6 essentials of a long-term equity portfolio

Markets are not far from their all-time high. Nothing looks wrong when markets are rising.

Many of us get tempted to invest in smaller and under-researched companies, hoping that they could become multi-bagger stocks someday. The other extreme could be to completely ignore the lofty valuations and invest only in a handful of large cap companies as if they are endless compounding machines.

Plus, some investors also find the appeal of attractive investment themes and unique strategies too compelling to resist.

Are you wondering how to construct a long term portfolio of stocks when markets are firing on all cylinders?

Time to go back to basics! Because, falling markets make many of us insomniac.

Investing should be more like watching paint dry or watching grass grow. If you want excitement, take $800 and go to Las Vegas—Paul Samuelson

There’s nothing wrong in placing a bet on hidden gems or investing in evergreen companies or pursuing any investment strategy or following the next ‘big thing’. Nonetheless, it’s imperative to strike the right balance.

Here, Benjamin Graham’s advice would come handy.

Buy not on optimism, but on arithmetic—Benjamin Graham

If you are shopping for common stocks, choose them the way you would buy groceries, not the way you would buy perfume– Benjamin Graham

So, what does arithmetic say about Indian stock markets at this juncture?

India’s market cap as a percentage of GDP was 57% at the end of FY20—thanks to massive price erosions caused by fear of the unknown on the onset of lockdowns. However, the unprecedented market rally (and fall in GDP) since then has already pushed the market cap-to-GDP back to ~80%.

Are markets expensive, again?

Note: GDP at current prices (Base year 2011-12)

# GDP is assumed 10% lower vis-à-vis that for FY20 and the present market cap is considered for the purpose of calculation of Market cap-to-GDP ratio

(Source: ACE Equity, BSE,RBI)

Massive liquidity infusions by governments across major economies to stave off slowdown fears have caused synchronized rallies in global equities. For instance, the market cap to GDP ratio in the US has touched 150%.

In justification, some experts argue that the US economy is home to some of the world’s finest tech-giants which have near monopoly businesses. True, but the bankruptcies filed by US companies in the first 9 months of 2020 have been the highest in the last 10 years for comparable time periods in those respective years.

Portfolio construction clue #1: Breaking down macro-data could be crucial for analysis but that should be treated only as a starting point. Relative performance of a market/economy matters a lot more.  

The composition of US equity markets is strikingly different from that of Indian markets. For instance, tech companies have a complete dominance in S&P 500 while India’s Nifty 500 still reflects old-fashioned sectoral weightages.

Who’s going to ride the tech-revolution?

(Source: S&P Global, NSE)

But does that mean India is going to miss the tech revolution and perhaps the Industry 4.0 moment?

In fact, India is likely to implement tech solutions to bridge the gaps in its growth map. Let’s not forget India’s average mobile data consumption is amongst the highest in the world. And the Direct Benefit Transfer (DBT) programme for LPG was the world’s largest DBT scheme.

Portfolio construction clue #2: Every market is different. Depending on demographics, socio-economic growth models, stage of development, composition of key indices would change. So please don’t compare oranges with grapes just because both of them are sweet and sour.

In the real world, things generally fluctuate between ‘pretty good’ and ‘not so hot.’ But in the world of investing, perception often swings from ‘flawless’ to ‘hopeless’—Howard Marks

Lately, some sectors have been experiencing the inverse of the above in Indian markets.

TCS became the second-Indian company to cross the benchmark of Rs 10 lakh crore of market capitalization a few days ago.

If you thought this was a great achievement for one of India’s oldest IT companies, this could perhaps just be a stopover in its marathon run. The company is optimistic about its future growth prospects.

As you would appreciate, Indian IT companies were perceived as mature and stable companies with low-growth prospects, until recently. And many investors couldn’t think of a fifth name beyond obvious 4—TCS, Infosys, Wipro and HCL Technologies. Now that the pandemic has accelerated technology adoption among businesses, suddenly, tech companies have made a comeback in the good-books of investors.

In fact, at the Q2FY21 earnings call, Rajesh Gopinathan, CEO of TCS, expressed that we could perhaps be at the start of a multi-year technology transmission cycle. The tech giant expects a massive technology-led transformation in the area of consumer experience and employee experience to play out over the next 5-10 years.

Needless to say, companies using technology intelligently can reap high dividends of the current phase of tech transformation.

Portfolio construction clue #3: In a rapidly changing geo-political, socio-economic and business landscape, it’s imperative to invest in a company that’s technologically ready for future challenges. IT isn’t a growth tool anymore, rather for many companies it’ll be the primary determinant of their survival in future.

