Sunday, 20 April 2014

RBI Intervention in Forex Markets-VRK100-20Apr2014



RBI Net Intervention In Forex Markets



























Risk versus Reward-Malkiel-VRK100-19Apr2014


Tuesday, 8 April 2014

Compare GDP, Exports & Population-VRK100-08Apr2014


Compare GDP, Exports and Population


Monday, 31 March 2014

How BSE Indices Fared-VRK100-31Mar14



How the BSE Indices Fared



As can be seen from the above table, while the S&P BSE Sensex has given a return of about 10 percent in the 25 quarters, Midcap and Smallcap indices have fared badly with a negative return of 28 and 47 percent respectively.

The rally in the Indian stock markets is led by large cap stocks--that too from stocks in FMCG, auto, healthcare and Information Technology stocks. The worst performing sectors are real estate, power, metal, PSU and capital goods sectors.

However, in the last few months, stocks in the capital goods and banking sectors are doing well while IT and healthcare stocks are lagging behind. The sector rotation is quite common in the markets. For the average investor, holding a portfolio of well-diversified stocks pays superior results in the long term of more than four to five years.




Friday, 28 March 2014

Basel III Norms Postponed to Suit Government-VRK100-28March2014




In a notification to commercial banks, Reserve Bank of India on 27 March 2014 has directed them to postpone full implementation of Basel III norms by one year to 31 March 2019, instead of the earlier timeline of 31 March 2018. This is a big relief for Indian banks who have been going through a phase of bad loans threatening their capital and profits. It is not a mere coincidence that this deferment is beneficial especially to public sector banks. There is a design behind it.

Who is the biggest beneficiary of RBI’s move?

The biggest beneficiary of the RBI’s decision to defer full implementation of Basel III norms will be Government of India (GOI). As a majority owner of public sector banks (PSBs), GOI is obligated to recapitalize PSBs in the next few years in accordance with the Basel III norms, which are much tougher than Basel II norms. PSBs have a market share of around 70 percent in Indian banking.

But, GOI has been facing a lot of problems on the fiscal front. India’s GDP growth rate has slowed down considerably in the last two to three years. Tax collections have come down, while subsidies have gone up substantially, with fiscal deficit worsening.

However, for the current financial year 2013-14, GOI has barely managed to rein in fiscal deficit within 4.8 percent of GDP, with some temporary measures such as extracting higher dividends from public sector understandings (PSUs), burdening LIC of India with stakes in PSUs and forcing some PSUs to buy shares in other PSUs.

GOI is likely to face severe resource crunch in the next few years until GDP growth rate picks up again. India is over-dependent on all sorts of subsidies. And there is this overhand of providing food security to two-thirds of India’s population. Burden of repayment of government bonds (both principal and interest) is very heavy in the next three years—which is a result of heavy government borrowing since 2008-09 till now.

RBI is in the habit of rescuing public sector banks, whenever they face headwinds either from global or domestic forces. Postponing the full implementation of Basel III norms is another clever decision by RBI to rescue GOI and public sector banks.

Whether Basel III Norms are Good for India?

Basel III norms will force Indian banks to set aside more capital as a percentage of their assets. The result is that banks’ ability to lend to needy sections will come down. India is a developing country and credit penetration is low compared to developed nations.

It is an irony that Indian banks have to set aside more capital, as part of international banking prudence, as a buffer to prevent any possibility of banking meltdown that happened in the wake of 2008/2009 global financial crisis triggered by Lehman Brothers collapse.

India is hungry for capital. Even though our savings are high, they are not enough to sustain lending activities in the economy. Due to statutory requirement (CRR and SLR), banks have to park a large part of their resources in government securities—it means a large part of banks’ funds are lent to GOI. Moreover, Indians invest more in physical capital—gold and real estate, rather than financial capital—to that extent banks’ ability to raise deposits or other forms of capital from public is crimped.

Developed nations are already developed. What I mean is that their economies are flat, with no expectations of higher growth and they require less capital. On the contrary, we have high expectations of GDP growth rates of above 8 percent.

As part of the international coordination, India is obligated to implement Basel III norms. However, Basel III norms allow considerable leeway to the implementing nations, because any norms need to be tweaked to suit local issues.

One hopes that RBI is wise enough to balance between India’s need for more loans and following international norms, without giving any impression of dilution of the spirit of Basel III norms.

