Three things you look in a company before investing – Growth, Growth & Growth

At Pi Square, the stocks we select show a major percentage increase in the current quarterly earnings per share (the most recently reported quarter) when compared to prior year’s same quarter. Historically, we have always seen that prices are slaves to earnings.  From 1990 to 2012 most of the very best performers in Indian Equity markets showed earnings gaining from 30% to 100% before their big price moves. So, if the best stocks had profit increases of this magnitude before they advanced rapidly in price, why should you settle for anything less? You may find that only 5% of listed stocks will show earnings gains on this size. But remember, you are looking for stocks that are exceptional, not lackluster. Don’t worry they are out there.

The EPS is the single most important element in the stock selection today. The greater the percentage increase, the better.   

We are amazed at how some professional money managers, let alone individual investors, buy equity when the current reported earnings are flat or even negative. There is absolutely no good reason for a stock to go anywhere in a big, sustainable way if its current earnings are poor. It’s not only quarterly EPS growth but consistent earnings growth and improving margins which shows efficiency of top management.  Look for top players in each segment, showing consistent growth and still priced at reasonable valuations. 

In February 2011, we analyzed FAG Bearings, second largest bearings manufacturer in India. It was valued at INR 795.00 on February 3, 2011. This is how last 4 quarters EPS numbers looked like.

Quarter	EPS	Growth (Y-O-Y)	Net Profit Margins (%)
Mar 10	13.52	61%	9.47%
Jun 10	20.36	82%	12.41%
Sep 10	18.92	90%	11.54%
Dec-10	20.31	105%	12.68%

At these levels in March 2011, FAG Bearings was priced at P/E of 10.00 and ROCE (Return on Capital Employed) of 31.60. Consistent growth, improving net margins and cheap valuations – FAG Bearings became a core holding for Pi Square Portfolio.  Below is the chart of FAG Bearings from February 2011 to February 2012.

In 12 months ending February 2012 FAG Bearings produced 76% returns compared to -8% by NIFTY (Index Returns).  FAG Bearings is a 100% debt free company with second largest market share in Bearings Industry.  FAG Germany owns 56% of total issued share capital of Indian subsidiary. In March 2009, FAG Bearings was priced at INR 277.00 (produced more than 500% return in just 3 years). 

As a retail Investor, keep your research simple and look for good valuations around you. Equity Investing will always reward a magical combination of growth and valuations. Don’t fall in trap of low book value or low P/E numbers – these are just numerical numbers without mix of business cycle or growth story attached.

-          Pi Square Research Team

Indian Equities 30% in 33 days.Seen it before? ....YES

Indian markets have started outperforming not only developed markets but also emerging markets in the correction phase. Indian Equities in local currencies has provided 20% in first 5 weeks and 30% in currency adjusted terms. Next question on every investors mind is “30% in 33 days! Seen it before?” Actually Yes. This rally – 33 trading days so far, and currency adjusted - only makes the middle of the 5 big rallies in the last decade. Lot of fund managers explained 2011 as a minor correction in the long term bull phase.

Change in valuation (1-Yr Fwd Consensus P/E) 100 Days into rallies

 So how is this rally different than rallies of the last decade?

a) More broad-based (relative mid-cap/small cap performance is second best)

 b) Starting from a relatively higher valuation (1yr fwd PE: 12.6x – second highest; range: 9x-16.5x)

c) Outperformance is led by the usual sector suspects (Materials: 16%, Industrials: 10%, Financials: 8% and as always

d) has been led by strong foreign Inflows, though this time there has been aggressive domestic selling (almost 50% of foreign buying). Not enough to say its ‘different this time’, but there are differences.

Liquidity driven rally has pushed emerging markets to next level outperforming Developed Markets once again in the recovery phase. India has led the global equity market rally: up 30% in 33 days in USD terms, 20% in local currency terms, and tracked closely only by Brazil amongst the relatively large EM’s. It’s in part a bounce-back from a very poor 2011 (-38% in USD), but it is nonetheless a very strong bounce-back.

India’s performance relative to EM’s (in local currency) has tended to be more middle of the road in the early part of the rally (local currency): with India Underperforming EM’s in the 2003 rally, and outperforming in the 2009 rallies (the two big EM rallies – the other two were a little more India-centric. Its USD based performance this time though is stronger than any of the other rallies in the early part; and that India went on to out-perform at the 100 day mark of these rallies suggests a very strong start.

