The mess at Karvy Stock Broking has actually dented stock investor confidence on brokers. What led to this? Was it a systemic failure?
Indeed, investor confidence has been shaken and several investors are shifting their demat accounts to larger, established players. While confidence in smaller, younger players may be impacted, there is a flight to safety to larger, established and regulated players.
These cases happen where businesses hold their own interests higher than clients’. It is not a systemic failure, but an isolated instance of breaking norms of prudent business behaviour.
We believe that the financial services industry is all about trust, and any player taking this lightly impacts the entire industry. The broking industry is unique in itself that it is made up of a milieu of long-serving smaller players, start-ups, and some trusted large banking companies.
Stockbrokers often crib about being over-regulated. But this kind of crisis keeps happening. Is the average investor safe with her broker?
Regulations are meant to safeguard the interest of the investors. In this case, it wasn’t strictly about regulation, but the interpretation of trust. The Depository Participant has a simple underlying principle that clients’ shares — while under Power of Attorney (POA) for administrative purposes — are held solely for them. They cannot and will not be used for anything else.
You don’t need regulation for this, but a culture of ethical behaviour. The investor must know that in financial services, he has to trust the intermediary. Trust is built over the years of keeping client interest paramount. There is a value to this. There is safety in this.
What should investors do to protect themselves in such a situation?
Be smart, follow basics. Investors must choose carefully whom they want to do business with. One must not open an account with anyone just because the office is close to home, a friend has recommended, or it has a fancy website. The critical question to ask is – can I trust the institution and the people behind it? It is, after all, your hard-earned money.
Let’s talk about the market. The indices have hit record highs while economic growth has slowed to a multi-quarter low. Isn’t that an aberration? What’s driving this rally? Is it sustainable?
There has been a disconnect between the macro-economic environment and markets, which could continue for some time. The Street seems to be factoring in a swift recovery in the economy, going by the rich valuations of the Nifty50. But we are not sure when the convergence between the economy and the market will take place. There is a mixed bag of factors in play here.
Trust is built over the years of keeping client interest paramount. There is a value to this. There is safety in this.
High-frequency indicators are not showing signs of macro improvement. But the broader Indices are close to near-highs. This is because of a faster recovery in earnings led by the corporate tax rate cut and lower loan-loss provisions for banks.
After the reduction in corporate tax rate, earnings have picked up in Q2FY20, and foreing portfolio investors (FPIs) have turned positive on India. Sentiment and flows are also driving markets higher as there have been some positive developments on the US-China trade war. The series of intervention by the Finance Ministry in the last two months has also changed the mood of the market.
There has been a remarkable difference in the performance of the top 20 stocks of the Nifty and the rest of the market. Most high-quality largecap stocks have benefited from the lower tax rate, and to that extent and their performance has further contributed to the Nifty’s up move.
Midcaps and smallcaps are the talk of the town. But since the last time we saw a rally in midcaps, the equation has changed with market regulator Sebi’s reclassification of funds. Can one expect midcaps to rebound like in the past?
If you look at the valuations, both the midcap and smallcap indices are trading at a discount to the Nifty50. The midcap index forward PE is at a 12% discount to the Nifty’s forward PE. (In the middle of this year, the discount of the midcap index vis-à-vis the Nifty50 had fallen to 20%).
Meanwhile, the underperformance of the smallcap index vis-a-vis the Nifty50 is closer to the three previous instances seen in the last 15 years. This portrays a good upside potential in the smallcaps against the largecaps. The midcap index too has broken the 200-week moving average on the upside and that could be a positive sign for the space.
For the mid and smallcaps to outperform the largecaps, we need a broad recovery in the economy with improved credit offtake along with better print of IIP and GDP growth. If the forthcoming Union Budget provides some incentives to taxpayers and investors, then we could see a broader rally in the market which could revive interest in the mid & smallcap space.
A base for future outperformance of mid and smallcap has been set in this calendar year which could fructify in next calendar year as and when there is a broader economic recovery. One can increase exposure in mid and smallcaps vis-à-vis largecaps with a two to three-year view.
Investors looking for value buys are facing a crucial question: which of the beaten-down stocks will rebound and which will probably never return to their previous highs again?
Investors need to be careful while evaluating value stocks and ascertaining whether they will recover or remain a value trap. Companies having deep value but lacking the ability to show revenue and earnings growth in future could be value traps and hence worth avoiding. Companies which are trading below their 10-year average valuations and can show revenue and earnings growth with recovery in their sector or economy, deserve to be evaluated and invested.
Investors should have a specific checklist or parameters like quality of management, promoter holding and pledged shares, margins, return ratios, cash flows, working capital, etc. before taking the final decision to invest in any value stock.
Excellent quality mid and smallcaps that have been beaten down due to the down cycle of the sector or economy and are available way below their RoE and RoCE, should be the preferred choice. Poorly governed companies with weak balance sheets and return ratios should be avoided as they may not be on investors’ and portfolio managers’ radar.
How do you read the outcome from the just-concluded Q2 earnings season? Some say the numbers were good for select stocks mostly because of the corporate tax cut?
The September quarter results were optically healthy on earnings but weak on revenue growth. EBITDA looks very high due to the adoption of Ind-AS 116. Net Profit figures for many companies are not comparable on a YoY basis as many of them have moved to lower corporate tax rate and reduced their deferred tax liabilities or assets to account for the lower tax rate. Adjusted net profit of Nifty 50 declined by 3.2% YoY.
Private sector banks reported weak earnings due to adjustment towards deferred tax assets, while SBI reported a significantly higher net profit as it continued with the earlier tax regime. Hence, if we see Nifty50 adjusted earnings growth excluding banks, then it has fallen by 10.5% in Q2FY20 on YoY basis.
Nifty50 companies that outperformed our estimates on PBT basis include Cipla, Dr Reddy’s, Maruti Suzuki, NTPC and Tata Motors. Similarly, Nifty 50 companies that underperformed our estimates are: GAIL, Hindustan Unilever, IndianOil Corp, Tata Steel, UPL and Ultratech Cement.
Sector-wise, banks, diversified financials, healthcare services, media and transportation delivered strong growth in net profit YoY while automobiles and components, gas utilities, metals and mining, oil & gas and telecom sectors declined YoY.