Market Reaction:

Anyway, shares of all listed banks, especially those of PSBs, will react positively to the RBI’s move after stock markets open today.


References:

RBI’s notification dated 27 March 2014 deferring full implementation of Basel III norms:


Notes:

CRR – cash reserve ratio
GDP – Gross domestic product or a measure of national income
SLR – statutory liquidity ratio

Disclaimer: The author is an investment analyst with a vested interest in the Indian stock markets. This is for information purposes only. This should not be construed as investment advice. Investors should consult their own financial advisers before taking any investment decisions. The author blogs at:


Tweets at @vrk100


Wednesday, 19 March 2014

CPSE ETF-Avoid Investing-VRK100-19Mar2014




Investment Case Against CPSE ETF:

If you invest in this ETF, your money will be vulnerable to concentration risk. This ETF invests in stocks of only 10 companies. Tracking the CPSE index, about 60% of your money will be deployed in only four stocks, namely, ONGC, Gail India, Oil India and Indian Oil Corporation. All these four stocks belong to oil & gas sector. The first three companies have been bearing subsidy burden of government’s oil marketing companies (OMCs)—BPCL, HPCL and IOC for several years. 

All these companies are owned by Government of India (GOI). The ETF performance will depend on the whims and fancies of ruling politicians and bureaucrats.

With only 10 stocks, we cannot call this ETF a diversified fund. Having only 10 stocks, that too all from the public sector, in an ETF is completely against the principles of diversification. An ETF is basically an investment vehicle that pools money, invests in a basket of securities and trades like a stock on a stock exchange.

When it comes to corporate governance rules, GOI has got a poor track record. Quite often, government’s actions are not guided by the interests of minority shareholders. In the past they have used public sector companies to meet their own political interests.

Recently, GOI has been encouraging cross holdings among public sector companies. A few days back, ONGC and Oil India picked up 10% stake in IOC. LIC of India has been buying stakes in BHEL, ONGC and others at the behest of GOI. Such arm-twisting on the part of GOI is not good for LIC policyholders also. This will complicate the valuation of public sector entities and it is not in the interests of minority shareholders of PSUs.

In the last few months, GOI has forced Coal India (about Rs 16,500 crore), NMDC and public sector banks to declare large dividends to fill up its coffers, instead of allowing the companies to invest in profitable avenues.  

This ETF will bear a lot of political risk. Government is very weak in setting policies and implementing them effectively. Though some form of autonomy is given to PSUs, overall control is done by respective ministries. The overall management of these companies continues to remain weak despite the companies having some inherent strengths.

Most of the companies in the CPSE index are from natural resources sector. This sector has been imperiled by lack of environmental clearances and regulatory risks. Even though Coal India is a monopoly, it is bedeviled with fuel supply agreements, imposed by the Government.  

Features:

The Composition of CPSE Index:

Company Name
Sector
Weight %

Company Name
Sector
Weight %
Oil & Natural Gas Corp 
Energy
26.72

Indian Oil Corp
Energy
6.82
GAIL (India) Ltd 
Energy
18.48

Power Finance Corp
Financial Servcs
6.49
Coal India Ltd
Metals
17.75

Container Corp of India
Services
6.40
Rural Electrification Corp
Financial Servcs
7.16

Bharat Electronics
Manufacturing
2.00
Oil India Ltd
Energy
7.04

Engineers India
Construction
1.13

Source: GSAM

The CPSE ETF is managed by Goldman Sachs Asset Management (GSAM). This is an open-ended exchange traded fund. The new fund offer (NFO) for retail investors opened on 19 March 2014 and closes on 21 March 2014. The scheme will be listed on the BSE/NSE next month. After listing on BSE/NSE, investors can buy and sell these units throughout the market hours through their trading account with a broker, just like they trade any listed stock. The ETF will track the CPSE index. Entry and exit load are nil. Minimum amount of subscription is Rs 5,000 per application for retail investors.  

The GOI wants to raise a maximum of Rs 3,000 crore through this ETF from retail and other investors. The GOI proposes to allot units at a 5% discount during the NFO. Moreover, it proposes to give, after one year, bonus units for those who invested in the NFO and stayed with their units for at least one year. The scheme is in compliance with the Rajiv Gandhi Equity Savings Scheme (RGESS), which has tax deductions subject to certain conditions.  

