Investing in India

Investing in India
An Insider’s View: Discovering Opportunities in India
by Sala Kannan

India is a land of great opportunity. The country experienced a record GDP growth rate of 8.5% last year. And its BSE index is up 40% since 2000, while the Nasdaq has gone nowhere in the same time period.

And when I heard about an Investing in India Conference in New York two weeks ago, I immediately booked my ticket on Amtrak.

Investing in India: Why India?

India presents the perfect option for an investor scouting for cheap, unknown stocks and undiscovered prospects. Many foreign investors are unaware of the steady transformations taking place in the Indian financial markets. They still view it as the land of crippling poverty and political instability.

The Bombay Stock Exchange is over 120 years old, and is Asia’s largest. It boasts a T+2 trading system, which is one of the most sophisticated in the world. Even the Nasdaq doesn’t have a T+2 system!

There is plenty of value in India, and for the investor who is willing to explore, there is a sea of stocks in undiscovered sectors. Take the consumer sector. India adds the population of Canada every year to its middle class. And that means there will be 432 million people in 2007 spending money on everything from cars, to medicine, to oil, and to houses.

Not only will these people consume, but they will also earn and produce wealth. By 2050, the largest English-speaking nation in the world will not be America. It will not be England. It will be India.

This spew of well-trained, highly educated, English-speaking professionals that India is churning our year after year is highly productive. So much so that every dollar paid to India for outsourcing services creates, in turn, $1.46.

And it is not just outsourcing that makes up the India story. It is a complex web of sectors and sub sectors ripe with potential, waiting to be discovered.

Investing in India: A Lesson on Investing

At the Investing in India Conference in New York, I met one of India’s most prominent value investors, Ajit Dayal. Dayal spoke to me on his strategy of value investing – something that applies to every asset class and stock market in the world.

He also told me about what he thinks of Indian small caps, politics, exports, infrastructure and much more. He told me that disciplined investing in cheap stocks is the recipe for success.

A former Vanguard fund manager and the founder of private equity funds, Dayal’s philosophy on investing is solid. He draws upon classic investment wisdom that is tempered with caution. Dayal is a far cry from many of the reckless money managers we see today.

And he was kind enough to speak to me about everything from his investment technique to small caps to cement.

But first, here is a little more about Dayal. He was the deputy chief investment officer of Hansberger Global Investors and a lead manager of the $2 billion Vanguard International Value Fund. He left his lucrative job in south Florida to go back to India – “because it’s home, because that’s where I belong,” he said.

At home, Dayal set up India’s first equity research house for institutional investors in 1990. Today, he runs Quantum Advisors and equity funds. He also founded, which is the Morningstar of Indian financial Web sites.

Dayal explained to me the potential pitfalls an investor should avoid in the coming months. At the Investing in India Conference in New York, many speakers were bullish on India. But many, I felt, added a heavy dose of irrational exuberance to their presentations. An error often made by investors who are too embroiled in their ideas – in this case, India.

But not Ajit Dayal…

(Quantum Advisors is not an SEC-registered institution. It manages money only for institutional investors.)

Q & A on Indian Investing:

Sala: “Why India? What’s in it for the American investor?”

Dayal: “In uncertain times like now, there is a simple and powerful story in India. Since 1980, India has been through eight governments – five were coalitions and three were single party. Despite these massive changes, the GDP growth rate in real terms has consistently been about 6% per annum.

“In fact, over the last 25 years, it’s been steadily around 6%, and I believe it will continue to grow. Global GDP is 3%, and India’s GDP is double that of the world.

“At this GDP growth rate, corporate profitability tends to be higher than in the developed world. The long-term EPS growth rate in India will be 15% in dollar terms; in the developed world (USA, Euro zone, Japan), it will be just 8%.

“So in India, EPS and the economy are growing twice as fast as the rest of the world.

“Also, P/E is 12 times next year’s earnings; that is 40% lower than world P/E. So a strong economy, discount to P/E and profit growth – that’s what India has to offer.”

Sala: “Many investors still view India as a market vulnerable to internal shocks. How will India’s political instability affect the market?”

Dayal: “Since 1980, we’ve had all kinds of shocks.

