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Economy

Podcast: Will Corporate Tax Cuts Fix India’s Bruised Economy? (Ep-11)

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“In the US, there was a talk of something called a Nifty50 in the early 1970s. A lot of those stocks traded at ridiculous P/E multiples. And people were told that these companies will never die. Just six years later, a portfolio of these 50 stocks was down some 60%. Not because these companies died and some of them never died or actually became bigger. But the point was that when you overpaid for the valuation, you ended up having too high expectations. Nobody would have thought Britannia will have to reduce the price of it’s biscuits, and they had to” – Deepak Shenoy

Host Deepak Shenoy (CEO) and Aditya Jaiswal (Analyst) discuss the corporate tax cut and it’s impact on the economy and most importantly, on our portfolios.

We discussed seven questions in the Podcast:

  1. Corporate tax cuts are fine but why aren’t we talking about the consumption demand? (1:26)
  2. Why corporate tax cuts? why not cut personal taxes? (9:15)
  3. How will the government bell the fiscal Cat? (13:00)
  4. Will India finally become the factory to the world? (16:58)
  5. Will the improving profitability lead to re-rating of the Indian market? (21:26)
  6. Why are the Megacaps rallying? (28:30)
  7. Are the good times back for our portfolios? (32:33)

Excerpts:

Everyone is talking about how the reduced taxes will lead to more cash in hand for corporates. Crisil even came up with a report that top 1,000 companies would save nearly INR 37,000 crore every year.
What will corporates do with the money?
Basically, reduced taxes should lead to tax savings for corporates. They will either cut prices, pay dividends or put up new plants. However, do corporates have any incentive to do capex today? A lot of these companies are already sitting on cash, be it Maruti Suzuki, Bajaj Auto, Nestle India. The reason there was no capex from their side was because the underlying demand itself wasn’t there. So, what about the revival of consumption? I can’t consume more unless my income goes up.

Why corporate tax cuts why not cut personal taxes?

This stimulus is definitely not a consumption stimulus, However, it aims to be an investment stimulus. Even if existing firms speed up the capex cycle, it is going to take at least the next 1-2 years for new capacities to set up, and wages to pick up. Would it have been better had the government had gone for cuts in personal taxes?

“If you provide a tax cut at a personal income tax level, it will benefit only a small percentage of the population. Is that going to change anything dramatically? But if one company decides to put up one plant, it’s going to hire 150 workers in order to just put up the plant. Each of those jobs will probably be below the taxable bracket, but they will consume more.” – Deepak Shenoy

How will the government bell the fiscal Cat? (13:00)
The tax cut is estimated to cost 1.45 lakh crore in lost tax revenue, now they govt clearly not in a position to let the fiscal deficit go up. Where will this money come from? If the government fails to maintain the fiscal deficit then it will have to borrow more, how will the interest rates go down if the govt borrows more- this becomes a vicious cycle! Is aggressive divestment by the govt is going to be the solution? (BPCL)

Will India finally become the factory to the world?

“if Apple were to make iPhones (in India), it won’t make iPhones only for the world, it will also make iPhones for Indians, but Indians can’t afford them. Chinese couldn’t afford them too. But now China is one of the largest buyers of iPhones because their per capita income has gone up to a point where they can afford iPhones… a 17% tax is a very competitive rate, But what this doesn’t do is address the fact that these companies are going to come in and compete with Indian companies that are doing the same thing…But this is a good problem to have” – Deepak Shenoy

The govt had announced Make In India policy in 2014 but what they have done now, the 15% tax rate for new manufacturing firms is the real Make in India push. Wages in China have grown to an average of $700 per month, in India it is less than $200/ month. Now with the ongoing trade war, can we compete with not only China but Bangladesh and Vietnam as well?

Will the improving profitability lead to re-rating of the Indian market?

Morgan Stanley and UBS both are turning positive on Indian corporate earnings and are talking about a cyclical recovery. Since, this tax cut is a permanent step, it is going to lead to a profitability jump and ROE expansion, does this calls for a rerating of the Indian market as a whole?

Why are the Megacaps rallying?

