Indian Equity Market Entering A Positive Phase

Nirmal Jain, Chairman, India Infoline delves into factors that have fostered the Indian equity market and believes that this is a favourable territory, in the long term if not immediately, though some volatility might continue in the near term.

• The liberalised Indian economy and the subsequent global integration have undoubtedly made the equity market more dynamic. The fact that favourable policies related to international trade and investment, privatisation, deregulation and tax reforms continued irrespective of the ruling government, definitely boosted the Indian entrepreneurial community to tap the capital market.
• Large-Caps offer a much better investment opportunity and a significantly lower investment risk compared to Small and Mid-Caps. It is important not to chase valuations blindly, or even price for that matter and most retail investors have fallen prey to this.

In the last two decades, the Indian equity market has traversed multiple cycles; short and long, thin and broad. The cyclical upsurge may have been triggered by different factors at different times, including rapid GDP growth, improved macro fundamentals and sector-specific success stories. An important point to note is that consistent outperformers in most cases have been Large-Caps. For instance, industry leaders like HDFC, ITC and Hero MotoCorp have delivered annual returns of 29 per cent, 28 per cent and 30 per cent respectively, since 1991.

Large-Caps typically command premium valuations but there is always the comfort factor that the losses, if any, are cushioned. Mid-Cap carnages have become a regular feature in our market. In our opinion, Large-Caps offer a much better investment opportunity and a significantly lower investment risk compared to Small and Mid-Caps. It is important not to chase valuations blindly, or even price for that matter and most retail investors have fallen prey to this.

A deeper probe into these tales of triumph reveals the two-fold enabling environment in which these prospects flourished – high quality of management and favourable governmental environment entailing minimal hurdles.

At a broad level, the liberalised Indian economy and the subsequent global integration have undoubtedly made the equity market more dynamic. The fact that favourable policies related to international trade and investment, privatisation, deregulation and tax reforms continued irrespective of the ruling government, definitely boosted the Indian entrepreneurial community to tap the capital market.

The consequential impact of growth acceleration, the beginning of new enterprises coupled with large disinvestments and new listings have already had a big expansionary effect on India’s market capitalisation. In early 1993, when the reforms process had just begun, India barely had any billion dollar companies listed on the BSE. Contrast it with today’s largest company (TCS) whose market cap is Rs 3 trillion. Many of the first-generation companies were professionally run, with considerable employee ownership, linking rewards to long-term value creation for all stakeholders. Not surprisingly, many of them have been multi-baggers in the last two decades.
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A look at some of the prominent value creators – HDFC, Reliance, Kotak, Sun Pharma and HDFC Bank among others, reveals the key success drivers – high quality people at the helm in terms of competence, governance and ability to identify scalable opportunities; strong market positioning and innovation in product and service offerings. These factors have enabled companies to deliver consistent growth.

With a strong growth in GDP and personal incomes in the two decades, sectors closely linked to the economy such as financials, healthcare and consumer-related (FMCG, Auto) have been among the prominent value creators. That the IT sector was best leveraged to employ the country’s skilled low-cost manpower has been amply seen in the value it has generated in a short span. In terms of ownership, private companies being more efficient and aggressive than public companies and have dominated the value creation process in the equity market.

The criticality of good governance and good government becomes even more relevant if you look at what is happening with some sectors and companies. The aviation sector has failed to take off due to stringent regulations. The Satyam saga has become synonymous with bad corporate governance. A prominent wind power company is hit by constant headwinds due to its inability to allocate capital efficiently.

The Indian equity market provides wider avenues and products to participate in the wealth creation process than any other asset class. Gold, which has been the flavour of the past decade, has actually given a modest annual return of 7.7 per cent since 1991 as compared to an average of over 20 per cent delivered by value creators in the Sensex. During the same period, the Sensex has given returns of 13.5 per cent per annum.

While value investors seek to identify great businesses trading at a discount to their intrinsic value, domestic individual investors typically respond to trailing returns and prefer low volatility. With global economy showing signs of stabilisation and domestic economy bottoming out, we see equities entering a long positive phase. While volatility may continue in the medium term, long-term investors need not be worried about it. They can gainfully place faith in selective value creation opportunities that the equity market continues to provide.