It is very hard to stop the present rally in the stock market
It is an unfortunate fact that there are several investors in Dalal Street who have preferred to stay on the sidelines and have not participated in the rally.
Initially, these investors were wary that that the dreaded CoronaVirus would come back with a vengeance and send the markets into a tailspin.
Now, they are worried that the markets are overvalued and are awaiting a correction.
Saurabh Mukherjea made it clear that this wait and watch approach is not a good strategy because the markets are unlikely to see a meaningful correction.
“It will be very hard to stop this market …. in an environment where earnings growth is going to be 25-35% consistently for several quarters to come for large companies, it will be very difficult to hold back the market …. for anybody out there, waiting on the sidelines worrying about valuations, life will be difficult,” he said in a blunt manner.
He explained that for the next four quarters, because of the YoY comparisons turning favourable, we will get even better earnings growth than the bumper quarter that we saw in Q3.
He pointed out that the only circumstance in which the market can see a pullback is if inflation comes back strongly and interest rates are hiked both in the western world and in India.
However, as things stand at present, neither of these events are likely to occur in the foreseeable future.
Don’t get suckered by low PE stocks
Saurabh is well aware that investors who have a left-out feeling are likely to make a grab for stocks quoting at low P/Es in the misconception that they have better “margin of safety” as compared to the high P/E stocks.
He strongly warned against the practice.
“Do not get suckered by low PE multiples into getting into sectors which are capex friendly but which have a really troubled history of broken balance sheets and poor governance,” he said.
He advised that we should instead follow the “Marcellus way” of investing by avoiding heavily regulated sectors like metals, power, infrastructure and real estate where it is very difficult to generate return on capital above the cost of capital.
The better way is to play the economic upcycle through three cyclical sectors, namely, auto and auto ancillaries; Banks and NBFCs and building material i.e. tiles, pipes, paints, adhesives etc.
He also advised that we stick to clean, well run and high quality companies with a long track record of high quality capital allocation.
High conviction stocks from various sectors
Saurabh revealed that he prefers to invest in second rung lenders which are well run and have a good balance sheet and tier one ratios in excess of 20%.
AU Small Finance Bank and Aavas Financiers fit these requirements.
“We have been very clear that over the next three, four, five years, there is a lot of money to be made in India by investing in high quality lenders and high quality savings plays. AU Finance, Aavas are part of that strategy for Marcellus. We also obviously have the traditional lenders HDFC Bank, Kotak Bank, Axis Bank and so on. We are adding the second run lenders,” he stated.
Auto and auto ancillaries
Saurabh is also gung-ho about the auto sector.
“The second space where we have very enthusiastically increased our positions through 2020 was auto and auto ancillaries,” he said.
He revealed that his portfolio has bought stocks of large-caps like Maruti Suzuki and Eicher Motors and also small-caps like Sterling Tools, Lumax and Suprajit Engineering.
“That is this theme where we are very confident that over the next one or two years, even if EV makes a meaningful entry into the Indian landscape, these firms will do well. We are adding these stocks. You will need car headlights and hence you will need Lumax. Even with EVs, you will need fasteners for your car and hence you need Sterling Tools. So auto and auto ancillaries remain an exciting space,” he said.
Saurabh pointed out that the specialty chemicals sector has great scope because the West and China want to reduce their production because of the environmental hazards associated with it.
That production will have to go somewhere and a big part of global specialty chemicals production is coming to India, he said.
His favourite stocks are Divi’s, Alkyl Amines and GMM Pfaulder.
“There seems to be an enormous demand. The most obvious way to play this is to play the main supplier of this industry GMM Pfaudler,” he said.
“In the next one-one-and-a-half years, demand and production pipelines are full for the special chemicals industry and we are looking for other ways to monetise this,” he added.
Saurabh opined that the building materials sector is set for a two-three years bumper run as the real estate cycle turns down.
Some of the top stocks in the building materials sector include Astral Poly, Asian Paints, Pidilite and Berger Paints.
“These are traditional Marcellus favourites and we continue with those,” he said.
Saurabh revealed that Divi’s Lab and Abbott Laboratories are his all-time favourite Pharma stocks.
Divi’s is more a play on API rather than pharma per se, he said.
Divi’s does not make the formulation. It supplies APIs which go into formulations. It is one of the leading API suppliers in the world.
“A steady 20% compounding in this company should be possible over the next five, six, seven years. Among the export centric pharma plays, Divi’s would remain our chosen play,” he stated.
Saurabh described Abbott as “the most moated company” because their stable of products is without comparison in the domestic landscape.
He pointed out that the stock is presently flat because the FII holding is capped out at 75% and more FII money cannot come into the stock.
“The Abbott franchise in India has enormous potential and it will keep bringing better products from their western stables and adding into the formidable line up they have in India,” he opined.
Agreed its not just about low PEs. Quality compounders that have proven ability to deliver thru cycles are never usually ‘cheap’. Gokulram Arunasalam