The India Story: 10 Time-tested Investment Trends

The last word on the global financial crisis has not been said yet. Just when many thought that capitalism was dead, things started looking up. The world quickly went into the recovery mode, led by emerging markets such as India and China. But the fears of a return to crisis-mode have not entirely gone away. In particular, most pundits think the US is not out of the woods. The developing global situation will very much be a consideration for the Indian investor, though the country, itself, is poised for a much more rapid growth phase. Short-term trends suggest a thousand things to confuse the investor. To bring clarity in this age of uncertainty, we looked at trends that have held true through the ups and downs of the world economy over several years. They represent the strong undercurrents of the economy and may very well last deep into the future.

Infographics by Minal Shetty & Hemal Sheth

Past: Since the last five years, the Indian markets have given the highest returns at 27% annually when compared to its other BRIC counterparts. This outperformance came with lower volatility.

Present: Many observers put India only at the second spot in investment attractiveness and give China the thumbs up, because India’s impressive growth is still slower than its northern neighbour’s.

Future: But, India is the best opportunity in the next five years. This outperformance could continue given the bottoms-up growth of its consumer market. China is more over-valued and more volatile.

 

Past: Government deficits and interest rates must typically move together. But this relationship was broken between 2003 and 2008, when interest rates fell even though deficits were rising.

Present: The yield on benchmark 10-year government bond is catching up rapidly with the fiscal deficit since 2008, as if to undo the divergence of the previous five years.

Future: The government’s spending on infrastructure and social sector will keep the fiscal deficit high. We may be looking at a high interest rate regime.

Past: In the last 18 years, the government has increased its dependence on market borrowings to bridge the deficit, from 18 percent to 99 percent.

Present: Its domestic borrowings will be high, supporting high interest rates and sucking out liquidity from the financial system.

Future: Whenever the government enters the market, bond yields would rise. Bond prices will fall giving an attractive window for fixed income investors.

 

• The asset turnover ratio has declined from 1x in 2002-03 to 0.84x in 2008-09. This suggests that companies have built capacities for the future.
• Financial leverage (equity multiplier) of the companies has remained around 2 times throughout the period, but has shown a marginal decrease over the last few years, possibly due to the easier access to the equity markets.
• The primary driver for ROE has been increase in profit margins.
• Investments in fixed assets have increased substantially from 2006-07 onwards, on account of higher growth in the economy
• Return on Net Worth in 2008-09 decreased on account of decline in corporate profitability in the second half and many companies made forex losses.
• With global economies coming out of recession, India’s corporate profitability would improve and so would RONW.
• Investment in fixed assets is expected to remain healthy. Particularly, sectors like telecom (3G capex spend), power, oil & gas and Infrastructure will take the lead.
• Dividend payout is expected to increase over the longer term with the telecom and real-estate industries starting to reward shareholders.

 

Past: Rising commodity prices led a drop in the growth rate of profit margins between 2003 and 2008. In 2009, the situation worsened with the onset of the crisis.

Present: Margins came back with falling input costs.

Future: Management of commodity cycles will be crucial.

Past: Despite rising input prices, Indian companies gained in EBITDA margins through higher sales. However, the crisis spoiled the party in 2009.

Present: But employee costs have been going up.

Future: EBITDA margins would remain range-bound near 27 percent, higher than 25 percent seen in 2008-09.

 

 

 

Past: FIIs clearly lead the rise in the stock market and appreciation of the rupee.

Present: The weakening of the dollar is driving more FII flows towards India and the higher-yielding rupee. This will support the markets and eventually lead to a stronger rupee.

Future: The outlook for the economy looks increasingly encouraging. India and China are the most attractive destinations for FII inflows. So, foreign interest is not likely to abate anytime soon.

 

 

Valuation theory, which says higher growth attracts higher PE, works well in Indian markets. This works both ways, on the upmove but especially during a downtrend. Take a call on GDP growth and you could get the markets right.

 

There seems to be a fairly low positive correlation between bond yields and Nifty P/E (around 0.37). Higher yields mean higher borrowing cost for companies and thus lower profitability. Naturally, P/E will go up until the market prices it in.

Infographics by Minal Shetty & Hemal Sheth

Crisil Research is India’s largest, independent and integrated research house
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