As the ETF units are traded like stocks on exchanges, adequate liquidity is available for retail investors having demat accounts. The expense ratio of the fund is 0.49%, which is very low compared to other ETFs available in India.

Return Expectations:

How much return can one expect from this ETF? As you are aware, stocks do not offer any guaranteed return. Returns are a function of company’s business prospects, investor sentiment and liquidity in stock markets.

Foreign institutional investors (FIIs) are big investors in Indian equities. Of late, they have been showing preference to invest more in private sector companies rather than PSUs. At present, investor sentiment is generally upbeat about Indian equities.

Given that public sector companies are good in paying dividends, PSUs enjoy dividend yields of up to 4%, much higher than their private sector counterparts. The PSUs may not go bankrupt given the government’s implicit sovereign guarantee, but the GOI may allow certain companies (e.g., Air India, BSNL) to bleed as long as possible. Even with schemes like US-64 that was run by the then state-owned and unregeulated Unit Trust, investors lost heavily.

However, as happened in 2008 and 2009, PSUs with good balance sheets typically do well when stock markets are afflicted with global crises.

There is this narrative going round that one can buy these units in NFO and sell them after one year to earn a return of about 11 percent without any risk. My question is if everybody wants to sell these units after one year, who will buy from you? Remember Reliance Power IPO during the 2008 stock market peak when investors and speculators lost heavily in the IPO because everybody wanted to sell and there were no buyers?  



Why an ETF with only 10 stocks?

It’s strange that the capital markets regulator SEBI allowed an ETF to be floated with just 10 stocks. Is it because as an arm of the GOI, they cannot say no to the all-powerful state? I’ve a rhetorical question, will SEBI allow an ETF to be launched with just 10 stocks in the private sector? Even insurance regulator IRDA allowed insurers to invest in this highly concentrated ETF. It’s very strange that the regulators want to be a party to the government’s efforts to raise money for their fiscal profligacy.

Why cannot the GOI introduce an ETF that consists of 30 or 60 PSU stocks from a variety of industries and sectors?

Final Words:

Reports suggest that anchor investors invested about Rs 850 crore in this ETF fund yesterday. Institutional investors have sophistication and they are supposed to be masters in risk mitigation. What is suitable for them may not be suitable for retail investors.

The CPSE ETF has completely failed as an investment case when you consider the principles of risk mitigation and diversification. The fund is not adequately diversified to provide any cushion during market meltdowns. The concentration risk is very high and non-sophisticated investors may find the fund too risky for their equity portfolios.

But I would like to add that I’m not telling you not to consider the stocks of PSUs individually. Depending on your risk appetite and portfolio management perspective, you can definitely consider individual PSU stocks provided you’ve done your own research on these companies and they’re suitable for your investment objectives and goals. While evaluating, please take into account all your investments—direct equities, equity mutual funds and ULIPs—as a total package.  

My sincere view is that investors should allocate money towards equities as per their long-term financial plan, asset allocation and risk profile. Making individual investments ignoring the fundamental principles of personal finance will not help you.

You should not be solely guided by tax benefits or sops (like 5% discount and bonus units in this case) while making serious investments.  

While making investments, first see if you have any surplus money, whether the investment offers any return, convenience, liquidity and downside protection. The bottom line is that the CPSE ETF does not offer any diversification, nor does it offer any downside protection.

Unsophisticated retail investors are better off with time-tested index funds, tracking Nifty 50, Junior Nifty or BSE 200 index or some large-cap well-diversified mutual funds with long-term track record that are available in the market.
  
Related Articles:




Notes:

CPSE ETF – Central public sector enterprises’ exchange traded fund
GOI – Government of India
GSAM – Goldman Sachs Asset Management
NSE – National Stock Exchange
SEBI – Securities and Exchange Board of India, the capital market regulator
PSU – Public sector undertakings or public sector enterprises or state-owned enterprises
ULIPs – Unit-linked insurance plans that typically invest in stocks

Disclosure: Don’t own any shares in the above stocks. But I own a few shares in a few PSUs.
Disclaimer: The information provided is only for information purposes and should not be construed as investment advice. Investors should consult their own financial advisers before making any investments. The author is an investment analyst with a vested interests. He blogs at:




Thursday, 13 March 2014

India Forex Reserves-Abysmal Returns-VRK100-13Mar14




Abysmal Rate of Return on India’s Forex Reserves:

India’s foreign exchange reserves do not earn much returns for the Reserve Bank of India, that is, for the Government of India. They are abysmally low. During the period July 2007 to June 2008, the returns were 4.82 percent. But since then earnings rate of our foreign exchange reserves has come down drastically.

