ETMarkets Smart Talk- Plan to invest in smallcaps? Avoid firms with high P/E ratios and weak fundamentals: Harjeet Singh Arora

“It is essential to prioritise a margin of safety and use prudence while investing. Avoid firms with high price-to-earnings (PE) ratios and weak fundamentals,” says Harjeet Singh Arora, Managing Director, Mastertrust.

In an interview with ETMarkets, Arora said: “When investing in small and midcap firms, a thorough grasp of the economic cycle is important.” Edited excerpts:

What are the risks to the rally that we see in Indian markets?
EL Nino and unforeseen rainfall patterns may push inflation higher up the scale. El Nino disrupts weather which reduces rainfall and thus agricultural productivity.

If the United States continues to raise its interest rates amid an impending global recession, it is expected to have a significant impact on the country's economic slowdown.

Higher interest rates make borrowing more expensive, which deters investment and lowers economic activity. The end consequence might create a challenging economic environment and increase price pressures.

RBI kept the interest rates unchanged in June. What does the rate trajectory look like for the rest of FY24?
The Federal Reserve's policy on interest rates will be the primary source of direction for the RBI. The central bank is expected to maintain low rates for some time unless there are any significant surprises in the data.

But the unexpected figures can push the RBI to change its mind. The Federal Reserve's policies and the overall outlook of the world economy play a crucial role in how the RBI does its business.

The RBI continuously tracks these trends to make well-informed choices about its interest rates that support domestic economic growth and stability.

How should investors play the markets in terms of asset allocation? With rates remaining status quo – where does the fixed-income market stand?
Our primary objective is to hold a diversified investment portfolio that includes stocks, bonds and commodities such as gold and silver.

With Indian interest rates expected to peak and already factored into current yield levels, investors have the option to explore AAA/AA fixed income either directly or through mutual funds.

If interest rates fall over the medium term and lead to positive mark-to-market (MTM) returns, they will benefit from higher yields thereby.

This technique allows investors to maximize the total return on their investments by taking advantage of positive market conditions and potential interest income opportunities.

How should one play small & midcaps stocks?
It is essential to prioritise a margin of safety and use prudence while investing. Avoid firms with high price-to-earnings (PE) ratios and weak fundamentals.

Instead, focus on industries that have seen sizable corrections as a result of economic cycle downturns. When investing in small and midcap firms, a thorough grasp of the economic cycle is important.

One may choose the best times to enter the market by being aware of how industries cycle. This strategy promotes prudent investing practices, aligns investment choices with the dynamics of the economic cycle, and reduces risks while increasing the possibility of obtaining favourable returns.

How do you pick stocks for your portfolio? What filters do you use?
Several important indicators offer useful information when assessing stock selection. Making educated judgements may be aided by keeping an eye on developments in the EBITDA margin, PAT (Profit After Tax), interest coverage ratio, various receivables, debt levels, shareholding pattern, ROE/ROCE (Return on Equity/Return on Capital Employed), corporate governance procedures, and contingent liabilities.

A good interest coverage ratio provides the ability to repay debt while growing EBIDTA margin and PAT shows improving profitability. Low amounts of debt and other receivables point to effective operations. An orderly and transparent ownership structure represents the trust of investors.

Effective capital utilisation is indicated by a high ROE/ROCE, and strong corporate governance protects shareholder interests. Assessing contingent liabilities enables you to identify potential hazards.

These metrics may be used to find stocks with sound fundamentals, room to expand, and responsible risk management techniques.

There is some nervousness in markets, but we are inching towards record highs. What is your view for the rest of 2023?
As of now, domestic indices have fared better when compared to their global counterparts, and even the Indian vix indicates a calm in the stock market.

Keeping in view the same, we believe markets to remain range-bound, drawing impetus from US-fed policies, geo-political events and macroeconomic developments in India.

Consequently, a discerning bottom-up approach is recommended for navigating the remainder of 2023. The market's path will be significantly influenced by global cues.

Volatility is anticipated to continue amid persistent uncertainty, however, market prospects seem optimistic as the 2024 elections draw near.

The governor also highlighted that FII flows which have made a comeback supported equities. What is fueling the optimism because we are no longer cheap?
Even though the global economy faces a possible road to a downtrend, the Indian economy has performed the contrary, making it an attractive destination for FIIs.

The prevailing socio-economic stability, coupled with a restrained inclination towards populist measures along with the government’s thrust on comprehensive policies like the introduction of the PLI scheme, will continue to attract FII flows in India.

The China plus one strategy, hold of the rupee vis-à-vis the dollar, along with Q4 earnings aligning with market expectations, further substantiated FII purchases.

Moreover, favourable projections for a normal monsoon season have elevated prospects for domestic growth as well. All these factors combined are increasing the FII flows even.

What is your view on banks? Is there a lot of optimism around the banking space amid strong macros and robust GDP growth?
Banks are well-positioned to maintain their positive performance trend, which has been bolstered by operational efficiency and notable advancements in asset quality management over the past few years, with strong underwriting practices across public and private sector banks.

Owing to the withdrawal of Rs 2000 notes, the liquidity infusion will help banks to continue to maintain stable NIMs in the upcoming quarters.

Despite the prevailing global challenges, the Indian banking sector is resilient because of a Strong balance sheet, diversified business and reduction in non-performing loans in the system.

The banking system is stable and unaffected by recent events in the global financial ecosystem.

(Disclaimer: Recommendations, suggestions, views, and opinions given by experts are their own. These do not represent the views of the Economic Times)