All the mega-cap stocks are moving as if there is no tomorrow. Asian paints is trading at a P/E of 75, DMART is at 115 P/E, Britannia at 64 P/E, and not just consumption stocks, even Bajaj finance is trading at 12x BV. Why is this happening? Is it like DIIs are willing to pay top dollar for quality companies or is this clearly mis-pricing?

“In the US, there was a talk of something called a Nifty50 in the early 1970s. A lot of those stocks traded at ridiculous P/E multiples. And people were told that these companies will never die. Just six years later, a portfolio of these 50 stocks was down some 60%. Not because these companies died and some of them never died or actually became bigger. But the point was that when you overpaid for the valuation, you ended up having too high expectations. Nobody would have thought Britannia will have to reduce the price of it’s biscuits, and they had to” – Deepak Shenoy

Are the good times back for the portfolios? Is this the time when we start using the cash and the debt we had kept aside till the weakness was over?

As long as you know that you’re walking on eggs, it’s easier to understand that you have to be nimble- Deepak Shenoy

You can also listen to our podcasts on our app: www.capitalmind.in/podcast

Transcript:

Deepak: Hi folks, welcome to Capitalmind’s podcast and yet again, we discuss a topic on corporate tax cuts. This is going to be an interesting topic because everybody thinks this is a phenomenal thing, this is an interesting thing, or some of them say this is a bad thing. Let’s go discuss this topic thread where we’ll follow it up with a post at Capitalmind and would love to hear your thoughts and questions. So firstly, welcome Aditya to the show and let’s get this going. What’s happening with corporate tax cuts?

Aditya: Hi, Deepak, thanks a lot. It’s a pleasure being here doing the podcast with you. So we have read a lot of details about the tax cuts from 30% to 25% and reducing of a surcharge. So I just want to directly jump to the second order effects of the tax cuts. This is definitely not a consumption boost, right?

This is not a consumption stimulus. It is basically an investment stimulus or rather, I would say that this intends to be an investment stimulus. So everyone is talking about how the reduced taxes will lead to more cash in the hand of corporates. Crystal came up with a report that thousands of companies would save nearly 37000 crore every year. But my question is what are they going to do with this money? So they will either cut prices, pay dividends or put up new plants, right? But the point is, do corporates have the intention to do a capex right now? Because a lot of these companies are already sitting on a pile of cash, be it Model T or be it Mahindra & Mahindra. The reason there was no capex from their side was because the underlying demand itself was missing. So what about the revival of consumption? You can’t consume without income growth, right. So these tax cuts do not do much for the consumption demand, do they?

Deepak: There are two thought processes to how consumption comes about in India. Consumption isn’t necessarily only personal. So personal would be like demand for cars. Now, demand for cars again can come from two kinds of sources. When I create a new plant, or when I hire more people for that plant, I hire more workers, and I hire more executives. I’m going to see a vehicular increase, because all the people in that locality are going to buy cars, buy two wheelers. The plant itself is going to buy vehicles, commercial vehicles, perhaps trucks, perhaps feeders, loaders, JCBs. So there is a knock on impact of saying, listen, part of this consumption demand we talk about is actually investment demand that results in consumption, and what we’re actually going to see here and I actually believe this is a very interesting and a very good use of the RBI dividend that the government has received, that they will use this money to push investment and not consumption.

I think consumption wise, India’s consumption has always been good. We will always have good consumption demand. The investment demand, which is specifically capex, specifically new investments, and new plants, is mired in a number of data issues, because what we call capex is usually just building of a new plant, buying equipment. But as you see more and more people can actually start new businesses by just signing up for a shared rental office, buying a few bikes, hiring a few delivery people and they have a business. They don’t need a whole lot of space, a whole lot of plans, a whole lot of things. What happens is that there’s not reflecting what is called the capital expenditure or investment or gross capital formation part of GDP. It records itself in consumption.

So you will see a rise in consumption simply because even investment causes consumption and that’s not a bad thing. Having said that, will this at least increase it? Let me look at this from another podcast we’ve done earlier, which was the rising cost of capital in India. Why will you do business in India if the safe interest rate that you can reach, achieve, is good enough for you to not have to run a business at all? Why would you do that when your cost of capital is so high that it is unviable to reach these businesses? When you increase the ROE, the ROE is, remember, net profit after tax divided with the amount of capital you have invested in the business. So, if I earn an eight rupee profit on a 100 rupee capital investment, I’m making 8% ROE.