As per the latest data from Reserve Bank of India, the earnings rate on India’s foreign currency assets and gold has come down to a meager 1.45 percent for the period starting from July 2012 to June 2013.  It may be noted that lower rate of earnings reflects generally low global interest rate scenario, that has been prevalent across most of the developed markets since the 2007-2008 global financial crisis.

Accretion to foreign exchange reserves is highly expensive. When RBI buys foreign exchange (mostly US dollars) to add to its reserves, it releases money (rupees) into the banking system. To neutralize the impact of excess money, RBI issues government securities and takes away that money from the banking system. This process is called sterilization, which entails huge cost to the Government. 

RBI resorted to massive accretion of foreign exchange reserves in 2006 and 2007 to arrest steep appreciation of rupee’s external value against the US dollar. The excess money created in the banking system was simultaneously absorbed through normal open market operations (OMOs) and Market Stabilisation Scheme (MSS).

RBI deploys these foreign exchange reserves in several instruments, mainly in the US Treasury securities and earns some return on them. Of course, there are various objectives of holding these reserves. Earnings are just incidental to the larger objectives of macroeconomic policies. 

India’s Import Cover is Declining:



India’s import cover is on the decline for the past six years. From a recent peak of 12.4 months at the end of September 2009, it has nosedived to 6.6 months for September 2013, as per the latest data from RBI.

Indian rupee witnessed steep depreciation against the dollar in the past few years, due to a variety of local and global factors. RBI intervened heavily in the markets and sold foreign exchange to shore up the rupee’s external value, resulting in erosion of reserves. (Of course, reserves are now increasing and the latest figure is $ 294.36 billion. Rupee is now gaining against the US dollar in the past few months).

India’s import cover fell to a low of three weeks of imports as at end of December 1990; reached a peak of 16.9 months of imports as at end of March2004. Import cover is the number of months of imports foreign exchange reserves could pay for.

Related Articles:

Spectacular Rise of Rupee Amidst Weak Leadership

Indian Rupee Continues to Fall


Date source: RBI website. Note: RBI’s financial year starts from July and ends with June.

Disclaimer: The author is an investment analyst. He blogs at:


Tuesday, 4 March 2014

Small Savings Interest Rates-VRK100-04Mar2014



The Government of India had today announced revision of interest rates for small savings schemes for the financial year 2014-15. These revised interest rates, as given in the above table, are effective from April 1st, 2014. As part of the Shyamala Gopinath Committee recommendations, the Government has been revising these interest rates every year.

As can be seen above, the interest rates are revised upwards by up to 0.2 percent (or 20 basis points) for time deposits. These term deposits for periods of 1-year and up to 5-year and recurring deposits for 5-year period are offered at post offices available across the country.

But in the case of SCSS, MIS, NSC and PPF, the government has not changed the rates.

The relevant government announcement can be accessed at:



Friday, 3 January 2014

What is GDP?-VRK100-03Jan2014




GDP is one of the great inventions of the 20th century. It is the single most important number that is used by all economic agents to compare the economic strengths of nations. It is exactly 80 years since the term ‘GDP’ was coined by Nobel laureate Simon Kuznets, who was a Russian-American economist.

GDP stands for Gross Domestic Product. It is the total value of all goods produced and services provided within a country. As a single number, GDP reflects the overall economic activity in a country. The GDP numbers are expressed in real (after inflation) terms. The GDP figures are revealed every quarter by the government authorities after compiling the national accounts.

Of course, there are skeptics who question the validity of using GDP to measure the well-being of a nation. Let us talk about that in a later post. For the time being, let us be ‘happy’ with this GDP figure!

Related Articles:


- - -

Disclaimer: The author is an investment analyst, equity investor and freelance writer. This write-up is for information purposes only and should not be taken as investment advice. He blogs at:



Connect with him on twitter @vrk100


Thursday, 2 January 2014

Indian Hotels-Losses and Dividends-VRK100-02Jan2014


 


The Indian Hotels Company Limited has been consistently making losses ever since the 2008 global financial crisis hit the company very badly. The company is commonly known as Taj Group of Hotels, owned by Tata Sons.

