investment strategy | stocks to buy: Want to protect your portfolio against inflation? Enter these 2 sectors

“The platform’s actions are difficult to understand and project, but I believe that over the next three to five years or so, maximum wealth will be created by these new-era digital companies,” says Dipan MehtaDirector, Action Elixir

What could an inflation-insulated trade be? What are some of the companies one should buy assuming the economy is doing well and what are the companies or companies that will be insulated despite inflation?
I’m thinking of two sectors – software and banking, especially software, because a lot of IT services are provided from India and in India we don’t have such a serious problem as some other western countries. There is a very decent demand, new projects are on the way, new licenses, new sales are doing exceptionally well. Some of these companies have made acquisitions in the past, they are also going very well and this correction has meant that many large and mid cap software companies have also corrected significantly and especially in the mid cap space , there were concerns about valuations, but now, with a correction ranging from 10% to 30%, PE multiples are also reasonable.

Mid and large-cap software companies, especially mid-cap companies, will continue to surprise when it comes to their revenue growth rates and even smaller mid-cap projects for mid-cap companies can make a huge difference in their turnover. If one wants to avoid problems with inflation, then of course software is a sector.

In India, banks should also do exceptionally well. A lot of banks have their loans linked to interest rates, to base rates and those start going up as soon as the interest rates go up and there’s always enough liquidity. Many large banks are sitting on huge amounts of CASA and reluctant to raise the savings rate.

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There could be a slight increase in net interest margins if inflation were to remain at these levels. But as I said, this inflation is going to have a very different impact on India in terms of global liquidity and that’s really the issue right now. If the Federal Reserve starts shrinking its balance sheet and raising interest rates, then automatically a lot of money is pouring out into the world that was targeting risky assets like emerging markets could be hit and the current selloff we’re seeing from the share of the IFIs can only intensify further. That’s really the problem with inflation.

The latest RBI policy was exceptional and I hope they have a correct assessment that inflation is not really a problem in India. Anyway, we’ve been dealing with 4% to 7-8% inflation for many years and once volatile food and crude oil prices are factored into the inflation figure then year by year we will see inflation come down to 4% in India. which is quite reasonable.

Has the recent price action on Zomato been a buying opportunity? do you have
First, a disclosure that we have already bought into Zomato and Nykaa and you don’t want to average when the stock price corrects. These are hard actions to understand and project, but I believe that over the next three to five years or so, maximum wealth will be created by these new era digital businesses. It’s just that right now sitting here we don’t know what the spectacular winners will be so we’re trying to buy them like a basket and if you don’t have any of these companies in your portfolio it’s a good correction to buy into some of these stocks. Just take a leap of faith and be prepared to invest for three to five years. Buy them as a basket, so if one or two of them don’t work, the ones you have can come out on top. So I’m not as negative as The Street on these companies.

Globally, many of these companies suffered huge losses in the early years, but only to come back and once their business model was established and subscriber numbers and revenue reached a particular break-even point, nothing stops them. You can see this happening in stocks like Facebook, Amazon and to some extent Twitter and even now companies like Uber and Airbnb are still holding up pretty well despite huge losses.

Similar experiences have also taken place in the Chinese market. Some of India’s new era digital businesses will be great wealth creators. It’s just that we don’t know which ones they are right now. So if one wants to play on this particular investment theme, it’s best to buy them as a basket and hope that one or two of those stocks in your basket will turn out to be phenomenal multibaggers.

Why a Nykaa and why is everyone bullish on PolicyBazaar? Nykaa’s business will be disrupted as they will have to compete with the Tatas and Reliances of the world.
It’s not that Nykaa doesn’t face competition. In the early years, I would have looked at that space as well, like Flipkart and Amazon, but Nykaa eventually became the market leader. And of course Reliance and Tatas and many new entrants will come but first and foremost the space is big enough to accommodate more peers.

Second, Nykaa is a bit ahead of those companies in terms of understanding consumer preferences, positioning, brand appeal and the whole ecosystem that they’ve created and the platforms that they’ve created that’s currently in a virtuous economic cycle.

There will be competition and they also know how to handle that competition. They have been doing it for so many years. So that’s something that doesn’t really concern me. We are unable to estimate, not just for Nykaa, but for all of these companies, when and at what operating levels will the type of expenditures they make for business development fall below real income growth? The real problem is that we don’t really know how much of the spend and P&L goes to business development, brand building, platform promotion and how much is regular overhead.

That’s something we can’t really estimate at this point. But I’m pretty sure and we’ve seen this experience globally that at some point, maybe 2x that revenue or 3x that revenue, you’ll see there’s a huge breakeven point that has been reached. Then, whatever revenue grows above that amount is reflected directly in the bottom line. Therein lies the mystery of investing in these companies and I’m pretty sure the message the street is sending to promoters of these companies has been very well received as well.

So as long as you are a private actor, you think and act differently. But once you’re a publicly traded player you have to report quarterly numbers and analysts ask questions and stock prices start to correct like they’ve been doing, I’m pretty sure the CEOs and senior management of companies also have a good in-depth look at the expenses they are making, their business plans, how they can return to profitability, or how they can return to profitability sooner than expected.

So there’s a lot of action going on in this space and I don’t want to miss that. So like I said buy a few, I didn’t bet the bank there. You can make small investments in such companies and I hope that one or two of them will become anything 10 bagger, 20 bagger in three to five years. This will justify making small investments in these businesses.

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