last 15 years. Low volatility is sometimes a result of the fact that there is not enough economic momentum for prices to tread higher, and the low valuations do not allow the market to fall a whole lot.

Global markets have been in a state of crisis since 2008. In this period, 2008-2015 (the last full year for which data is available), Nifty companies grew their cumulative revenue by 15% pa (in-line with long term nominal GDP growth and Index rate of return) and profits by 10% pa. This has resulted in the profitability pendulum swinging from way above median for the Nifty companies in 2008 to way below median in 2015. The weighted average sales growth of our consolidated portfolio is 18% pa while net profit growth is about 16% pa, for the cited period. If the companies you hold, can deliver this kind of performance through one of the darker periods in the global economy, it gives one a lot of comfort to be able to deal with whatever future crises may come. We feel confident of India’s prospects over the next 5-10 years and even more so for our portfolio companies. The recent correction has allowed more companies in our universe to come close to buy point and we think this provides an excellent opportunity to invest.