As shown in the above table, the company made very big losses in 2009-10, 2010-11 and 2012-13. Even in 2008-09 and 2011-12, the company’s profits were very meager. The total losses between 2008-09 (after the global financial crisis) and 2012-13, on a consolidated basis, amounted to Rs 639 crore.

But these massive losses did not deter the company from paying hefty dividends to shareholders. Around 38 percent of the total stake in the company is owned by the promoters, the Tatas. While the consolidated losses were Rs 639 crore in the last five years, the total dividends paid were Rs 380 crore during the same period.

While there is nothing unlawful about this, valid questions can be raised against the prudence of the company’s management in doling out liberal dividends.

Is this how the Tatas milk their companies, even though loss-making, for their own benefit—in the form of dividends? It is a known fact in the corporate world that when business conditions are horrible, companies skip dividends altogether or cut them drastically to weather the difficult conditions.

Why can’t the company use the precious cash to retire its massive debt and bring down the large interest cost, instead of doling out dividends?

The company made huge acquisitions in the US, Australia and others. It tried to take over the US-based Orient Express Hotels when it bought 6.9 percent stake in the company in 2007. But Orient Express rejected Tatas’ overtures.

Now these investments and acquisitions turned out to be lemons (with the benefit of hindsight). And the shareholders of Indian Hotels have suffered in the last five to six years, as the company is saddled with massive debt.

Indian Hotels has disappointed the equity investors and is not making any amends to its profligate ways. Can the company do some soul searching now that its adventures have become very costly?

If the Tatas admit their costly mistakes humbly, it would do a lot of good for their corporate governance practices.    

Is anyone at Securities and Exchange Board of India (the capital market regulator) or the company’s board of directors listening?

Corporate governance is dead! And long live corporate governance!


- - -

Disclaimer: The author is an investment analyst, equity investor and freelance writer. The author has a vested interest in the Indian stock markets. This write-up is for information purposes only and should not be taken as investment advice. Investors are advised to consult their financial advisor before taking any investment decisions. The author owns equity shares in the above mentioned company. He blogs at:



Connect with him on twitter @vrk100


Wednesday, 1 January 2014

Outlook for Indian Stocks in 2014-VRK100-31Dec2013





During the calendar year 2013, the S&P BSE Sensex 30 index clocked a return of 9 percent, while the NSE’s Nifty 50 index rose by 6.8 percent. But the BSE Dollex 30 index recorded a negative return of 3.5 percent due to steep depreciation, around 12 percent, of Indian rupee against the US dollar. Dollex 30 is dollar-linked version of Sensex. Let us see which sectors have come out winners and losers and what is in store for Indian stocks in 2014.

Sectoral performance:

Among the sectors that have done well are BSE IT index and Healthcare indices, with a gain of 60 and 23 percent respectively. Significantly, both these sectors have partly benefited from the rupee fall. Other things that benefited these sectors are strong export growth, investors’ bias towards companies with strong balance sheets and better corporate governance, good potential for growth and slight recovery in the US economy. Other sectors that have done well include FMCG and Automotive sectors.

Real estate and public sector companies continue to be among the worst-performing sectors in 2013. The BSE Realty and PSU indices showed a negative growth of 32 and 19 percent respectively.

Returns and Volatility:

The Sensex return of 9 percent in 2013 does not reflect the volatility of stock markets in 2013. The benchmark index started the year with 19,510 and reached a peak of 20,328 (intra-day) on 17May2013. But due to fears of Fed tapering, steep fall of rupee against dollar, high current account deficit and policy-related paralysis in India; the index fell to an intra-day low of 17,922 on 27Aug2013.

After the US Federal Reserve deferring the proposed tapering, Raghuram Rajan taking over the reins of Reserve Bank of India and return of FII portfolio inflows; the Indian stock markets recovered sharply with the Sensex reaching an intra-day high of 21,484 on 09Dec2013. By the end of December 2013, the index closed at 21,171. Between May and August 2013, the Sensex fell by 12 percent.

