Quality stocks richly valued; wait for earnings to catch up with valuations: Akash Prakash

In an interview with ET Now, Akash Prakash, CEO & MD, Amansa Capital, shares his views on whether one can do bottom fishing at current levels. Excerpts:
Nikunj Dalmia: In February, when the Indian markets were in a euphoric mode, you were the first money manager who went on record that it is too good to be true. Now fault lines are visible. So, where do we go from here?
Akash Prakash: We are still optimistic on India on a slightly longer-term basis. I recently wrote an article suggesting why our conviction will get tested. That is exactly what is happening now. Investors are getting nervous. Investors are questioning – should we be invested in India? The conviction on do you believe this is a long-term story or not is going to get tested because the market is treading water right now, but we remain positive on India. We think that the market will do well over the next two to three years. But you are in an air pocket right now where the market wants to see greater visibility of corporate earnings. In the last quarter, we had negative earnings growth year-on-year (minimum 10-11 per cent.

For FY15, growth in earnings was basically zero. Obviously, that was far weaker than anyone would have anticipated 12 months ago. Therefore, the recovery in earnings has been quite disappointed. It is taking much longer than what investors would have anticipated. The markets will tread water. The next stage of the cycle in my opinion is only when the markets start getting more comfortable that the earnings recovery is happening. That is not happening as yet. Therefore, you are going to tread water till we see more visibility.

Nikunj Dalmia: But from a valuation standpoint, do you think a 10 per cent correction is warranted? According to most brokerages, Indian markets are trading at about 14-15 times one-year forward EPS. There is some degree of optimistic earning assumption as well. But largely, 15-16 times is just a shade away from the historical average.
Akash Prakash: That is true. But if you break up the problem, the bull argument seems right. The bull argument is that you are trading 15-16 times and you are trading on below normal earnings. Therefore, if you normalise profit margins back to GDP growth of 5.5-6 per cent and not 7 per cent of GDP, you are probably at 12-13 times, if not lower. That is the bull argument. Why are you talking about valuations being so expensive? It is actually not expensive. The bear argument, if you disaggregate that 15-16 times, you have about 200 companies which are trading at 35 times, which are good business models. Those are the companies you would like to own.
I mean they are not trading at 15-16 times. Name me one good-quality company of very significant size with a PE of 15 times. I cannot find one, have you? That number is a fallacy of composition. Good quality companies are trading at 25 times or 30 times and a whole bunch of mediocre companies are trading at 10 times. So, the problem that investors are finding or at least we are finding is that if you want to maintain quality in terms of the type of businesses, the market is not cheap. You name me one good-quality company, which is trading at 15, it is either 30 times or it is 10 times.
Nikunj Dalmia: So what do you do in this kind of market? What you want to buy is not cheap. What you do not want to buy is cheap.
Akash Prakash: That is why the market will go through a period of consolidation, where two things will happen. One, as you go through a period of consolidation, earnings will catch up. Some of the good quality companies will become a little cheap and others would become cheaper. Somebody will sell, someone will have redemption.
In addition, you have to find the cusp, the companies which are not intuitively obvious as having a great last 10-year track record. Something which is not obviously known as a high quality blue chip, but you think it is better company than what credit market gives it. Something that you think has very good long-term prospects, for which the economies of the business are changing.

Therefore, it is priced as a mediocre business, but you think it is going to become a good business. That is where what you have to do. As I said before, I do not think you can easily find it today. So, you have to stretch harder -- either find businesses which are going to become great in your opinion or which are misunderstood by the market.