Old stories vs new stories
Savvy investors will hunt for mulitbaggers in good old, beaten down sectors than wait for expensive sunrise sectors

Equity investors are in the constant quest for a sector that will fetch them extraordinary returns. The trouble is, only one or two such sectors are born in a decade, and the great returns from them go unmistakably to the private market first. The private market referred here being private equity or venture funds.

By the time promising companies from a sector get listed, their valuations are already in the stratosphere that the chances of a retail investor holding a multibagger from a new sector is rather low. When too much money chases a new stock, that builds up long-term risks for those holding the scrip.

To illustrate, e-commerce is now seen as a sunrise sector, but no retail investors has got a chance to hold a leading e-comm share in the last five years, though the valuations are already in the billion dollar terrain.

Similarly, internet security and quick service restaurants are also being touted as the next big things. There is hardly a listed opportunity in those sectors, but for the exception of those quoting at high-risk valuations.

In such a setup. instead of looking for new stories to invest, investors can have a re-look at existing sectors where the macro-structure is changing and a re-rating of the whole sector is expected. Only that the sector should have a good number of choices to diversify portfolio risk.

One doesn’t need to go through complex analyses to spot structural changes happening in a sector. A simpler way is to look for a change in the factors that created trouble for that sector. This could be for any reason, like government policy change or internal dynamics leading to a shakeout—where weak players are absorbed by large players with cleaner balance sheets.

Another factor to look at is whether the news flow about the sector is negative. When the general view about a sector is negative, the stocks in that space become cheap. In contrast, if the market is bullish about a sector, the stocks tend to be expensive. Careful bottom fishing tends to give superior returns.

At this point, probably two sectors are undergoing macro-structural changes that are not fully appreciated by the market. There could be reasons for this, like investors lost money in the past on false alarms about positive changes or the pace of structural changes is slow to match a bull phase of the market. The Street tends to ignore such cases, when faster short-term returns are available elsewhere. But outsized returns come only when an investor take an intelligent risk.

The two sectors meant here are, real estate and PSU banking. The real estate sector has been at the receiving end of the market for years now. But finally, things are changing for the sector. It is now mandatory for all states to set up a Real Estate Regulatory Authority to oversee the sector. The presence of a regulator generally improves the sector’s profile, though there would be short-term pain. Over a period, the sector becomes cleaner and bigger.

Just look at the way the stock market developed after it got Sebi as a regulator in 1992. In 25 years, the size and reach of the Indian capital market has grown 100 times or more.

With real estate getting a regulator, fly by night operators in this market would find it tough to operate. All those who have graduated from being property dealer to real estate developers are probably going to become dealers again. Only companies with a reasonable size of balance sheet will now be able to float new projects. Many troubled players and projects will move into the hands of large companies. Already, many unorganised players have started approaching big players for joint development of projects.

No doubt, the sector will emerge stronger from the current pain but it won’t happen overnight. Since this structural changes are market-driven, they will take time to show up in company bottom lines. So, investors will have to be patient after making an extremely careful choice. Only players who are not over-leveraged and have a reputation for on-time project delivery should be looked at.

The second and a more critical sector undergoing structural changes is PSU banking. More capital is set to flow into public sector banks, which will now have more disciplined borrowers than before. Going forward, no promoters will take a bank loan for granted. So, PSU banks, which will remain focussed on corporate lending, will witness a sea-change in their operating environment a few quarters down the line.

Massive provisions made in the past will come back as higher income and earnings in their balance sheets. The sudden flush of money will also lower the cost of funds for the banks. Plus, the sector will see a phase of consolidation, which would give large banks with solid macro-structure a much higher valuation than now.

Though PSU banks are unlikely to make greater inroads into the retail space, the mammoth corporate lending space alone is good enough for these banks to grow their loan books at a decent pace.

Let the bad news pour in, but savvy investors will ignore it and stay focussed on companies and stocks where growth would multiply when good times return. After all, a stock won’t become a multi-bagger in a year or two. It’s a patient game.


(Rajiv Nagpal is consulting editor, Financial Chronicle)

Rajiv Nagpal