But between September and December 2013, the benchmark index rose by 18 percent, giving some cheer to scary and wary investors. During 2013, the FIIs have brought in USD 20 billion to Indian equity markets.

Why the Difference between Sensex and Nifty Returns?

While Sensex recorded a gain of 9 percent, the Nifty rose by 6.8 percent only. The difference is due to the fact that Sensex consists of 30 companies, while the Nifty reflects prices of 50 blue chip companies. Moreover, at the start of 2013, Nifty was concentrated toward banks and financial companies. During July and August 2013, banking sector lost heavily—though banking stocks recovered in the last four months.  For 2013, the BSE Bankex lost 9.4 percent—causing the difference between Sensex and Nifty returns.

BSE Market Capitalization:

Total Market Capitalisation of All BSE companies:

Rs Crore
USD Billion
USD-INR
Dec.2007
71 69 985
 1 818
39.41
Dec.2010
72 96 726
 1 616
44.44
Dec.2013
70 44 258
 1 125
61.80
Note: Figures are end of the month; USD-INR is US dollar-Indian rupee exchange rate


Some interesting facts come out when you look at the above table. The market cap of all BSE companies at the end of December 2007 was Rs 71.70 lakh crore, converted to USD 1,818 billlion. But the market cap slumped to USD 1,125 billion (a fall of 38 percent) by the end of December 2013, though in rupee terms it fell by only 2 percent.

Two factors contributed to the steep fall in market cap, in dollar terms, of all BSE companies. One is the steep depreciation of rupee against the dollar. Another factor is the fact that broader indices themselves have fallen. For example, BSE 200 index lost 4.7 percent between December 2007 and December 2013.

Performance Chart for 2013:

Indices
31-Dec-13
31-Dec-12
% change




BSE Sensex
 21 171
 19 427
9.0
BSE DOLLEX 30
 2 816
 2 917
(3.5)
BSE 200
 2 531
 2 424
4.4
BSE Mid Cap
 6 706
 7 113
(5.7)
BSE Small Cap
 6 551
 7 380
(11.2)




BSE Auto
 12 259
 11 426
7.3
BSE Bankex
 13 002
 14 345
(9.4)
BSE Capital Goods
 10 264
 10 868
(5.6)
BSE Consumer Durables
 5 821
 7 719
(24.6)
BSE FMCG
 6 567
 5 916
11.0
BSE Healthcare
 9 966
 8 132
22.6
BSE IT
 9 082
 5 684
59.8
BSE Metal
 9 964
 11 070
(10.0)
BSE Oil & Gas
 8 834
 8 519
3.7
BSE Power
 1 701
 1 991
(14.6)
BSE PSU
 5 910
 7 335
(19.4)
BSE Realty
 1 433
 2 111
(32.1)
BSE TECK
 5 051
 3 428
47.4




Nifty 50
 6 304
 5 905
6.8


As can be seen from the above table, the performance of Sensex, BSE Mid Cap and Small Cap indices differs widely—though select mid cap and small cap companies delivered good to decent returns in the latter half of 2013.

It is interesting to note that mid cap and small cap stocks did better than Sensex in 2012. Investors mood changes—some years they’re optimistic about large caps and in some years they shift their bias towards mid and small cap companies. In general, it’s difficult to predict the mood swings of investors.



What to Expect in 2014?

However, my sense is that small cap and mid cap companies may do well in 2014, subject to the caveat that 2014 general election will throw up a stable government and the Indian economy will fare well next year. Having said that, I would like to add that investors are required to be more diligent as far as small cap and mid cap companies are concerned. They’ve to be very careful about choosing their stock picks. If they’re not experienced, they better consult their financial advisors before investing.

World markets, particularly the US and Japanese, have done extremely well with S&P 500 rising by close to 30 percent and Nikkei 225 by 57 percent in calendar year 2013.

I always maintain that investors have to take care of their asset allocation first. After asset allocation, they’ve to take a portfolio approach towards their equity investments. At this point of time, my thinking goes like this. Suppose you have a stock portfolio with stocks from companies with strong balance sheets, robust cash flows and high perception of corporate governance. Such a portfolio may not outperform benchmark indices if the economy quickly makes a turnaround and interest rates start falling.

This is due to the fact that any sharp turnaround accompanied by falling interest rates will benefit highly-leveraged companies and where investors are highly pessimistic about prospects. (Readers have to take my views with a pinch of salt, because I may change my view quickly depending on market dynamics and outlook on economy).

