Recently, champagne was uncorked and party balloons set afloat to celebrate the BSE Sensex’ tryst with 30000. And why not? The unique thing about this stock market rally is that, from its early stages in 2014, it has seen enthusiastic participation from domestic retail investors. The mutual fund industry is in a celebratory mood, having raked in over ₹1 lakh crore in new equity money in FY17, topping off ₹94,000 crore in FY16 and ₹80,000 crore in FY15. Nearly half of the inflows now come from systematic investment plans.
The EPFO after seeing its equity debut pay off in 2016, is eager to deploy over 15 per cent of its inflows in shares each year. The National Pension System received ₹1.33 lakh crore in contributions in FY17, with about 20 per cent of this redirected into equities.
No doubt, it is great to see Indian savers turning long-term investors in the stock market, after much coaxing and cajoling. But for investors to sustain this romance, they will need to enjoy a good return experience from their recent investments. Returns, in turn, can only come from a healthy pipeline of new business ideas and profit growth outpacing expectations for the listed firms. On both these counts, unfortunately, the Indian stock market is on a shaky footing.
For starters, while there’s a lot of new money flooding the market, where are the new investment opportunities to absorb it? Initial Public Offers (IPOs) are the key avenue through which firms with novel business ideas tap investors for capital. Therefore, it is a strong pipeline of new listings that makes a country’s stock market contemporary and vibrant.
There was much back-slapping recently when India’s IPO fund-raising hit a six-year high. In FY17, 25 new listings on the main board mopped up ₹28,220 crore. In the past decade, record primary market collections were reported in FY11 (₹31,000 crore) and FY08 (₹41,000 crore). But comparing these ‘records’ to the size of India’s secondary market tells us about the moribund state of the primary markets. What difference can 25 new listings raising ₹30,000 crore, make to a market with 5800 listed stocks and a total capitalisation of over ₹110 lakh crore? It’s a drop in the ocean.
If we add up systematic investment plans, the NPS, EPF and insurers, we are easily looking at over ₹1 lakh crore of equity purchases annually, just from domestic sources. Then, there are those 800-pound gorillas — Foreign Portfolio Investors, who pumped ₹30,900 crore into this market in March alone!
It is clear from these numbers that the supply of new primary market investment opportunities is woefully short of demand. It is not as if IPOs are of uniformly good quality either; a good number are duds. This is why IPOs from sound issuers such as Avenue Supermarts (D-Mart) set off such a feeding frenzy among investors. The D-Mart stock, after a 100 times over-subscription, doubled on listing and now trades at a lofty 65 times forward earnings. It is now touted to be the most expensive retail stock in the world!
Not making the cutThe problem of too much new money chasing too few IPOs would be easily solved if India’s numerically large listed universe was made up mainly of good quality businesses. But sadly, that is not the case.
We ran an experimental screener on the Capitaline database to arrive at a likely shortlist for a long-term investor, using basic fundamental filters. Of the 5520 companies in the database, we first had to root out 1017 firms that hadn’t filed their financials in FY16. Of the remaining, we weeded out 505 companies with negative networth, which would not feature on the shopping list of any fundamental investor. If we looked only at profitable companies, the list shrank by a further 1338 firms, as these reported net losses. As we turned finicky and screened for companies with a minimum ₹10-crore net profit and a 12 per cent return on equity, we were left with just 580 firms on our shortlist.
Slim pickingsProfessional money managers would apply several qualitative filters on top of these basic ones to cherry-pick stocks — sector and earnings prospects, earnings visibility, management quality, governance record. You can imagine the extremely slim pickings for them in this market. This is in fact the reason why most mutual fund companies in India restrict their coverage universe to just 200 or 250 stocks, unless they manage a small or micro-cap fund (when the number can go up to 400).
Institutional investors shy away from smaller stocks due to liquidity risks too. It is an open secret among fund managers that if you manage a large-sized fund, it is best not to stray too far beyond the top 200 stocks by market-cap, as impact costs can be prohibitive both for building and exiting these positions. It is the lack of sufficient investment options, in fact, that has forced a couple of micro-cap mutual funds to shut their gates to new investors recently. Therefore, unless fundamentals change dramatically (like a large set of companies suddenly turning around), a good portion of that new money pouring into Indian equities will end up chasing the same old set of 200 or 300 investment-worthy names.
When a flash-flood of liquidity chases a stagnant pool of investment opportunities, what you will obviously get is stretched stock valuations. This is indeed why the price-earnings multiple of the Nifty500 index, a broad market bellwether, has already soared from 17 times trailing earnings in April 2013 to 27 times now. Awash in liquidity, even professional investors haven’t waited for earnings to catch up.
This problem of riches calls for urgent policy attention. For SEBI, fattening up the primary market pipeline by wooing more good-quality issuers to the main board should be a top policy priority.
Interestingly, the Centre is in a unique position to contribute to a robust IPO pipeline. It will not find a more opportune time to expedite the listing of the marquee public sector behemoths. Thanks to liquidity, public sector disinvestment offers may find takers among genuine investors, instead of needing a backdoor bailout.