If my 8% came after 35% tax, pretax I would have to earn something like say 12 or 13 rupees. Today, if I earn the same 12 or 13 rupees and I pay only 22% tax, my return on equity just became 10 rupees out of a 100. That means I have a 10% ROE. My 8% ROE went to a 10% ROE overnight simply because I could pay a much lower tax rate. So if earlier ROE is now 8% is a misnomer, most Indian businesses work at 16% ROEs. In fact, that is expected when a government gives a project that anybody who invest in this project will earn a 16% ROE or RO.

So if you look at that ROE from that perspective and you reduce the tax rate, a 16% ROE can become an 18% ROW literally overnight. Now, if you were to say that, “Listen, we will pay these dividends to shareholders.” The answer to that as well, that’s money in the hands of the consumer. Though, if they will otherwise reduce prices, yes, this money again in the hands of consumers, who are going to buy those goods or people who didn’t have the capacity to buy a certain good at a certain price, now looks at this as an attractive offer and starts to buy it. Remember this is a consumption good, so you can’t delay it forever. I can delay buying a car for six months, but if I see the car price come down and I need the car, earlier, which it was not affordable, I’ll go get it now saying, “You know what? We’ve got a good deal. Why don’t we just go in and buy it right now?”

Consumption good, when it’s prices fall, its consumption actually increases. And we’ve seen that whether it is mobile phones, whether it has been data connectivity or many of the others where inflation’s actually been negative over years and yet we’ve got much lower, much higher consumption than we have had earlier. The second part of this equation is if the companies then say, “Listen, I will just make a lot of profits and I will do nothing with the cash.” I don’t think that’s going to happen, because companies also look to this as, if I put the cash in the bank, I’m going to get 8%. Now it’s falling. It’s 7%, 6% every day. But if I were to invest in a project now with lower taxes, if I was a manufacturing plant it’s only 15% plus surcharge 17%. So otherwise it’s 22% plus surcharge, which is 25%. It’s much lower than me trying to do a whole lot of other things.

So why don’t I just invest in the business, increase my capex and then wait as demand will come in. This capex led investment cycle is a very interesting one in the sense that it spurs consumption at a later date. The first thing that it does is create new investment, which results in the purchase of a lot of things we call consumption like cars, cement, steel. You’re building new offices, you’re hiring new people, you’re giving people more money in order to be able to get more money out. Remember, it’s not just the big companies, it’s more likely to impact the smaller companies for whom credit is always be in pain and they are able to park their money. Instead of running a shop, I might as well keep the money in the bank, because what’s the point. Here, if net after tax, I’m getting a much lower tax rate and a much higher post-tax income. I might say, “No, let’s choose to run the business instead.” And I get clarity, at least for the next three or four years, I will not see that changing.

This is the investment consumption, investment based consumption that I think India will see in the next few years and it’ll impact more SMEs then the large companies. And I’ll come to why, because large companies tend to take more of the exemptions, which are available and now with a new 22% tax rate, you can’t take a lot of the exemptions that you earlier got or MAT credit, for instance, which is largely used by big companies and not by SMEs. So the smaller and medium set up is the one that really benefits from a tax cut. The large companies, not quite so much.

Aditya: Completely agree with you on the point of investment based consumption, but my question is, what is the quickest way to boost demand? Put money in the hands of people. So do you believe that cutting personal taxes would have been a better decision?

Deepak: I don’t think so. I believe strongly that cutting personal taxes doesn’t actually create a whole lot of consumption demand from here. I’ll give you an example, up to five lakhs, you don’t have to pay any tax.

Aditya: Yes.

Deepak: That is a huge tax cut for over 95% of all registered tax payers in the country. If you provide a tax cut at the personal income tax level, you will only benefit a very small percentage of population. I’m not saying the number of amount of money. Not a person that is say 5% of taxpayers and taxpayers themselves are only about 7% of the population. So you’re talking of 0.35 or .4% of the population will spend more. Is that going to change anything dramatically? No. But if one company decides to put up one plant, it’s going to hire 150 workers in order to just put up the plant.