“[former prime ministers] Rajiv Gandhi and Indira Gandhi were assassinated, we had the Ayodhya issue [a religious clash], natural disasters…you name it, we’ve had it.

“But the stock market is a function of money flow.

“In 2000-2003, EPS in India was growing, but the stock market went nowhere, because there was no money flow. After 2003, the world was willing to move money to India, and the market went up. So in the long run, the stock market is a function of money flow, not external events – and this is true for anywhere in the world.”

Sala: “In May 2004, the Indian stock market saw its biggest crash in history. Can this happen again?”

Dayal: “Yes. It could be any external event, anything that happens in America, a sharp U.S. rate rise…all this will cause a return to perceived less-risky assets. Money will flow out of emerging markets and into assets like bonds. I believe that will happen, and when it does, it will be very dramatic.”

Sala: “How do you choose stocks for your funds?”

Dayal: “We talk to a lot of companies. Meet management. We spend a lot of time understanding the business model, industry and competition. Our time focus is what differentiates us from others.

“At company conference calls and meetings, all analysts ask about this quarter and last quarter and the next quarter. We ask about the company’s plans for the next five years.

“We are early buyers of stocks, and early sellers, too (which is the problem with value investing). But eventually, fundamentals will prevail.

“Think of it as a channel. Value investing dictates this channel, and we invest within the channel. We leave out all the noise that is outside the channel. We don’t act on fear and greed, and we don’t worry about missing the party. We stay away from the noise.”

Sala: “Do you like to sell at all?”

Dayal: “Of course. In January ’04, when everyone was singing the “India is shining” slogan, we took a cash position from 2-35% for four months. January, February, March, April, we were in 35% cash. In May ’04, when the market collapsed, we jumped in and started buying.”

Sala: “What sectors do you like?”

Dayal: “I don’t have a sector view; I don’t wake up in the morning and say, ‘Today, I love telecom.’ But we did own cement companies when no one else liked them.”

Sala: “What is your opinion of small-cap stocks?”

Dayal: “What happened in 1994-95 is happening now. Everyone piled into small caps, and there was a lot of danger for small and mid caps. Then, after the Mexican economic crisis in ’95, the market came crashing down.

“Take Infosys. Since April 2003, the stock more than tripled. Risk? There is no risk. So you can find large stocks like that with lesser risk.

“Investor comfort is always low in small caps because the stock hasn’t seen enough bull- and bear-market cycles. So you have no idea how a founder of a small-cap company will behave.

“You don’t know if they are building a business or a valuation game. I don’t look at market cap. For us, long-term trading volume is more important. But that’s not to say we don’t own small and mid caps.”

Sala: “Are there any truly undiscovered sectors with plenty of value in India?”

Dayal: “Yes. You can find a lot of undiscovered value within these three major themes: the export story (India is exporting more), the consumer-demand story (people are wealthier and consume more) and the infrastructure story (India needs to invest in infrastructure more).”

Sala: “How do you think the Indian market will do in the next five years?”

Dayal: “It’s done well in the last few years, and given the long-term GDP growth rate and low P/E ratios, I’m confident it will continue.”

Sala: “In the last two years, foreign institutional investment has really shot up in India. Do you smell a bubble?”

Dayal: “Yes. All the carry trade and impatient money is skimming the surface, trying to find its next home for the next couple of months.

“In India, there have been scams where the retail investor has been cheated. And in all cases, punishment has been delayed. So retail participation has been very low, lower than what the foreigners have injected in India. But the money flow hasn’t come from retail investors.”

Sala: “Are emerging markets just another fad?”

Dayal: “In 1999, the most respected analysts on Wall Street said, ‘The Nasdaq will beat emerging markets – you can get all the upside with the Nasdaq without the downside of emerging markets.’

“Look what happened.

“When John Templeton started investing, Japan and Germany were emerging markets, too. See where they are today – fully developed, and they have come a full cycle.”

Sala: “Thank you, Mr. Dayal.”

If there is one lesson that we take away from this conversation with Dayal, it should be the fact that investing takes more than just fads. Like Dayal said, stay away from the noise and the impatient money. Invest for the long term and be willing to exercise discipline.