The markets hit all-time high last week. MOTILAL OSWAL, chairman & managing director, Motilal Oswal Financial Services tells Puneet Wadhwa that he expects foreign institutional flows to remain strong over the next few quarters, given the promise of political stability and concurrent prospects of economic reforms, coupled with a strengthening rupee. Edited excerpts:
Do you think the current market levels are sustainable?
We stand at a great divide now. While earnings have been largely flat over the last three years, market indices are touching new highs. Our research team estimates a healthy 21 per cent earnings CAGR (compounded annual growth rate) over the next three years, aided by a low base of H2FY17 and recovery in metals, public sector banks (PSBs) and oil & gas stocks. Current valuations leave little margin for error on the earnings front - any disappointment could trigger a correction. Yet, the earnings season has been positive so far, with most companies reporting in-line, or better-than-expected results.
Also, the macro backdrop is conducive - inflation under control, twin deficits within tolerance limits, government sticking to the fiscal consolidation path, and stable currency among others. Goods and services tax (GST) bill is on track for implementation from July 2017. The Bharatiya Janata Party's (BJP's) strong showing in the recent state and other local elections should provide tailwinds for further reforms. With all these positives, the current market levels should sustain.
But some experts expect growth in corporate earnings in FY18 to be in early teens. How do you respond to that?
We expect Sensex EPS (earnings per share) to grow at a CAGR (compounded annual growth rate) of 21 per cent over FY17-19, significantly higher than three per cent CAGR over FY12-17. Cyclicals would drive the performance, in our view. For FY17, we expect Sensex EPS to decline one per cent to Rs 1,309. The low base of FY17 (especially H2FY17, due to demonetisation) should aid a sharp rebound in FY18. We estimate 20 per cent growth in Sensex EPS to Rs 1,572 in FY18, followed by 21 per cent growth to Rs 1,904 in FY19.
Which sectors and stocks, according to you, will lead the next phase of market rally from here on?
While most sectors are currently trading at a premium to 10-year average valuations, I do not think we are in a bubble zone. In my view, the biggest risk that investors need to be mindful of is probable earnings disappointments - current valuations leave little margin for error on the earnings front. Delivery of the projected earnings growth is crucial for valuations to sustain and expand.
How do you see foreign institutional flows playing out over the next few quarters?
I expect foreign institutional flows to remain strong over the next few quarters, especially given the promise of political stability and concurrent prospects of economic reforms, coupled with a strengthening rupee.
Do you see active retail participation?
Retail participation tends to increase in rallying markets and is usually the highest at the peak. I expect an increase in active retail participation with rising market indices, more so in the derivatives segment. However, I would prefer that lay investors use the mutual fund route to invest. This is because stock-picking is an expert's domain. Though it is easy to equate high returns with smart stock-picking, one should understand that in rallying markets, even poor quality stocks often deliver disproportionate returns.
In which sectors and stocks do you find valuation comfort at this stage?
While most sectors are currently trading at a premium to long-term averages, valuations of capital goods, healthcare, metals, oil & gas, technology and utilities stocks appear reasonable. However, this does not necessarily make all stocks in these sectors great buys.
What more policy action do you expect from the government in its remaining tenure?
Political stability lends itself well to economic reforms. The government has made significant progress on GST, which should be implemented in July. I believe, it will now turn its attention to the pending agricultural, banking and labour reforms.
What are your targets and plans for your business for the next fiscal?
The overall business model is moving towards annuity revenue sources. This, coupled with strong incremental shares, is driving visibility of earnings and growth. Our operating metrics remain strong. We achieved an ROE (return on equity) of over 20 per cent, and believe this is sustainable. All our businesses offer huge headroom for growth.
Capital market business contributes less than 50 per cent of your revenues. Will this fall further?
While the share of capital markets has reduced, it still continues to grow in absolute terms. The linear / annuity nature of earnings from the housing finance and asset management businesses is complemented with the potential upside offered by the capital markets businesses. Even within broking, our distribution business has seen traction this year, and the trail-income based earning model from distribution should give an annuity component even to the broking business, as this business scales up even further going forward.