Earnings growth matters more than valuation multiple: Anish Tawakley

Earnings growth matters more than PE compression in long-term wealth creation, says DSP MF CIO

If earnings growth remains healthy over a three-year period, investors can still generate reasonable returns even if valuations compress somewhat, according to Anish Tawakley, chief investment officer (CIO) at DSP Mutual Fund. In an interview with Abhishek Kumar in Mumbai, Tawakley, says disruptions caused by the West Asia crisis are temporary and investors should use short-term volatility to add to positions. Edited excerpts:

 

Do markets fully reflect West Asia risks, especially if oil stays elevated?

 

Our view is that these disruptions are temporary. Investors should avoid panicking and use any short-term volatility to add to positions.

 

India’s economy remains fundamentally well placed outside of this temporary geopolitical issue. Demand is recovering and the economy still has some spare capacity. Hence, the economy can regain momentum once this external shock is behind us. Even if oil prices stay elevated, India has substantial forex reserves that can help cushion the impact, rather than fully passing higher costs through to the economy. Policymakers should focus on avoiding a sharp drop in productive oil consumption, as that would hurt economic activity.

 

How do you view largecap valuations currently?

 

Largecap valuations are not cheap, but they are also not outrageously expensive. At these levels, if the economy does well, one can make reasonable returns.

 

For long-term investors, what matters more is earnings growth rather than whether the PE multiple moves from 21x to 19x. If earnings growth remains healthy over a three-year period, investors can still generate reasonable returns even if valuations compress somewhat.

 

Small- and midcap stocks have rallied sharply. Do you think the trend can continue?

 

The post-Covid period saw a massive capital-raising cycle in equities. Such phases are often followed by prolonged periods of disappointment because expectations become excessive. Promoters and private equity investors have also sold heavily during this period, while in some cases the market may be overlooking concerns around corporate governance and earnings quality.

 

By poor quality of earnings, I mean profits that are not backed by cash flows. Many companies report accounting profits even as inventories, receivables or intangible assets rise sharply on the balance sheet. This is especially relevant in small- and mid-cap companies. The bigger risk is not necessarily the PE multiple itself, but the quality of the “E” — the earnings — on which those multiples are being assigned.

 

What are your expectations for earnings growth this financial year?

 

This year is likely to be challenging because companies may use the uncertainty created by the geopolitical environment to ‘kitchen sink’ old problems and clean up balance sheets.

 

As a result, I would not be overly optimistic about earnings growth this year. However, if the economy remains fundamentally healthy, investors should be willing to tolerate one year of modest earnings growth.

If we still achieve double-digit earnings growth in a year like this, that would be reasonably satisfactory.

 

Has the geopolitical uncertainty led to any changes in portfolio positioning?

 

The economy remains well placed from a cyclical perspective. There is still slack in the economy and the cycle has not peaked yet. In such an environment, I prefer domestic cyclicals. Areas I like include automobiles, financials, including banks and insurance companies, and cement. We also like capital goods companies, despite margins having peaked.

 

On the other hand, I am relatively less positive on sectors such as FMCG (fast-moving consumer goods), metals and IT (information technology). Metals are more linked to global cycles rather than domestic cycles.

 

Why are you cautious on the IT sector despite the correction in valuations?

 

The broader India-based IT services ecosystem, including GCCs (global capability centers) and India operations of global companies, remains healthy. However, listed Indian IT vendors are facing increasing competitive pressures. Global companies are now far more comfortable building their own captive centres in India, rather than outsourcing work to Indian vendors. Regulatory clarity around transfer pricing has also reduced earlier hurdles, encouraging multinationals to directly expand operations in India and work with a wider set of vendors.

 

This raises questions around the sustainability of the historically high margins enjoyed by Indian IT vendors, even before considering the impact of AI. So while valuations have corrected and these remain fundamentally strong businesses, I remain cautious because the competitive landscape has structurally changed.

 

As the new CIO, are you making any changes to the investment approach at DSP?

 

There is already a strong alignment (between me and the existing team). The focus is not on changing the philosophy at DSP, but on ensuring that it is implemented and executed consistently. We will continue to buy fundamentally strong businesses at reasonable valuations and remain rational even when markets are irrational.

 

One key aspect of the philosophy is avoiding momentum investing. To enforce that discipline, we are introducing some guardrails and processes that act as "speed breakers" against impulsive decisions driven by market excitement.

 

We are also working to ensure that insights from the forensic team are reflected in portfolios faster, incorporated into portfolio decisions more quickly, and effectively.

 

What is your view on the debt market, especially long duration bonds, given the talks around rate hike possibilities?

 

A one-time increase in oil prices does not necessarily lead to recurring inflation and, therefore, may not justify rate hikes.

 

A common misconception is that investors often confuse a one-time rise in prices with recurring inflation. If inflation is not persistent, there is less justification for central banks to keep raising rates aggressively.

 

Yes, yields have moved up materially and that has significantly hurt returns of long-duration funds over the last one year.

 

However, if there is no strong case for interest rate hikes from here, then the current yield curve appears steep enough. In that scenario, the yield curve should gradually flatten over time, which would be supportive for long-duration bonds.

 

Should investors invest lump sum into equities right now or take a staggered approach?

 

Multi-asset and asset-allocation products remain good investment options because they allow fund managers to respond to volatility and market panic in a disciplined manner.

 

Given the current uncertainty, a staggered investment approach is justified. Markets may not move smoothly from here.

 

However, I would certainly not recommend withdrawing money from equities at this stage, especially in the largecap space.