MNCs are the best bet

The “Black Monday” should have impacted only the traders. Investors should not have had a reason to worry. This five per cent fall is a wake up call. Every five to eight years, the markets do give people a shock and this was close to one of those, though I do not think that we are past the (Chinese) wall of worries.

We all tend to forget that we are sitting on the biggest ever asset bubble created in history. Post the 2008 crash, central banks have been printing money to keep the magic of the markets alive. A lot of growth we have seen in the last few years has been the result of this printing press operations.

We all like to say that “India” is different and we are growing. Looking at results of Indian companies; I do not get that confidence. Indian companies are becoming less and less efficient in using money. The returns are falling. And I understand that capacity utilisation of most industrial products are at decade lows. What it means is that there is no way we will see new capacities coming up for some length of time since existing capacities can meet growing demand for a few more years.

Before the Black Monday, what I saw was that the mid cap stocks had become priced like collectors’ items and the large caps were at valuations that were still high. Even after the Thursday rally, the Nifty is trading at 22 times earnings of the last 12 months. This is not exactly cheap. Of course, the argument is that the earnings numbers are low because of weak growth and from here earnings will rise rapidly, and thus we should not look at 22 as expensive.

On the Monday that the market fell sharply, there were just ‘trading’ opportunities. A lot of mid cap stocks have seen exit from institutional investors and this means that their prices will languish for a long time. A mid cap that lost 40 per cent, has to rise by 66 per cent to come back to the same level. Thus, a long wait ahead. In our markets, any upmove starts with the large cap stocks and then the froth is provided by the mid caps and small caps.

When the trend reverses, so does the order. What I did notice in this volatility was the behaviour of stocks with consistently high returns on capital. They stood almost firm, not falling as hard at all. Indian companies by and large do not ‘report’ or enjoy high returns on capital. So there is a clear divide between the returns reported by the MNCs and the Indian companies as a universe. Of course, we can argue that the MNCs are predominantly in the consumer spending space and it is unfair to compare them with Indian companies in smokestack industries like aluminium, textiles, contractors (now called infrastructure companies) etc. However, for an investor, the only thing that matters is the earning power of the capital depoloyed by a company.

So, if I were to take blind picks, without bothering too much about what the company does etc, I will just be buying the MNC companies that have been around for a few years. Such a portfolio should very comfortably beat the broad indices over the long term. Further, they also fall less in down markets. The other thing I like about MNC is that most of them are in businesses that have a low fixed asset base. They are in industries or sectors where they have built strong brands over years. The brands certainly give them a better return on shareholder money.

For example, if we see a HUL or a Colgate versus a Dabur or a Marico, the return on equity tells us the story. Maybe the Indian companies grow faster, but the shareholders at the MNCs are looking like a happier lot.

Even if I take the example of a sector dominated by Indian companies, Maruti Suzuki profitability stands out as compared to a Tata Motors or a M&M or a Ashok Leyland. Just put the return numbers side by side and the difference is noticeable.

Thus, in volatile and uncertain markets, I would be happy to be holding quality portfoio that has the common factor of high return on capital employed (ROCE). And simplifying it further, I would be happy to be holding a bunch of MNC company stocks. Yes, one caution though. The MNC stocks are priced aggressively. They may not offer as much prospective returns as select Indian companies can give. But the universe of Indian companies is a minefield and if I am not equipped to slice and dice, choosing a MNC universe may be the easy way to ‘lazy’ investing.