So, you talked about premium consumption, and it looks like there’s still some headroom left within that because the bulk of that trading is also done and it’s not just Covid right now.
Mihir Vora: surely. Therefore, durable goods should continue to perform well. Because theories like per capita are still valid. Among automobiles, the SUV segment will probably continue to perform well. It already accounts for more than 50-60% of the market, and is expected to continue to do well in the future. We are talking about hotels. What we’re talking about is travel and tourism, airlines, all those areas could be better. Even in real estate, we can see that premium real estate performs better.
So it’s basically an upper bound on consumption that is likely to outperform. But now that many naysayers are talking about a frothy small-cap market, that view is out of line and undergoing a bit of a correction. This is a time when others are saying large-cap stocks are safer. You guys are coming up with a small-cap fund. Please explain the rationale behind it. Isn’t it difficult to choose stocks at this level?
Mihir Vora: Absolutely not. The good news is that the market is actually quite rational. In other words, while many stocks have set new highs, there are also many stocks that have not. For example, the entire chemical pack, the entire defense pack, the railroad pack, many of these stocks will actually be modified by 20-30-40%. In fact, the chemical sector is down 30% two years after its peak. Many stocks in the IT industry also adjusted. As a result, the market fluctuates wildly, and small-cap indexes, for example, are high because, as these stocks correct, pharmaceutical companies, for example, catch up. So there are a lot of other segments that have caught up. So the headline numbers tend to mask a little bit of the underlying churn that’s happening in that segment. And whether we like it or not, mid-cap and small-cap stocks now account for 40% of market capitalization.
is that so?
Mihir Vora: yes. So 20 years ago, the top 100 stocks accounted for about 82% of market capitalization.The top 100 stocks accounted for 82% of the market capitalization.
Mihir Vora: Large cap. Today, that percentage is close to 60%.
But how much of the market capitalization comes from small-cap stocks?
Mihir Vora: Although such an analysis is possible, if you look at the price-to-earnings ratio of a small-cap index, it is exactly the same as the price-to-earnings ratio of a large-cap index. And if you look at small-cap earnings growth, if you take loss-making companies out of it, small-cap earnings growth is actually twice that of large-cap stocks.
No, I understand. What I’m trying to say is that I remember reading somewhere that 40% of market capitalization is in small and mid-cap stocks, but only 20% of revenue is in small and mid-cap stocks.
Mihir Vora: I wouldn’t say that because we need to get rid of some of the big bank and telecom related losses and things like that. Taking that into account, the numbers probably aren’t that skewed. Because according to the data we have, the P/E ratio after two years is high. Large-cap stocks are similar to small-cap stocks, so their percentage returns shouldn’t be that different. Mid-cap stocks, the middle 150. So the top 100 are large-cap stocks, then the next 150. If you aggregate those 150 again, I don’t like looking at aggregates, but if you look at aggregates, the P/E ratio is much higher, about 27 versus 20 for large and small stocks.
You talked about the value on the table with respect to chemicals, defense, and railroads. Let’s take defense and railways. Because they, like the index, have experienced significant truncation and departure from the top. But that means, structurally, we’re still confident about these two areas.
Mihir Vora: absolutely. These are long-term themes that we have identified. We talked about that during the flexi-cap, so that won’t change in about six months. The whole argument is that for the first time the private sector entered the defense field and now the private sector has entered there and has uncovered industry after industry. For example, in pharmaceuticals, we are starting from scratch, the private sector has come in, and we are world leaders. The same goes for IT services, and the same goes for cars and car parts.
So why not defend?
Mihir Vora: With the private sector coming in for the first time, the runway for growth could be very long.
So the defense story is a big one, but there are two ways to think about it. Look at government-backed companies. These companies are authorized to provide sophisticated security on order or by appointment. Or is it a better idea to look at private companies, which are going to be quite large in terms of defense business?
Mihir Vora: Actually both. There aren’t 50 stocks to choose from anyway. So I think both are possible. Although there are only a small number of government-linked companies, they will continue to be the nodal institution, ultimately because governments trust their public sector units.
So the entire manufacturing sector and the ecosystem will get a bit of a boost. But should you start increasing your IT allocation now, or should you wait a few more quarters?
Mihir Vora: You know, big IT companies, I think they’re boring companies. We are talking about growth rates between 6% and 9%. I think we are back to pre-COVID-19 levels of growth. Therefore, it is frankly the small and medium-sized enterprises in the IT industry that need to make stock picks.
The same goes for private banks: are old companies boring, or is there still hope?
Mihir Vora: No, private banks still have scope to take market share away from PSUs. PSU is still big. So it’s not as boring as it sounds.
