Strong Managements, Supportive Policies Key To Value Creation

Sandip Sabharwal, CEO-Portfolio Management Services, Prabhudas Lilladher talks about the sectors that have created value since the economic reforms of the 90s, helping investors get inflation-beating returns from equities.

• Wherever government interference or policies impact, the growth of companies have seen periods of strong returns when policies have been supportive and extremely poor returns when policy has been a hindrance. There are companies that were the blue chips of yesteryears, but did not have a strategy for growth or shareholder value creation and have thus been waylaid over a period of time. On the other hand, there are those that have taken global competition head on, innovated on products, acquired capabilities by acquisitions and created shareholder wealth.
• Given the demographics of our economy and the fact that global growth opportunities might be muted for several years going forward due to fiscal correction required across the developed world, it is probable that the wealth creators of the next two decades might be those which are either domestic focussed or acquire strong global market access through the acquisition of capabilities via mergers and acquisitions on the global stage.

Value creation over the long term is always a facet of stock market investing. Most individuals who have invested over the long run have made strong returns from their investments. The fall in the markets since the stock market peak of 2007 has built a strong conviction in the minds of people that equity is a bad word and investment in equities should be avoided.

In reality, however, in an economy like India where growth is likely to average seven per cent plus over the long term and the demographics are so strong that the working population will keep growing over the next three decades at least, it is investing in equity or real estate that will earn inflation-beating returns.
[PAGE BREAK]

The decade of the 1990s started off with the boom induced by the first round of economic reforms that were unleashed, and the economy was opened up after the crisis in the early 1990s. This lead to a huge spike in the stock markets, which was largely driven by the unknown. At that stage, various companies belonging to core sectors like cement, steel, automobiles, etc. shot up before the boom peaked off in the year 1992. Post that, the performance of the overall economy and the markets was nothing to speak of till the advent of the new millennium. Economic growth remained modest and a lot of companies that had overinvested in capacities suffered a lot.

However, there were some companies that did create significant wealth for investors during that period. The first set of companies were the stocks that were the fancy of the 1990s, i.e. MNC stocks across the universe, but specifically from the FMCG and Pharmaceutical sectors. Here, due to the poor performance of the economy and virtually a total absence of any sort of investment cycle, a large number of companies including Hindustan Lever, Colgate Palmolive, Glaxo Pharmaceuticals, Aventis, etc. gave very strong returns and their valuations continuously moved up.

There was also another set of companies that emerged and became huge wealth creators in that period. These were the Information Technology and domestic Pharmaceutical companies. Cost cutting was the first reason that triggered outsourcing by companies from the US, which lead to the emergence of companies like Infosys, TCS, Satyam, Wipro, etc., which leveraged the labour arbitrage at the initial stage before moving up the skill ladder slowly over the next several years. Investors who invested in these companies at an early stage made multibagger returns despite the huge crash in the years 2000 and 2001.

Domestic Pharmaceutical companies took advantage of the low cost manufacturing and skilled manpower to start supplying generic products to the developed markets as medicines started going off patent. This included companies like Ranbaxy, Dr Reddy’s Labs, Sun Pharmaceuticals, etc. This phenomenon has continued strongly even till date, where Indian companies are now extremely strong in the global generic space although many have tried and failed to actually come out with any new product.

These companies continue to be wealth creators even now. Both these sectors did well as they had high return ratios, high cash flow generation and no policy risks from the government. Also, both these sets of companies leveraged the growth opportunities in developed countries, specifically the US, to grow rapidly.

As the second round of economic reforms and investments started in 2002-03, another strong set of wealth creators emerged in the form of Public and Private Sector Banks. The initial rally was started by Public Sector Banks that were holding a huge amount of government securities, which created major capital gains for them as inflation fell and bonds rallied. New generation Private Sector Banks, with their strong risk management, low political interference and focus on profitable growth have been wealth creators over the last decade.
[PAGE BREAK]

The last decade has also seen homegrown FMCG companies coming up in a big way. Companies like Asian Paints, Pidilite Industries, Dabur, Marico, etc. have been huge wealth creators with their high return ratios and strong cash generation.

Several companies from core sectors like cement, automobiles, telecom etc. have also been strong wealth generators for long-term investors. However, due to cyclicality, the returns from these sectors have come in waves and there have been periods of strong and weak returns.

Wherever government interference or policies impact, the growth of companies have seen periods of strong returns when policies have been supportive and extremely poor returns when policy has been a hindrance, as has been the case over the last five years. There are companies that were the blue chips of yesteryears, but did not have a strategy for growth or shareholder value creation and have thus been waylaid over a period of time. On the other hand, there are those that have taken global competition head on, innovated on products, acquired capabilities by acquisitions and created shareholder wealth. This includes companies like Mahindra & Mahindra and Tata Motors.

The key to strong wealth creation over the long run seems to lie with generating strong cash flows, investing cautiously, walking away from unprofitable ventures, innovating on products and services, as well as recognising risks. Strong managements who understand their business and have been able to leverage domestic or global opportunities have been strong wealth generators.

Given the demographics of our economy and the fact that global growth opportunities might be muted for several years going forward due to fiscal correction required across the developed world, it is probable that the wealth creators of the next two decades might be those which are either domestic focussed or acquire strong global market access through the acquisition of capabilities via mergers and acquisitions on the global stage. However, it is also true that in a vast majority of products and services, the market share of India is still very small. Market share gains can still create huge growth in the global market place.

To conclude, I would say that equity investing over long periods of time in a diversified basket of stocks will always create inflation-beating returns. Patience is the key.