Indian equity valuations justified now? Avendus Olivo's Pathak shares his investment mantra

The 50-scrip index finished 2021 with a gain of 24 percent -- its best year since 2017. 

The high valuations are broadly justified given the improved growth outlook, said Pathak. On a bottom-up basis, there are a lot of stocks where valuations are attractive in keeping with the quality and growth of the business, he said.

Bottom-up investing is a style of investing in which the focus is on individual securities and not on the overall macroeconomic environment and market cycles.

Pathak believes the current valuations reflect the following:

A rebound in overall economic growth with normalisation of activity post-pandemic; GDP growth likely to be much stronger in the coming years than a few years before COVID; benefits of many disruptive reforms such as GST, IBC and RERA will start to flow in going forward

This will lead to a strong corporate earnings growth cycle in the next few years; BSE 500 corporate profit-to-GDP ratio, which fell to 2.4 percent in 2020 from 4 percent in 2011, to rebound smartly on account of higher top-line growth, operating leverage, cost rationalisations, lower interest rates

Nifty50 companies expected to average PAT growth of around 27 percent over next two years

Corporate profitability to improve rapidly; BSE 500 companies' average return on equity has clearly bottomed out, having fallen from 15 percent in 2011 to around nine percent in 2020

Corporate India has deleveraged substantially in the last few years, with improved quality of balance sheets comparatively

"If a continued disruption of economic activity happens for the third time, it will be punitive," Pathak said. "While the Omicron variant of COVID-19 seems to have been accounted for, the pandemic continues to be a risk. It is interesting to note that the market has been quite resilient during the second wave. This was mainly because overall economic activity continued unrestricted except for localised lockdowns. The risk of a third wave remains – and the risk is stoppage/disruption of economic activity should there be large scale hospitalisations and high mortality," he said.

But that doesn't mean one cannot strike a fine balance between quality of business and valuations. His message to investors: "Compromise neither on the quality of business nor on valuations."

He sees a lot of stock opportunities in the consumption, banking, financial services and IT services spaces. "We are also increasingly focussed on businesses that are benefiting from next-generation megatrends such as mainstreaming of digitalisation and China Plus One i.e. diversification of global supply chains," he said.

"Within consumption, we prefer consumer discretionary especially food tech companies. Within banking, we prefer large private banks, and in financial services, we like platform companies. We also prefer large-cap IT services companies," said Pathak.

Pathak is of the view that India's capital market is undergoing a big transformation with the listing of new-age companies. He finds it nice to see the enablement of public participation in the digital economy and expects new-age businesses to form nearly 10-12 percent of the country’s overall mcap over the next 2-3 years.

"This is exactly playing out the same way as it did in the Chinese markets over the last decade. The listing of new-age businesses has the potential to help increase India’s weightage in global indices, as most of these companies have a very high free float. We have seen this happen with China in the same way," he said.

Most of the new-age businesses are convenience transaction platforms selling goods or services, believes Pathak. "The same set of parameters can be used to analyse them as we do to traditional firms," he said.

He lists the following parameters to do this:

size of opportunity

competitive landscape

operational excellence

unit economics

path to profitability