What else should you look for?

Slicing macro data differently, we found that the top 500 listed companies in India collectively clocked revenues equivalent to ~40% of India’s GDP over the last 5 financial years.

Dominance of the top 500 companies…

(Source: ACE Equity, RBI)

But guess what, contribution of the Top 100 companies alone was in the high twenties. And, 169 out of 500 companies managed to beat their 4-year average net profit growth in FY 20. Interestingly, they were spread across the spectrum of market capitalization and industries.

Some of them have been domestic plays while a few others have been export-focused companies. It’s noteworthy that, a few PSUs too managed to record higher profit growth in FY20 as compared to their 4-year average.

Do not take yearly results too seriously. Instead, focus on four or five-year averages—Warren Buffett

When you combine this quantitative data with qualitative information, short listing stocks for your portfolio may become easy. In the current context, you may want to look at companies that are increasing their tech-competence since it’s believed that the post-pandemic business world is going to be more digital.

For instance, ICICI Bank recently launched iStartup 2.0 through which it claims to have introduced many industry-first features for the start-up ecosystem to address their banking and beyond banking needs, such as instant payment of GST, automatic bank reconciliation and inward-outward remittances amongst others.

Early this year, HDFC Ltd. announced that it will invest Rs 100 crore every year in tech start-ups.

And these are not isolated examples. In fact, India’s full-service digital banks have been redefining Indian banking.

Other consumer facing companies aren’t far behind.

FMCG companies such as HUL are going beyond SMAC (Social, Mobile, Analytics and Cloud) and slowly embracing DARQ (Distributed Ledgers, AI, Augmented Reality and Quantum Computing) to meet new challenges of business such as customization and contact-less on-demand delivery.

Manufacturing industries are also preparing themselves for greater automation and use of digital technologies such as on AI, edge computing, cloud technologies and additive manufacturing to stay competitive.

Usually, big companies have a strong financial muscle to keep up with tech-capex. Again, please don’t generalize. Evaluate companies at a more granular level.

Time is the friend of the wonderful company, the enemy of the mediocre— Warren Buffett

Portfolio construction clue #4: Bluechip companies benefit disproportionately as a country prospers. However, smaller yet well-managed companies also stand to gain in the process of economic growth. The key here is to narrow down on companies that have seen a growth momentum, which clearly reflects in their financial performance.  Going beyond tech-readiness of a company, you should try to evaluate the competence and efficiency of a management to make intelligent use of technology. Soon, Return on Information Technology (ROIT) may become an important indicator in corporate communications.

Besides the above 4 portfolio construction clues, you must analyze financial strength, market share and ESG compliance of a company.

Finally, 6 essentials…

  1. Your portfolio should have adequate proxies on India’s economic growth.

  2. A portfolio should be comprised of a mix of large cap, mid cap and small cap companies.

  3. It should cut across multiple investment themes and sectors of the economy.

  4. Companies to be bought in the portfolio should be future-ready.

  5. Financial strengths and impeccable governance record are important stock selection parameters.

  6. Last but not the least, valuation of a company matters since it decides the level of profit you make.

Where can Ventura help?

Our research analysts and experts navigate through thousands of data points to spot investment ideas. As and when they discover anything interesting, they share the same with readers/viewers. So be it a stocks breaking out of sideways patterns and warming up for a rally, or a hidden gem which is expected to do well in future, our experts make a quick video or write about it.

Here’re some glimpses…

A detailed report on CDSL

A quick update on India’s tea market

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All these inputs can help you stay a well-informed long term equity investor.

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Please Note (read as a disclaimer): None of the stocks discussed in the article are recommendations to buy, hold or sell. This could just be the starting point for deeper analysis that you might want to carry out on your own. You may also take professional help as you feel appropriate.

 

Disclaimer

We, Ventura Securities Ltd, (SEBI Registration Number INH000001634) its Analysts & Associates with regard to blog article hereby solemnly declare & disclose that:

Consult your financial advisor before taking any investment decision.

We do not have any financial interest of any nature in the company. We do not individually or collectively hold 1% or more of the securities of the company. We do not have any other material conflicts of interest in the company. We do not act as a market maker in securities of the company. We do not have any directorships or other material relationships with the company. We do not have any personal interests in the securities of the company. We do not have any past significant relationships with the company such as Investment Banking or other advisory assignments or intermediary relationships. We are not responsible for the risk associated with the investment/disinvestment decision made on the basis of this blog article.

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