Ramesh Damani on consumption stocks, falling knife, DCF and valuing a company

http://www.smartinvestor.in/market/exptspks-82421-exptspksdet-Second_rung_consumer_stocks_are_fairly_cheap.htm

While Indian markets are range-bound, there are some uncertainties globally which include the US reaching its debt ceiling early next month. Domestically, events like RBI’s policy meeting on Tuesday and talks of FDI in retail sector are also keeping markets in a wait-and-watch mode. Jitendra Kumar Gupta speaks to Ramesh Damani, member, BSE on these issues. Excerpts:

Led by the optimism about falling commodity prices and that inflation rate might fall some time later in the year, people believe the markets could be better in the second half. Your comments.They are looking for a better second half. I am also in that camp. I will choose to be in bullish camp but I think the market needs to spend another 3-6 months in a consolidation zone. Generally, timing the markets is very hard. Only at the extremes of the markets, when they are over bought or oversold, it sometimes benefits.




Currently, the markets are nowhere at extremes of pessimism or optimism. We see nothing for the markets to say make their new life time high or for the markets to go down towards October 2008 lows.

However, the undertone is good and individual stocks are doing well. It is good time to buy individual companies and bet on. At this point do not expect any dramatic turn in the markets.

In the last six year, so many crises have hit India including the change in government and the global financial crisis in the 2008, but still the Indian markets are near 10 per cent lower to their all time peak. So, timing the market based on certain events like crude oil price going up or gold touching all time high generally does not work.

Key events you foresee?My sense is policy reforms will come from Delhi. For example, there will be change in norms for FDI in retail. All this tends to be good, but as the Indian economy has slowed down there will be some disappointment in terms of the results over the next ten days.

Do global events worry you?There are two big global crises that the people are pondering on. First of all, the US debt ceiling and what happens there. Does the US default once the debt ceiling expires. My feeling is no. Both the parties there—republican and democrats—are posturing that they will go to the brink but they would not go beyond the brink or default. That crisis is unlikely to take place. If it does, it would be a technical default. Everyone knows that the US is a solvent nation. In the sense, the dip in the market at that point in time will probably present buying opportunities in the US equities. Among other issues relating to the Euro zone, the markets have well discounted the Greece problem. Also, the good news is that the Greece accounts for just two per cent of the European economy. So keep your eyes on the price (of stocks).

A lot of attention is given to India’s consumption story recently. Do you see that as a theme to invest in?

The theme that is emerging out of this bull market in India is that any consumer centric business is actually given the best valuation multiple now. There is logic to this. We go down to a mall on Sunday it is packed. You take an airline to any metro city on the weekend it’s packed. Go to any fast food restaurant it is packed. So, the Indian consumers are for the first time becoming the growth engines of the economy. This is also a reason that lot of consumer stocks are catching very fancy valuations. I do not think it is an aberration. I think this is a new kid on the block. Consumers are opening their wallet and spending and are driving the economy forward.

May be you do not look at the first rung stocks which have already appreciated handsomely. But look at the second rung stocks the suppliers to the consumer industry, aviation industry or the logistic industry, which makes sure the supplies are all over the place. You will probably find good bargains in these areas.

Don't you think that most of these stocks have run up? Is there enough margin of safety?Probably, the margin of safety is not there. But, whenever we have seen the leadership in the market, like we have seen cement stocks in 1992 or the technology stocks in the year 2000, these stocks generally have long way to go. They are seen as expensive initially but as the earnings catch up they get re-rated and become even more expensive. I would probably not consider some of the front run stocks may be Jubilant Food, VIP Industries and United Breweries to name the few, but the second rung stocks are fairly cheap. The underling hypothesis is that the consumer boom is for real. How you play it depends on your skills as a stock picker.

Buying the first rung stocks while giving you momentum and excitement are not necessarily the place where you get the margin of safety and long term appreciation. But buying the second rung stocks will probably give you both.

We are looking at this consumer space very aggressively. Hypothesis that India is going to grow from 50 million consumers to 500 million consumers in the 20 years, and if that happens as some studies have suggested that would have profound implications on the spending and investments in this country in terms of housing, vacation, media, FMCG to name few.

There is this maxim ‘never catch a falling knife’. In the present context, when a lot many stocks are on free fall do you think that has lessons to learn?The maxim comes from the principle that a lot of people start buying just because the stock has fallen 10 per cent, 20 per cent or 50 per cent. This is fairly dangerous way to make a living. When we go back to the technology boom and see the so called K-10 stocks in that era, they fell from the peak they made by 50 per cent and then by another 50 per cent and then another 50 per cent. So, any time if you try to bargain hunt or catch the falling knife you essentially put blood on your hands. There is only one way to buy the stock, buy them when they are cheap and you do that by way of including variety of factors.

Can you briefly tell us such factors?We want to buy them cheap relative to its external opportunities. That’s the number one rule in the financial markets. If you buy cheap even in the case of a bad purchase decision you will be able to get out of it over a period of time. Besides, understand the market capitalisation, understand the discounted cash flow (DCF), price to earnings ratio and look at the external opportunities.

Do you really rely on DCF as your overall investment process?We try to find out the obvious. If I expect a business to make Rs 1,000 crore profit over the next five years and currently getting the same business at Rs 500 crore then you do not need to put that into an spread sheet and figure it out. It is not a rocket science. The way to do it is understand the market capitalisation and external opportunities. For instance a logistics industry, if say the Indian economy is suppose to grow from a trillion dollar to five trillion dollar there would be enormous movement of the goods. Also, with the introduction of the GST they will create a national market place for the first time. And today you are getting these companies at Rs 500-1,000 crore, which is clearly at the lower end of the spectrum.