Where should you look for the next multibagger?

There is a lot of scope for some of the utility stocks to do much better, says S Naren, CIO, ICICI Prudential AMC The portfolios which you manage are centred around buying into utilities. They are cheap and are big beneficiaries of low interest rates. What is the way forward for utilities which normally do well when rates are coming down rather than a pro inflation environment?Actually we were looking at it recently. We researched stocks where valuations are very cheap relative to history and we came out with utilities. It is still the cheapest sector relative to history at this point of time. And that continues despite the move in the last three months because you have to look at how it is on a one-year basis or a three-year basis and I believe that what Covid showed us in the last one year is that there are things which you cannot live without -- electricity, IT and telecom. These are the three things which you cannot live without and that is why utilities have to get rerated more. They have done well in the last three months but on a one-year basis, many of the stocks continue to be underperformers. There is scope for them. If you compare utilities against another sector like metals, it has drastically outperformed utilities and there is a lot of scope for some of the utility stocks to do much better from where they are at this point of time. That is how we look at it currently. One central argument and one realisation for all of us has been the importance of digitisation and the relevance of Indian IT companies. Do you think that the IT companies are fully valued or could this be a structural trend rather than a sugar rush?Initially, we thought that this is like 2008 and we were a bit cautious. Then we realised that after Covid we could have seen a structural change in growth and that growth could have gone up structurally because at the end of the day, the kind of investment that every company has to make in technology -- be it the work from home (WFH) framework, the digitisation framework or an ecommerce framework -- has gone up significantly. We have to agree that post-Covid, the outlook is better for the Indian IT companies. When we did the same analysis for IT that we did for utilities, we found that IT is one of the sectors which has got drastically rerated compared to the pre Covid period. The question is how much of it has already been built in the stock prices? Maybe some of the companies will give us guidance this month and once they give the guidance, we will get an idea of how much is already built into it and how much has not built into it. Having said that, it is not just the guidance for this year which is important, the long-term growth guidance with changes which are going to happen is very important. There is a lot of dilemma whether for the next five years, the growth rate for the IT companies have gone up or not. There is a lot of thinking going on in our firm about the growth rate of the Indian IT sector due to what has happened in the last 12 to 18 months. Last decade we saw that companies which were reducing debt, and zero debt companies, companies which were extremely focussed on higher ROCE and higher return on equity did rather well. Could the reverse happen now? Over the last two years, I kept telling my colleagues to bet on solvent leveraged companies. There are so many people who said we will bet on solvent non-leverage companies and I used to tell them to bet on solvent leveraged companies. I never told them to bet on insolvent leveraged companies. But the reality is, in the last one year, solvent leveraged companies have done much better than solvent non-leveraged companies. I believe that the solvent leveraged companies for the next few years can do much better because the interest rates at which the solvent leveraged companies are borrowing today, is really a mouth-watering 3-4-5% for the next one, two, three, four years. Many of the AAA companies are borrowing at such low interest rates that I still believe that the solvent leveraged companies have a huge positive benefit which is coming out of low interest rates. There are companies which are just too cash rich and they do not know what to do with the cash and for a period of time they were the darlings of the market. But I am not that comfortable there. I tell those companies why don’t you return all the money back to the shareholders because anyway you are getting no return on the surplus debt that you are sitting on. If you look at it, at least three years back you were getting 7-8% in most of the debt mutual funds. Today if you invest in a liquid fund, you get 3%. So why not return all that money back to the shareholders? I think solvent leverage is a much better theme than solvent no-leverage at this point of time. I keep telling my colleagues that growth is something which will always be rewarded. This is a world where growth is not easy to get and that is why if IT companies are going to deliver good growth for the next five years and they are going to get very good valuations. That is the reality and we need to recognise that leverage in a limited way and not in an excessive way is a positive. But leverage in an excessive way may be negative like what happened to infrastructure companies in 2008-09-10. That is the way in which we have been looking at it and the last one year has been profitable for us in many of the stocks where we have invested in solvent leveraged themes. Market price is a function of EPS and PE. For the next three years, which end of the market do you think could surprise us with EPS expansion? Of course, if both happen, then we have a multi bagger. It is rare that EPS and PE multiples go up together?Clearly the cyclical part of the market is going to surprise us on EPS and I have seen that in the sectors which surprised us on EPS, for a few years PE also expanded. You might have both but all these parties can go down the day the global central banks say we want to spoil the party and we are going to increase interest rates. I believe it is the global central banks which are going to finally play spoilsport. But the last one year has been exceptional.

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