In an interaction with Vinay Jaising, MD, Portfolio Management Services of JM Financial Services Ltd

India is looking relatively stronger than the rest of the world both in terms of earning visibility and growth which should make the equity markets outshine, believes Vinay Jaising, MD, Portfolio Management Services of JM Financial Services Ltd

Can you provide a general evaluation of the present equity market situation?
 

If we were to look at YTD numbers, MSCI India is flat, underperforming NASDAQ which is up 24 per cent and MSCI World which is up 8 per cent and MSCI EM 2 per cent.

(Source- Bloomberg)

Going ahead we expect the Indian market to outperform the global peers as:  

1. India’s higher valuation compared to the rest of the world has corrected – From a peaked of 110 per cent compared to EM; and 52 per cent compared to MSCI World we now stand at 72 per cent and 22% premium respectively.
2. On an absolute basis though the Indian market is only 1 per cent below its peak; we have been largely in the 16k-18k band for the NIFTY 50 for the last two years despite an impressive 25 per cent CAGR in earnings in the same period. We are now trading at of 20 x F2024 earnings which is in line with our 5-year average multiples.  
3. In the Debt market the World seems to be going back to a Risk off trade and appreciating higher Earnings visibility and economic stability and betting on India.  This can be seen in the negative carry of the 2 year – 10-year Interest rate of US which increased from 50 bps top 75 bps in the last month. Even the absolute interest rates in US have gone up by almost 50bps during the same period with 2 year being at 4.56 per cent and 10 year being at 3.8 per cent.  As against this India has witnessed almost 20-25 bps reduction in the 2 year – 10-year Interest rate which are 6.83 per cent and 7 per cent respectively, with a positive yield of 17 bps. The positive yield of India and lowering rates as against negative yield in US suggests a possible recession in US as against steady state economy growth in India specially in its domestic front.

(Source- Bloomberg).

c) Quarterly Results of ~400 companies have come out for 4QF23 showcasing sales growth of 13 per cent and PAT growth of 19 per cent YoY. The importance of this result and strong growth is shown in its QoQ Sales growth of 4 per cent and PAT growth of 33 per cent excluding financials. In F2023 India Inc. has witnessed a revenue growth of 23 per cent and PAT growth of 10 per cent..

This has led to positive earnings revising for India Inc. All the misses came in Global facing sectors – IT, Healthcare and Metal; largely due to global slowdown and hence weaker revenue growth

(Source- Capitaline, JM Financial).

What are the specific parameters you look for selecting Small-Cap companies? 

With the Indian market growth by a CAGR of over 16 per cent in the last 20 years, the definition of Small Cap has changed substantially.

In December 2011 a Company under USD 400 million was considered small cap. Today in 12 years this number has gone up 5-fold to USD 1.9 bn. The SEBI defines a small Cap Company as the 251^st company in Market cap and lower. Today we have over 5200 listed Companies

So the question is rather more Complicated – Is there really a difference between selection of a small cap or a large cap company. We think the answer is NO, however the spade work for selection stocks in small cap is tougher than for large cap.

We use a two prong approach for our portfolio construction:

First we focus on our Macro view of India; the key themes we think will play out in the current environment and which has longevity in earnings. Then we look at bottom up analysis on look at each company individually focusing on a) Industry and b) Company strengths. On Industry we focus on finding those which have a growing secular market, which is scalable and sustainable.  The industry should be in growth stage on the business cycle with pricing power and higher margins leading to consistency of ROCE and high FCF and high quality profits

On Companies we focus on their moats and competitive advantage which could be a Cost or Technology advantage. Management quality, Corporate Governance; Forensic analysis of its Balance Sheet. Valuation plays an important role along with Margin of safety and earnings growth viability after we understand the business model of the company.

In the case of Small Cap Companies, our selection criterion remains the same; however we prefer a small fish in a big pond as against a big fish in an aquarium. The spade work for small cap to gain these parameters is however tougher than for large cap.  

 What is the maximum drawdown you are comfortable with for small-cap stocks? 

The average daily trading volume in India today has moved leaps and bounds. NSE, the largest index in the country has a daily Cash turnover of Rs 534 billion up 5 fold in last 10 years from Rs113 bn in 2012. Surprisingly the volatility of the small cap index at 22 per cent in the last 20 years is similar to BSE Sensex the large cap index.  However, the same cannot be said when it comes to individual stocks. We have time and again witnessed huge volatility in small cap. Individual stocks. Here we use 2 principals to guide us during drawdown a) Discipline b) The Core thesis of our investment of the stock.

On discipline every 15 per cent move of the stock downwards or upwards we reassess our investment rationale including our assumptions to our models. In case   our thesis is playing out however stock is falling for some technical reason which is not a governance issue we build up our scale.  And the other way round if our thesis is getting weaker and the price is correcting we do not shy away from selling. Normally we give some time to analysis because our decision is having a drawdown; however if the drawdown is 25 per cent or higher it could trigger our stop loss policy if we are not convinced with our thesis. To us it is important to do something with massive drawdowns; i.e. Buy more to average or sell due to lack of conviction

Taking NO ACTION is something we rarely do.

After underperforming in the last one and half year, what is your outlook on the performance of the small-cap stocks compared to Large-Cap stocks in FY2024? 

Firstly; let us look at Data: in the last 18 months’ large cap has moved up 7 per cent and small and mid by 6 per cent each; so really there is nothing to differentiate. In a 3-year horizon however small cap at a CAGR of 41 per cent has outperformed large cap which has grown 25%. In a 20-year horizon again all the caps have surprisingly given similar returns of 16-18 per cent.

Hence, we believe one should not look at a company based on its current capitalisation but more so at its future prospects which makes it a large-cap company. Industry selection is key to success along with a positive Macro environment.

The Indian economy is vibrant for growth for all kinds of Companies – HDFC the Country’s largest bank has grown at 20 per cent CAGR in profits for the last 8 years. During the same time, the profitability of the small cap index has gone up by 14 per cent and 11 per cent for the large-cap index. The P/E for Large Cap and Small Cap is around 20x and 19x respectively.