Why tumbling Sensex, Nifty could be good news for you

Global markets are in a tizzy over a debt crisis in Europe. Investors always wait for a correction in the market to enter. The general tendency in India is to be risk averse. There are only 4 crore mutual fund investor accounts in India. The number of demat account holders is much less than that. Everyone wants to make money in the stock market. But they do not want to lose. 

If you have been waiting on the sideline to buy equity shares or invest in equity mutual funds, the fall in share prices could be your chance to get in.

Here are some pointers: 

Why are shares down: Indian equity markets are part of a global financial system. Foreign institutional investors own nearly half of the free float of top listed companies in BSE 500. Free float is the non-promoter holding in a publicly listed company. When FIIs are net buyers, shares rally and when they sell, shares fall. Foreign funds are disillusioned about India. They are not really pulling money out of India. They are not putting any new money either. Instead, they are looking to buy elsewhere in Indonesia and other markets. The reason is not because Indian equities are doing badly. They are miffed with the uncertainty over tax issues. They are also not convinced that the government in India is serious about controlling its expenditure and reigning in the budget deficit. These issues matter to large institutional investors looking for long-term growth.

What this fall means for you: Indian shares get beaten down. They are falliing not because companies are likely to perform badly. They are falling because a category of investor (FIIs) plans to stay out of investing in Indian equities. This is an opportunity for those waiting on the sideline. You have a market where share prices are falling but profit growth is not. As a thumb rule, good companies clock a profit growth higher than the growth in country’s gross domestic product. Worse case predictions put India’s GDP growth for 2012-13 at 6 per cent. Morgan Stanley, a large global bank, expects Indian companies to grow profits at 16 per cent despite all macro-economic headwinds. Morgan Stanley thinks that companies could report stable profit margins (profit as a percentage of net sales) going forward and expects the net profit growth of frontline companies. “While this may not be a high conviction call, we believe the market is pricing in very little in terms of growth,” Morgan Stanley told its clients recently.

Share prices only follow growth in profits: Stock market prices today are a factor of profit expectation tomorrow for companies. Research from leading investment banks, stockbroking outfits suggests no contraction in profits for Indian companies. Morgan Stanley points out that a country’s investment rate helps corporate profit growth. This is the rate at which money is invested for productive growth. It currently stands at 34.4 per cent of GDP. The investment rate has fallen from 38.1 per cent in 2007-08. However, it would take a dramatic drop in investment rate for corporate profits to suffer. Also, top companies could increase dividend payout during 2012-13. Foreign investors are concerned that corporate profits in India are too dependent on government policy and external environment. 

It is not just Morgan Stanley: “Either way, with Nifty below 5000, it appears a good time to accumulate fundamentally strong stocks from a 12-month perspective as they have corrected sharply and the prospects of further easing in global liquidity mean flows may come back in a few months,” said Macquarie, an Australian Bank on Indian equities last week.

Why are valuations attractive: “We believe that, unless the world spins into another crisis, it is difficult to imagine that Indian equities will go substantially lower on a relative basis,” said Morgan Stanley in a strategy note last week. This is because the historical valuation of Indian equities in terms of ‘share price to book value per share’ is much closer to the bottom than to the peak. Book value per share is assets of a company divided by the number of equity shares outstanding. According to Morgan Stanley’s analysis, the value of MSCI India index (tracked by almost all foreign institutional investor for allocating money to India) is at a multiple of 2.5 times the book value. During the peak in the market, it was over 6 times and has fallen below 2 or around 2 times when shares fell to their bottom in 2001 or 2008. Typically, investors begin buying at current levels.

Government is showing an intention to control subsidies: The announcement on a cut in liquefied petroleum gas cylinders that could save the budget over Rs 4,000 crore should be seen as a step towards fiscal consolidation. The government has to rein in subsidies if it wishes to meet the fiscal deficit target of 5.1 per cent of the GDP. The fall in the rupee value is also because of poor budget management by the government. Increased borrowing by the government makes RBI’s job to manage liquidity in the financial system difficult. The central bank also has to sell forex reserves to prop up the rupee. If the government acts on the intention to curtail expenditure, it would stem the rupee fall.

Corporate executives are not that bearish on future growth: About 91 per cent of senior finance executives surveyed in India by American Express Group said that they were confident of meeting growth targets. They said their growth prospects would be more dependent on domestic sales than on exports over the next two years. Also, nearly half (47 per cent) of Indian CFOs were not keen to tap their cash reserves over the next year. The executives believe cash reserves would be mostly for funding ongoing operations or to finance acquisitions and expand operations. Large Indian companies are sitting on a pile of cash. They flagged the sharp rupee fluctuation as the biggest worry. The Indian rupee rose sharply in February 2012 but fell 9 per cent since March 2012. Companies are more concerned about the volatility than the direction of the currency.