Will this outperformance continue? We believe the jury is still out. In 2003, India was sitting on very low valuations and high operating leverage at the start of rally. And in 2009, valuations were a lot lower and while India did face a financing crisis economic momentum was only mildly interrupted by the slow down. This time, while the market’s start has been strong in absolute and relative terms; starting valuations are less compelling, and its economic outlook more tepid.

MSCI India relative to MSCI GEM in rallies (USD)

Leaders and laggards are pretty traditional:

Are the leaders and laggards very different this time? Not really: it’s the rate sensitives – Materials / Industrials/ Financials that drove the market. And it’s the traditional defensives – Consumers, IT and healthcare that make up the rear. We believe if the rally is to continue, then it will largely be these sectors that will lead, although materials will potentially be a little less predictable given the increasingly varied global driver. We also expect Consumer discretionary to potentially outperform going forward given their relative rate sensitivity and make more of a mark compared to the material sector.

Sector Leaders and Laggards in rallies (returns relative to MSCI India)

Conclusion:

We do however choose to run some risk and at the market level, stick with what we believe is fair value for the Indian market. Which remains 19,400 for Dec2012, based on a March 13 PE multiple of 14.5X, a slight discount to the markets long term multiple of 16X. We recognize the market mood has changed, there is more capital that is available (and that is critical for a market / economy like India), and there is probably a little less caution with the corporate sector than two months ago. But not enough has changed on the ground in the broader economy, or the corporate sector. We argue that while the macro and the market have moved favorably – the economy/corporate sector have to play catch up, and deliver in earnings, investment, expansion and risk appetite. From liquidity rally, we will see a minor fundamental correction which will allow long terms investors to enter again with high risk – high reward ratio. India is still a long term growth story and as at heart majority of India is still living in villages, actual growth will be seen in small and mid-size corporate in next 4-5 years.

Equities or Debt - what's my solution?

Retail equity investors always make a mistake of entering markets at wrong time and exiting at even worst point. Equity Investors are not happy given current market conditions and many investors have given up on investing in Equities all together. The average return given by the debt (short-term and long-term) fund category has been higher than those delivered by the Sensex, Nifty or the equity diversified fund category in the past three, six and 12 months. Alarmingly, even in the past two years, average returns delivered by equity diversified funds and key equity indices aren’t significantly different from those of debt funds. Given that equity is a relatively riskier asset class compared to debt, it is also expected to deliver better returns than the latter.

The fact that debt instruments have beaten equities in the developed markets, like the US, in the recent past, as well as over longer time frames of say 30 years only increases the scare if a similar situation could occur in India as well. If the trend in Indian equity markets doesn’t improve visibly from here on, the equity category might end up delivering below-par returns in the two- to three-year periods, as well. However, experts say though Indian equities have been laggards in recent times, a trend which may continue for some time, the asset class should undoubtedly outperform debt in a longer time frame of 3 to 5 years. This is why we feel it is important to balance your portfolio with right investment class at the right time.

EQUITY: A LONG-TERM PERFORMER
Scheme/Index	3-month	6-month	1-year	2-year	3-year	5-year	10-year
Debt Short-Term Average	8.45	9.25	8.38	6.72	7.84	7.91	6.74
Debt Long-Term Average	6.11	7.46	6.82	5.68	7.16	6.71	6.78
Equity Diversified Average	-3.08	-3.96	-17.03	7.4	21.71	7.26	24.7
BSE Sensex	-0.74	-4.91	-15.94	5.06	18.21	5.99	19.11
Prices of Gold	16.44	25.61	42.28	29.6	34.18	24.96
S&P Nifty	-0.89	-4.57	-15.88	5.91	18.92	6.78	18.13
Returns in %. For debt schemes, returns for less than 1 year are simple annualized, and greater than 1 year are compound annualized.
For equity diversified schemes, returns for less than 1 year are absolute, and greater than 1 year are compound annualized. Data as on Nov 4
Source: Icraonline.com

It is very subjective how you see long term equity returns. Value investors like Warren Buffet and Peter Lynch benefited from market corrections as they added majority of their portfolios when common investors were running away from the capital markets and valuations were attractive. If one manages his/her portfolio actively (shifting from equity to debt when markets are volatile or selling when markets are running above historical averages) it is very easy to secure 15-20% per year from equities. Warren Buffet has proved it over the years that fundamental investing can create life-time wealth for long-term investors.

Gold has been on an exceptional run for last few years outperforming every asset class. Gold has provided more than 24% p.a. for retail investors in last 5 years.

