Equity investments should give about 15% annual returns over next 5 years: Raamdeo Agrawal

Motilal Oswal Financial Services‘ chairman Raamdeo Agrawal sees 15% returns from Indian equities as a probable outcome over the next five years. In an interview with Nishanth Vasudevan, the seasoned investor spoke about foreign investor sentiment, Zepto and capital gains tax, among other topics. Edited excerpts:

How are you assessing the market at this point?

I see this economy growing at about 7.5-8.5%, with corporate profits growing at more like 13-14%. So the index itself should give 12-14%.

Then it depends on how we manage our portfolios. Making 15% annually over the next five years seems to me the most likely outcome. That will double your portfolio. Markets have stagnated for two years, and maybe there will be another year of stagnation.

The Nifty is trading at 20 times, and if earnings grow by 15%, you can reduce the P/E multiple to 17. I think the markets will most likely go up by 15-20%.

Why aren’t foreign investors buying this story then?

Foreign investors are chasing momentum, like Korea and Taiwan. And the biggest momentum is in the US itself, so it is very difficult to get money out of there. All the money is heading there. This quarter, their earnings are up 47%. So, clearly, why would money come out of there?India had become the funding market for their allocations to other emerging markets because of the AI story. Now they are completely rattled by whatever is happening in Korea. Every day it is up 8% or down 8%. The AI story is still on, but AI is not the only thing in the market.

The good part is FIIs are in a “stop selling” mode in India. That itself solves 90% of the problem for me. We are in a phase where the downside is limited.

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Is India’s capital gains tax regime a deterrent for foreign investors?

See, it is one of the irritants for sure, but I don’t think that is the breaking point. The pain is coming from somewhere else, particularly the weak currency. They bring in dollars and must pay capital gains tax in rupees. So even if they have not made money in dollar terms, they still must pay capital gains tax. That’s what hurts them.

The thing is, most emerging markets generally don’t have capital gains tax, and it is worth thinking about. If you want a good long-term relationship with FIIs and want to keep attracting them, there should be a very friendly environment.

As one of the large investors in Zepto, what is your reading of its recent IPO attempt?

The message is very clear; till companies are actually profitable, or very close to becoming profitable within a visible timeframe, they should not tap the public market. Because it is very difficult to make the public market understand the underlying value.

Public markets are all about earnings, earnings and earnings. And every quarter you have to report them. You could be growing at 100%, and so there will be a cost of acquisition and, hence, there will be some losses. A large private investor can understand that; the public market cannot.

Mutual fund investors have to mark to market every day. So they don’t want to invest at a price at which they can have a mark-to-market loss tomorrow.

So my sense is that maybe it was a little premature for the company to tap the public market, and that too at this scale. They must have learnt from this.

Did this episode disappoint you?

Whenever something fails like this, I feel bad. You don’t want any entrepreneur to go through this kind of pain. Whether my investment is a failure will be decided after 10 years, not now.

But it looks bad when a company in which you have invested is passing through these kinds of challenges.

Did the promoters ask you for advice on the IPO? Did you speak to them after that?

Not after, but while this was going on, whatever I could suggest, I suggested to them. Once you are no longer hot in the minds of public-market investors, there is very little you can do about it. You have to become desirable, or worthy, for those mutual funds.

They are big guys, and it is their money. You have to become more worthy of their money. Basically, that is the message in total.

Among bank stocks, which ones are you liking the most?

I think the industry has the most pristine balance sheets I have ever seen. Now lending has started; credit growth is at 18%. The ones with the best management will do well. That includes ICICI, SBI, the AUs of the world, Federal Bank or Karur Vysya Bank. When you have an economy with a ₹230-240 lakh crore credit book, 18% growth is massive.

What about HDFC Bank?

There is pessimism among investors at large. All those things will someday be behind them; the regulatory requirements and all.

I can understand the pessimism around the stock price, but the bank is rock solid. Valuation-wise, this is among the lowest you could ever get it-probably the lowest in its history.

You have been sceptical about how to value IT stocks because of the AI disruption. Have you changed your mind?

A little bit. So, jobs will not be the issue. The issue is how much will the market expand. Obviously, clients will ask for productivity gains to be passed on to them.

To my mind, the bargaining position of services companies is a little weaker. So I would say they are “headwinded”, but it’s not as disastrous as it was thought to be 12 months ago.

But what are current valuations reflecting?

Valuations are reflecting almost a terminal-value kind of situation, literally zero growth.

You are getting a 5-6% free cash flow yield, which is around your bond yield. Now, I think we have seen the bottom, but the growth phase has still not started. It may stay here for some time, until there is clarity on enterprise AI.

Do you see a bubble in the AI theme?

Financial markets have seen big bubbles in 2000 and 2008. So, markets are very alert to this situation in AI. They are not letting it go completely out of hand. There is a self-correcting mechanism where people go overboard and then come back, like we are seeing in Korea.

Look at the sheer size of AI capex ($2-3 trillion a year), and that is spreading across the world. The world is sucking in all kinds of products such as cables, construction, cement, etc. So this prosperity is translating into corporate earnings. And hence the P/E multiples are looking reasonable.

If AI capex is overdone, then everything is overdone. If it isn’t, there might be some kind of slowdown, but I don’t think there will be a collapse.

As a stakeholder in the broking business, what is your take on disruption in the market around the closing auction system?

They were trying to solve a problem through this. But right now, it looks like it has created a bigger problem. That said, these things can be part and parcel of long-term reforms. When dematerialisation was made compulsory, there were problems then as well. Eventually everybody fell in line. Sebi is absolutely on top of the matter. If it is not working at the desired level, they will review it and do whatever is required. I don’t know. Let’s see.