Aggressively Priced Small-Cap Stocks Are An Area Of Concern, Says Anup Maheshwari
DSP BlackRock sees potential for 20 percent plus earnings growth in next one year.
Valuations of small cap stocks are significantly higher than they were even a year ago, according to Anup Maheshwari, executive vice president and head of equities at DSP BlackRock Investment Managers.
The large cap stocks are relatively better off, from a valuation standpoint, and DSP BlackRock is seeing buying opportunities in the top 300 companies by market capitalisation, Maheshwari told BloombergQuint in an interview.
He expects earnings growth to accelerate to 20 percent or more by the next financial year, which if sustained over the next five years, could justify current valuations.
Here are edited excerpts from that conversation.
Valuation Concerns
How do you read valuations currently, and based on that, do you expect a time-wise correction if not a price wise correction?
Valuations are to be looked at from a market-cap context. Over the last three years, you have gone down the market cap chain, valuations have become more expensive. Smaller companies have become much more expensive than their larger peers. So our area of concern is in some really small companies which are too aggressively priced, that becomes a challenge in terms of future returns. These companies might be very good but we have to make sure that there is return potential from them. But as you go up the market cap chain, we are not seeing valuations being as stretched. They are definitely higher than they were few years ago. But there are enough bottom-up opportunities as we go up the market cap chain that are still worth looking at.
We do recognise that we need earnings growth to pick up quickly to justify some of the valuations that exist today. We are confident that the earnings growth will come through but there’s a bit of forward pricing of that in the markets already.
Having said that, for investors there is a lot of interest in the equities, at the moment. There’s a lot of money chasing markets today which can tend to push markets more than we normally would like. So there is always this challenge of the ideal valuations you would want to buy at versus the reality of the market. If take a slightly longer term view, and you have earnings growing over the next five terms, then you can pretty much justify some of the valuations existing even today.
Pick-up In Earnings?
You have also mentioned that corporate earnings, when taken as a ratio to the GDP, are at 10-year lows and you are expecting earnings to return over the next couple of years. What will drive earnings growth?
In the very immediate term, in the next one year, there is a lot of reversion to mean happening, which is creating this potential for 20 percent plus earnings growth. It’s coming mainly from some of the banks that have reported a drop in profits in the last few years, some of those profits are coming back. Similarly commodity stocks. We’ve seen seven or eight names which are creating growth in the coming year just because of the base effect. What will be more important is, after this base effect plays itself out, will you continue to maintain growth? That’s something we’ll have to keep evaluating from stage to stage. But, right now, we do feel that next year should be a higher growth year. And as of now, even FY19, at least corporate commentary, seems to be on the rising path not on the declining path. Hopefully we’ll have a capex cycle come up somewhere two to three years down the road and that should also help in terms of earnings growth subsequently. So we are a little more comfortable on earnings in the coming year and then we have to keep re-evaluating to see that further sustains or not.
Geopolitics-Led Corrections: Buying Opportunities?
What are the geopolitical factors that could determine the direction of the markets going forward?
Geopolitical is way too difficult to predict. Geopolitical factors often come unannounced. We are aware of a lot of conversations, the world over, about some tensions in various regions of the world and politically dispensations are a lot more more aggressive at this stage. We’ve got some problems with our own neighbours at the moment. It’s difficult to gauge, how out of hand they can get at a point in time. Ideally, if they stay the way they are, market will focus more on corporate earnings, but if there is any blow-up there, in the short run what tends to happen is people forget about earnings. The short run tends to be more psychological for the markets and very position-driven. If there is an event like that, you may get a correction, but then the key question to ask is - does this impact corporate earnings fundamentally or structurally in any way. If the answer is no, there is an opportunity to buy. That’s how we normally see such events.
Large Caps: Safe Havens?
Are you suggesting that there is more value in larger caps and that is possibly a safer place to play right now, as compared to the relatively smaller ones?
Yes, that’s exactly what I am saying. There are some interesting opportunities in the larger caps. And if you have high liquidity, cheaper valuations, more stable companies, that can withstand negative cycles better, then it’s always an interesting place to look at. That would be a first port of a call. Of course, there are some wonderful companies as you go down the market cap chain - new companies coming through, great entrepreneurship, but you have to look at some of these in the context of the price that we are paying for them. And there is no doubt that the valuations today are considerably higher than what we would normally have paid if you rewind back just a few years ago. So I think we find more opportunities within the top 300 by market cap.