Let me assume that around 70 percent of your money is currently invested in companies with strong cash flows, decent balance sheets, zero debt and high profit margins.

My feeling is that around 20% to 30% of your money can be allocated to companies with moderate debt (means debt-equity ratio of 0.4 to 0.8), strong corporate governance and managements, reasonable but not very high interest coverage ratios, low operating profit margins and with potential to increase capacity utilization in the next 12 to 18 months. (Many companies are at present struggling with low capacity utilization which negatively impacted their profit margins).

The idea is that if and when the expected turnaround happens, these companies with moderate debt will be highly benefited as compared to companies with strong balance sheets and rich valuations—that have already been discovered by the market. You may have observed this kind of churning actually happening to some extent in the market in the last two/three months—select stocks in auto ancillary, NBFC, capital goods and power equipment sectors have risen sharply.  

It goes without saying that higher risk is usually rewarded with higher returns, provided you do your homework properly—peppered with some luck.

Of course, in the long run (beyond three years), companies with strong balance sheets, robust cash flows, pricing power and competitive advantage will continue to perform well. For a long time, I have preferred companies with strong balance sheets, low debt-equity ratios, strong cash flows and high growth potential.

But now I am thinking that as long as around 70 to 80 percent of your money is invested in companies with strong balance sheets, competitive advantage, pricing power and strong profit margins; you can slightly tilt 20 to 30 percent of your money towards companies with moderate debt, strong managements, low interest coverage ratios and low profit margins. This churning can be done in the next six to nine months in a gradual manner—keeping in mind the changing market dynamics, electoral math and progress of India/world economy.

Select PSU stocks may offer some protection from any downside that is anticipated around the 2014 general elections.

This is not to say that India has no problems. As you are aware, India is currently bedeviled with persistently high inflation and moribund investment cycle—not to mention the high cost of subsidies and government policy/regulatory issues. The RBI has kept its option of raising interest rates open.

Government’s fiscal deficit is a problem as revenue collections have slowed down, while non-plan expenditure (mostly subsidies) shoots up. But unfortunately, plan expenditure is being cut according to several reports.

Global problems may continue to haunt the Indian markets going forward. The government’s divestment effort is making very slow progress.

Finance Minster P.Chidambaram has been trying to limit fiscal deficit to the budgeted 4.8 percent (of GDP), through some creative accounting and cut in plan expenditure. Current account deficit was controlled by imposing severe curbs on gold imports.

It is naïve to expect that government diktats can wean Indians away from the allure of gold. Once the gold import curbs are removed, the gold buying spree will come back with a vengeance. The government seems to have made no serious effort to increase and widen export basket and boost manufacturing sector.

Some headway is being made on the policy front, after years of policy logjam by the central government. Subsidies are cut partially in diesel, LPG and petrol. After a decade, Railway fares too have been increased though marginally. Tesco of the UK has announced FDI in multi-brand retail sector in partnership with the Tatas. Abu Dhabi-based Etihad Airways recently bought a 24 percent-stake in India’s Jet Airways. Air Asia of Malaysia is planning a joint venture with Tatas.

Share repurchases (buybacks) by listed companies are happening. Many foreign promoters—like, Unilever, Vodafone plc and Glaxo Pharma—have been increasing their stake in Indian subsidiaries.  In the last two to three years, foreigners seem to be more optimistic about the prospects of select Indian companies rather than Indian investors, who have been selling heavily. FIIs have pumped in USD 20 billion into Indian equities in 2013.

My sense is that BSE 200 broader index may give 15 to 20 percent return in 2014. My optimism stems from the fact that many Indian companies have been able to weather the storms and will be able to generate decent profits and robust cash flows in future also—despite the uncertainties surrounding the political, fiscal and external fronts.   

Notes:

BSE – Bombay Stock Exchange, FII – Foreign Institutional Investor, NSE – National Stock Exchange and PSU – Public Sector Undertakings.

- - -

Disclaimer: The author is an investment analyst, equity investor and freelance writer. The author has a vested interest in the Indian stock markets. This write-up is for information purposes only and should not be taken as investment advice. Investors are advised to consult their financial advisor before taking any investment decisions. He blogs at:



Connect with him on twitter @vrk100