Ridham Desai: Mid-Caps Are the Way to Go

Ridham Desai, strategist and head of Morgan Stanley's India equity research, talks to Forbes India about what to expect from the equity markets in the next two years

Published: Jun 20, 2011 06:47:20 AM IST
Updated: Feb 17, 2014 12:45:23 PM IST
Ridham Desai: Mid-Caps Are the Way to Go
Image: Alok Brahmbhatt
Ridham Desai, MD heading the Indian equity research team at Morgan Stanley

Ridham Desai
Age: 43 years
Career: Managing Director heading the Indian equity research team at Morgan Stanley; industry experience of over 20 years; previously an equity analyst at UBS
Interests: Formula 1, music and fitness

Indian companies have a return on equity (ROE) of 16 percent. What are the kind of returns you see going forward?
I think ROEs will only go up from here. In the past, we have had huge capex cycles and by 2008 we have seen a fall in asset utilisation ratios which brought down ROEs. But things are improving. We think that from here onwards they will move up to 20 percent. Essentially, the markets are trading at around 15 times forward earnings and I think 15 percent growth is not a bad deal at all.

Will they peak up to the 2007 levels of 23 percent?
It will take some time to reach that level as growth has to come back. We will get there by 2013 or 2014. In the previous cycle of 1994 to 2002, the ROEs troughed at 11 percent. This time they have troughed at 16 percent. This number, interestingly, was the high point of the previous cycle.
I think capital in India is very tightly managed and Indian companies are very frugal in the way they spend capital. But over the next 10 years we will see a fall in ROEs as interest rates start to fall and cost of capital also comes down for Indian companies.

What’s your view on mid-sized companies?
For the last six months, we have not been recommending mid-caps at all. But now we are. Over the last six months, we saw better prospects in large-cap stocks but today, our focus is more on stock picking than on the index. You will have to be a longer term investor for around 12-24 months [for mid-cap companies]. At the current valuations, I don’t see why investors won’t make money in this space because mid-caps have more value than large-caps. In 2009, we had the same view. It is not that mid-caps moved instantaneously, but over two years the segment has given good returns.

What were the concerns from international investors regarding policy changes in India?
Investors do not have large expectations as far as policy changes are concerned. They are more concerned about the inflation outlook and what happens to global commodity prices. If global commodity prices fall on a more sustained basis, then the outlook on India will change.

Can inflation hamper the India growth story?
Technically, India is facing a problem but structurally we don’t look at India having such a big problem because of inflation. I think our current potential growth rate is around 8 percent. I think that we can deal with inflation which is around 5 percent. India, historically, has never had a hyper-inflation problem. We haven’t gone through hyper-inflation like the Latin [American] economies or some of the Asian countries. The current cyclical inflation problem will recede as time passes and revert to our long term averages [of] around 5.5 percent.

What are the challenges for the India growth story?
The long term story is intact. There are some cyclical challenges. The biggest challenge is to revive the investment cycle. Much of the things to revive the investment cycle are in place. The corporate balance sheets are looking good. Profit cycles and demand is good. Policy response from the government in terms of correction in commodity prices is something that needs to happen. We need to have a better outlook on global growth. We need to have a clearer policy on energy, where we know where energy prices are moving and focus on infrastructure spending. Also, de-bottlenecking of railways is important where we have got into some capacity constraints.

(This story appears in the 01 July, 2011 issue of Forbes India. To visit our Archives, click here.)

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  • Indira Singh

    how much potential have rest in indian midcap company

    on Oct 6, 2014
  • Noel

    Why is that the wrong midcaps get the attention of the market. There are few good ones like; kpit; sasken; sonata; subex; binani zinc; kale; hexaware; geodesic; wwil; zee news; geometric; patni; mindtree; etc. which are performing but not going up.

    on Jun 30, 2011
  • Utpal Jalan

    At present what is happening is tactical, who in this world can afford to miss out on growing* story of India that too on a huge human base. Ofcourse INR is not a reserve currency and hence benefits associated with this may not fuel the growth story as it helped US and Europe, but still there is a story which is yet to unfold. The only concern is that India is costliest economy? sound strange? Base all the cost of living to per capita income ratio and any one can find India is at least 1.5 times costliest than US or Europe!! But still India consumes, Coz there is virtually no inclusive growth.

    on Jun 21, 2011