As we recently discussed with our research team, 2011 was the easiest and most predictable crash of recent times. Retail participation in equities has been very low in 2011 and very few fund managers have burned their hands this year with above average portfolio allocation. Pi Square financial advisers has been advising HNI Investors from start of the year to shift in debt and invest in equities below historical averages (post-August 2011). In short, the near-term outlook for the debt category looks good. But, if you are looking at equities with a longer-term horizon, of three years or more, this may not be a bad time to put in your money in bits and pieces.

For more information, please feel free to call us or email us at investors@pisquareinvestments.com

Thanks,

Vishrut Pathak

Pi Square Investments

Global Challengers 2011

Earlier this year BCG (Boston Consulting Group) came up with BCG Global Challengers 100 list, rising stars from rapidly developing economies are reshaping global industries. The 2011 global challengers are a diverse group, reflecting the dynamic nature of global competition. The list came from 16 countries, with China, India, Russia, Brazil, and Mexico dominating the list –although less so then they did in previous years.

Western corporate now fully recognize – even if they don’t understand – the rise of companies with global aspirations from rapidly developing economies. Established western brands such as Jaguar and Land Rover are now owned by Tata Group of India. Huawei Technologies and ZTE, both of China, are the second and fifth largest global manufacturers of mobile equipment, ranked by overall revenues. Mexico’s Grupo Bimbo is the largest bread baker in the world. Brazil’s JBS, the largest meat producer; and Russia’s United Company Rusal, the largest producer of aluminium. Revenue from these global challengers rose 18% annually from 2000 through 2009, triple the average annual growth achieved by both global peers and non-financial firms from S&P 500. All this reflects in return created by these global challengers. A long term, emerging market investor earned 17% p.a. compared to -0.7% from S&P 500 and 0.5% from Global peers.

The economic downturn took a tall on the total shareholder return of nearly all companies. But the performance of the global challengers has bounced back more quickly and strongly than that of other companies. It is very important for Long Term investors from developing economies to look at this new wave of growth engines of future. In 2011, BCG listed 20 companies from India, next only to china. This has been the greatest shift since 1999.

Seven Global challengers are from conglomerates; the most notable is Tata Group from India, which is operations in chemicals, communication, IT, beverages, automotive and steel sector. Over the last decade, the Tata Group has completed cross-border acquisitions whose value exceeds $17.5 billion. Tata Group now owns global names like Anglo-Dutch group Corus, General chemical industrial product, Eight’O Clock (a leading Coffee brand), Land Rover, Jaguar, British Salt and Tetley Tea. The Tata Group works collaboratively with its acquisitions. The acquired companies generally remain separate organizations and have operation freedoms. Tata also emphasizes the retention of top managers. The link that holds the acquisitions together is Tata’s corporate centre.

List of Indian companies part of BCG Global Challengers 2011

Name	Price (INR)	Market Cap (INR in Billions)	P/E
Bajaj Auto	1640.00	474.94	13.72
Bharat Forge	284.35	66.37	18.99
Bharti Airtel	377.90	1435.47	19.88
Crompton Greaves	137.90	88.43	13.93
Dr. Reddy Laboratories	1530.15	259.28	23.51
Hindalco Industries	121.65	233.09	10.37
Infosys Technologies	2722.70	1563.35	22.83
Larsen & Toubro	1336.00	816.08	20.22
Lupin Pharmaceuticals	465.00	208.32	28.63
Mahindra & Mahindra	801.10	492.44	18.19
Reliance Industries	835.40	2736.58	12.50
Suzlon Energy	36.15	64.34	19.33
Tata Chemicals	308.90	78.53	21.38
Tata Communications	182.70	52.16	30.91
Tata Consultancy Services	1048.25	2054.79	22.68
Tata Global Beverages	84.90	52.38	20.60
Tata Motors	177.95	526.25	31.06
Tata Steel	432.15	415.34	4.37
Vedanta Resources*
Wipro	353.90	870.12	16.30

 * Not Listed in India

Revenues at Indian equities are growing annually at more than 20% for last 3 years and are expected to grow at 20-30% for next 5 years. India provides a unique investment opportunity to create a lifetime wealth for long-term investors. Indian equities provided 717% returns in last 10 years compared to -0.7% for S&P 500.

For more information, please call us at +91-9925001805 or email us at investors@pisquareinvestments.com

-Vishrut Pathak

Pi Square Investments

(Download detailed copy of this report at  http://www.bcg.com/documents/file70055.pdf)