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Noted ex-fund manager Nilesh Shah, now MD of Kotak Mahindra Asset Management Company, believes most investors are better off doing systematic investment plans (SIPs) into fund schemes.
But he says that if you still want to do active stock picking, here's how you should do it.
Here's Shah's check-list: go with companies that throw off a lot of free cash flow and do not need frequent equity dilution, those that put a premium on sound governance and whose business models cannot be easily replicated.
In an interview with CNBC-TV18, Shah also talked about his near to medium term outlook on the markets, saying that a confluence of good news was helping equities.
He also discussed his views on several sectors, including IT and pharma. While pharma could be invested in from a three year view, he said IT companies could win by investing into their future.
Below is the verbatim transcript of Nilesh Shah's interview to Anuj Singhal & Sonia Shenoy on CNBC-TV18.
Anuj: Your theory is that today is the best time to start in systematic investment plan (SIP) but from retail investor's point of view some of them have participated in this market let us give them credit where it is due but a lot of them have missed out as well what is the next strategy?
A: The strategy remains the same; in a triveni sangam if I can call it we have mixture of flows right now. Sentiments are improving and fundamentals will eventually improve. Flow wise you have seen the power of liquidity. There are more buyers than sellers between mutual funds, foreign institutional investors (FIIs), insurance companies, retail and high networth individuals (HNIs) investors, pension funds and new pension scheme.
The buying of Indian equity this year will be anywhere between Rs 1,75,000 crore to 2,25,000 crore. The supply of paper is going to come from government's divestment and Initial public offering (IPOs) which might just range between Rs 1,20,000 crore to Rs 1,50,000 crore. So, unless until one of the large holders of Indian equity which could be promoters which could be FIIs turn out to be net seller this demand supply equation will continue to support prices.
The sentiments are improving because of passage of goods and services tax (GST) bill, because of good monsoon, because of 7th pay commission, because of some work done by the government, because of some improvement in global economy. Net-net entrepreneurs as well as investors are feeling more bullish about economy and market.
Finally, we are looking at earnings growth to recover which has been missing for last eight quarters. However, now with monsoon coming and interest rates coming down, liquidity improving there is reasonable good chance that earnings also will recover eventually. In this kind of scenario obviously, prices remains ahead of fundamental and if investors come via SIP route that will be the best option for them.
Anuj: Are we making the mistake of going by the past earning and I am just looking at the FY17 earnings and saying this market has become a bit expensive. Could this market go through an expansionary phase something that we saw in early 2000 as well?
A: If I want give the argument that this market is not very expensive or this market is still fair valued that will driven by the fact that they expected trajectory of interest rate is on the downward side. Globally, as well as locally interest rates will continue to decline which means the price to equity (P/E) ratio has to expand which means not only you will benefit from the earnings growth which comes because of the lower interest cost at the borrower level, it will also come through valuation re-rating as the overall risk free rated comes down.
The second thing is related to overall profit kitty. Normally profits have averaged somewhere around 6 percent of our gross domestic product (GDP). Today because of the downward cycle it is averaging somewhere between 4 to 4.50 percent of GDP. Even if we average it at about 6 percent it means there could be 33 percent rise in the profit from here and hence today's valuation doesn't look fair value plus but looks more like fair value. So, there are equal arguments for supporting the valuation at today levels. Who knows where the prices will settle, but the fact remains that we are seeing a conflicts of liquidity, sentiment and fundamentals which is a deadly combination for investors return.
Sonia: Your motto has always been to buy and hold on to a fundamentally solid stocks and it brings me to two stocks that you have always told us about Asian Paints and Eicher Motors both are sitting at new highs today. The example that you keep giving us if you rather bought an Asian Paints share rather than paint your house you could have bought a mansion today and similarly if many years back you would have bought into Eicher Motors shares rather than a bike you could have perhaps bought yourselves BMW or an Audi today. What is the evergreen stock of tomorrow? Where do you see the themes that can make you a lot of value say over next 10 years?
A: It is very difficult for us to give stock specific comment. Let me give you some of the characteristics of stocks which will create value for shareholders. Any stock which is generating free cashflow and which doesn't require dilution of capital I think they are big compounder. We have seen stocks like Motherson Sumi or Sundaram Finance which has never come out for capital market rates. MRF also will fall in that category. So, anyone who is very stingy with your capital who doesn't come to you for capital more often has a better chance of creating wealth compared to let us someone who is regular visitor to capital market.
The second thing which has happened in Indian market inline with global market is the premium for governance, premium for valuation. If your balance sheet is made depending upon the real fundamentals and not made to order to accountants then certainly that balance sheet will always carry more value.The premium for governance will continue to grow in the days to come, so focus on companies where premium on governance is very high.
The third thing is the business model, is it a model which can be replicated by others without too much of a trouble or is it a business model which is difficult for replication and hence you can be reasonably sure of sustenance of your profit. So, businesses which display this characteristic, good governances, less competition, less need of capital this are characteristics which will hold good for 5 -10 to 15-20 years.
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