Jayant Pai | firstname.lastname@example.org
Before jumping to build a portfolio of stocks impacted by the recent reforms, choose the ones which will benefit the most.
This article was published in Business Standard on September 23, 2012.
Three Fridays and three sets of good news – ECB President Mario Draghi’s promise to buy unlimited bonds, Ben Bernanke’s commitment to purchase mortgage backed securities worth $ 80 billion a month, along with diesel price hike by the Indian government and Mulayam Singh Yadav’s commitment that the UPA will not be destabilised soon – has brought the smile back on stock investors’ faces.
While the exultation is, no doubt, justified, this may also be a good time to dwell on how the impending changes may affect our investments going ahead.
While the hike in diesel prices and a reduction in the number of subsidised LPG cylinders may have invited the ire of consumers, it is expected to help equity investors in two ways:
Other things being equal, an impending reduction in the fiscal deficit will accord greater flexibility to the Reserve bank of India, who have so far, been lamenting that yawning deficit is acting as a big barrier to any further interest rate cut.
A cut in rates, apart from helping borrowers, also results in the lowering of the hurdle rate for investors in equity markets, by reducing the attractiveness of fixed income instruments.
Currently, the earnings yield for FY13E (calculated as 100/PE ratio) is around 6.50 per cent while the yield on one year fixed deposits is around 8.50 per cent. As rates taper off, this yield differential will reduce and PE ratios should expand even if earnings remain constant.
Also, an improvement in the country’s fiscal will reduce the threat of a credit rating downgrade. This in turn, will help corporates keep their overseas borrowing costs in check, which could percolate down to healthier earnings. The positive effect on the Indian Rupee also cannot be understated. It has already perked up nicely over the past few days. All-in-all, if all goes according to script, equity investors should be awakening to a new dawn and the golden age of high fixed income returns may be ending.
While all this sounds enticing, it would not be remiss if investors asked “What next?”. In other words, while the entire market will benefit, which stocks should they pick? Well, here are a few pointers for avid stock-pickers who want to build a reforms-oriented portfolio.
Don’t judge a book by its cover
While the changes announced in certain sectors will contribute to their overall growth, it does not mean that all the listed companies therein will benefit equally.
For instance, the entry of foreigners (albeit through joint ventures with an Indian partner) could actually increase the competitive intensity in a low-margin sector like retail. Also, incumbents may not be attractive enough to be bought out. Besides, if a listed Indian player enters into a joint venture with a foreign entity, their focus in the listed entity may get diluted. Even if that does not happen, future expansions may happen through the unlisted entity.
In the case of aviation, while most of the current crop of listed companies are in dire need of resuscitation, foreign investors will only be deem them attractive once clarity emerges on operational fronts such as aviation turbine fuel pricing, sharing of airport infrastructure etc.
Also, while liberalising the FDI regime in a complex sector like pharmaceuticals is welcome, foreign companies who have bought out Indian promoters have not had a very good experience so far, as various issues have cropped up after their purchase. Even today, issues like compulsory licensing dog the sector. Hence, here too it may not make sense to blindly chase Indian pharma companies these scrips in the hope that they will sell out soon.
Read between the lines
There are some other reforms that have still not happened and does sound ‘marquee’ but which can have far-reaching implications.
One of them is the restructuring of the State Electricity Boards and the other pertains to the Land Acquisition Bill.
The former should not only assist several banks who have lent to these companies, but also inspire greater investor confidence in the power sector. Clarity on the latter will certainly help most of the large Indian corporate houses who are involved in infrastructure and extractive industries.
Even property developers may benefit. However, once again, invest only after assessing the beneficiaries and the approximate extent by which they will benefit.
If all this sounds too daunting, participating in the stock market through mutual funds is a good option. If choosing a good scheme is too laborious, an index fund may suffice.