Investing in a post COVID World

We trust that this post continues to find all of you in good health. As the lockdown continues with relaxations, a new normal awaits all of us.  What is clear is that post Covid, the operating model of every industry across manufacturing and services will be impacted and rapid changes are required.

One macro theme which is emerging across the world – concentration of profits in industry leaders.  

The top 20 companies in India generate 70% of the country’s profits

A leading PMS published a stunning piece of research this week – The 20 most profitable companies in India are able to garner 70% of all the profits in India in the listed stocks space. This has gone up 5 times (from 14%) in the past 30 years.

Some of the below news items we see in the last one month also alludes to the fact, that big gets bigger.  Let us look at the data of companies from Industries which are worst hit by the lockdown (those with discretionary spends like real estate, automobiles, personal lending)

• Embassy REIT was able to collect 92% of their rentals in April
• Maruti is holding 25% of their market value in cash equivalents
• Bajaj Finance was able to raise money at 4.6% for 91 day CP

Please spend a minute to reflect on those numbers – it shows how the top companies within their segments are able to consolidate their position.

What is also interesting is that the list of top 20 companies keeps changing.  In FY09 the top profit generators included SBI, Reliance Communications, DLF, Sterlite, Punjab National Bank, BHEL and SAIL.  None of these are anywhere near the top now.

 The whole idea is to show how large and strong companies are responding to the crisis, based on the strength of their business model and the balance sheet.

We would like to highlight our key observations from the above data points

• Characteristics of these ‘quality’ companies – While the definition of a quality company is a huge topic by itself, some of the common parameters include
  • strong balance sheets (cash rich, low debt)
  • high operating margins, management which is focused on delivering shareholder value
  • industry leadership (in the top 3 in their industry)
  • efficient use of capital
  • earnings growth across business cycles
• High quality companies will deliver superior financial results in the long term- Ultimately it is the growth in earnings which drives valuations in the long run
• Longevity of high quality companies is dropping – Studies show that the average longevity of companies is dropping over time. Industry leadership also changes over time. So, buying and holding in a static manner will not work.

Periodic monitoring of the financial and operating metrics (not just the share prices), deep understanding of the business model is vital to decide whether to hold on to companies going forward. This is best left to investment professionals in the long run.

How to act as an investor in this scenario?

• Remain invested in portfolios of high quality companies through competent fund managers with proven track records
• Avoid buying stocks based on share price drop alone (DHFL, Yes Bank and many more examples) as a criteria.There is a reason for share price fall in these names
• Don’t get carried away by short term returns (either positive or negative). The industry is now seeing lots of flows coming to gold funds based on last one year returns and is seeing outflows from quality equity funds. Neither approach may be appropriate now
• It is essential to have a long-term orientation towards equity investing

As always, we should stick to our overall asset allocation plan.  Invest money in equity in a staggered manner over the next six months to one year, based on your risk appetite.

Stay home and stay safe.