IT stocks may have tested a bottom, a sharp correction from here is unlikely: Raamdeo Agrawal
The stock market is at a record high. Is there room for more upside?
These days, I am getting a lot of foreign visitors. They are telling me that India is a bright spot and are willing to pay for the stability. Valuations are high compared to other emerging markets (EMs) but they have a whole set of problems. If we compare ourselves with China as of now, India is in a better position. China is not liked very much today. But it is a large growing economy and remains competent in manufacturing. At 9-10 PE, China is cheap and I am bullish on Chinese markets. That doesn’t take away our merits. If we are able to engineer a 7% growth over the next few years, I don’t think it’s there in the price.
Cyclicals like PSU banks and industrials are the hot themes nowadays which are not the conventional ‘buy and hold’ stocks. What is your advice to investors?
‘Buy and hold’ is applicable only to consistent companies. They are typically about one-fifth of the market but are very expensive. In volatile companies, since earnings are not predictable, you cannot buy and hold forever. You can buy them very cheap. But whenever they become expensive and performance starts showing, you have to sell. Managements will guide you that this is the new normal but there is no new normal.
How long will the rally in PSU banks continue?
We think this is the mother of credit cycles and that’s triggering the valuation re-rating. At its 2008 peak, the price-to-book (PB) value of the
rose to about 3 times. After that, it crashed to 1. In 2018, again, it crashed to 0.8 times. Now, it is trading at around 1.8 times. Will it go back to 3 times? My sense is yes. But one should not say that at PB of 3 times, it’s a fantastic earnings story. That’s the mistake we make. There will not be consistency in valuations; it will be volatile. A lot will depend on how long the credit cycle will last. If it is a 7-8-year credit cycle, then the decade will belong to public sector banks such as . My understanding is political interference is not a concern anymore; the government is talking about appointing long-term chairmen. The government’s focus should be to bring consistency to these banks. That is when valuations become less volatile and long-term foreign investors look at them.
Is the worst over for IT shares?
It needs to be understood that the downcycle is in the valuation of these companies. In the last 20 years, there is not a year when the industry’s profits have not grown. The execution is top-class for top companies such as TCS, Infosys, , and . Now, L&T is executing very well. That is why the market is imparting them high PE multiples, which is not unreasonable. Don’t forget that the market itself is at 22-23 times (price-to-earnings ratio). is at 27 times, and is at about 24-25 times. So, the valuation premium is around 15%, which has come down from about 30%. It’s quite possible in the entire corrective phase for IT stocks, the valuation would be limited to the market valuation levels.
So, will you be a buyer in IT stocks at this juncture?
The point is that despair in valuation is not there right now. The stocks have tested some kind of a bottom and if the strength of the order book continues, then it’s very unlikely that the sector will see a significant decline from here. I would be scared if these companies do not form a good portion of my core portfolio from a buy-and-hold perspective. Even in buy and hold, you will have to go through corrections. So, right now they’re at the median. I would say a 5-10% decline below the median of 27 times could be a good time to buy.
Are mid-cap IT companies cheap after the correction?
No, they are not. Actually, the world thinks they can grow faster. But history has shown that’s not true. Companies like LTI-Mindtree are growing faster because of their management execution capabilities. I would be sceptical about the rest of the smaller IT companies.
You have been a supporter of new-age businesses. Are you disappointed in the way the market is seeing it?
I’m disappointed in myself. We couldn’t see the hype cycle. We had said that the hype will not last for more than six to 12 months. And yet we fell for that trap. These are large and exciting businesses but the issue is what valuation these companies should get. While they keep painting a positive picture, at the end of the day, they are loss-making. I think the unicorns are going to have a tough time. They are out of time and they will have to change their ways of losing money. They also have to find in the visible future ways to make money. New-age businesses have fallen from the phase of optimism to despair in the stock market cycle. I think 70-80% of the despair is over.
Do you expect telecom’s relative underperformance to end soon?
It’s a lost decade for the industry and even now it’s not making any economic profit. There is too much competition in the industry. So, the telecom infrastructure is great but the industry profitability is quite poor. It looks like everybody is tired of spending money and now they want to make money. My sense is that this could be a decade for telecom.
and are among the top wealth creators as per your study. How are the group companies being assessed?
Our knowledge of Adani group companies is limited. That said, it’s now a large and prominent group. It has grown fast and consistently also in the past five years. That has made their valuations very demanding.