I mean downstream it would probably affect a 1000 jobs. And each of those jobs produces incomes, which are mostly below the taxable bracket, but they will consume. That money will go into consumption. So you instead of saying that I’ll benefit .5% off, 7% of my population, I will benefit 10% of the overall population by saying, “Listen, 10% of the population will get jobs, maybe even temporary just related to my capex, but this will happen in the longer term. I will use this money and support consumption. It may not result in higher taxes today, but it will result in a lot of people who consume and then pay me the GST on consumption rather than income taxes.”

Aditya: Basically trickle down effect.

Deepak: I think this is one stage. Trickle down would be where you give the rich people money and they trickle it down to the poorer people. Here you are actually giving the corporates money and saying, “Go spend on capex.” And you can think of a corporate as the rich corporate, but like I said, the biggest beneficiary is the shopkeeper. The SME who refused to run his business because net after tax, he was getting such low returns that you suddenly boosted his returns by 20%. I mean, I’m saying six rupees, eight rubies became 10 rupees. That’s a 25% jump in my net income after tax. So by the way, if you’re a shopkeeper, it actually makes sense to register as a private limited company today, then run it as a proprietorship, because you save yourself at the highest tax bracket, that means about 10 lakhs per year, you are paying 30% tax. Even a shopkeeper nowadays, by the way, makes more than 10 lakhs a year, most likely 40 or 50 lakhs, because he has multiple stages of businesses.

If he were to not declare them and keep them as black money, that’s a waste, because you can’t do much with that black money. But now if he declares it, it’s just 22% tax, or 25% tax, which is much lower than he was paying earlier, which is 35, 36 and now up to 44% tax. So it actually makes sense when people do more into privately ordered companies rather than just do things the way they used to do earlier. So I think this will bring more people into the tax net in the future, because the people who register now, we’ll show it. And secondly that people will start seeing that less of their income goes towards tax and choose to run it the proper way, where running it through private limited organization instead. So I don’t think personal income tax reduction would have support consumption quite as much, basically because our net taxable population is relatively a very tiny one, 35 or 40 lakh tax payers actually pay tax versus the knock-on effects of investment.

Aditya: So what about the fiscal math? Like this whole stimulus exercise is going to cost about 1.45 lakh crore to the government. I don’t think the government is so naive that it’ll allow fiscal slippage. So do you see more divestments on the way like BPCL?

Deepak: Of course, I think not just BPCL, but Concord, and a bunch of others, and the government owned stakes in ITC, and Access Bank, and L & T. I don’t know about Access Bank, but maybe they still do. There is a significant reason for the government to disinvest in these companies anyhow, regardless of the fiscal math here. But more importantly, the fiscal arithmetic actually isn’t imbalanced in a significant way. I’ll tell you why. Because if you look at what the government itself releases as revenue forgone, with respect to all of these exemptions that people have been taking. SCZ, say 60000 crores and then something else, about 40000 crores.

So now if you take the lower tax rate, you cannot avail of these exemptions and therefore the revenue slippage on account of that will then balance itself out. Right? So where I was losing 60000 crores in SCZ tax revenue, I might lose only 30000 crores and therefore my losses, which I was going to lose one lakh, 40000 crores out of the tax cuts itself, now it’s only became one lakh, 10000 crores. Take another exemption out you’d lose… So I think we lose a lot lesser in reality. And because more companies will now choose to come into the tax net rather than stay out of it and will perhaps even declare income that they did not declare earlier, in the medium term, I’m talking two years from now, we will see a much higher compliance, because if more compliance comes, more taxes come.

Maybe this year is going to be a little tight, but they have the RBI dividend to change itself for the next six months. But after six months, again, in the next fiscal year we will still have a significant amount of RBI dividend, because RBIs continue to give good dividends, not huge, but good at least about say one lakh crores. But apart from that you’re going to get this business knock-on effect of either capex itself resulting in businesses that will pay more tax. And also more GSC through the higher consumption that’s going to occur as a result, but also because a lot of other businesses are going to say, “I’d rather be a taxpayer than not be a tax payer,” and pay some tax. Now that some may be a little bit, but do you see 35% you’re always getting away the small guy. At 25% you have a greater chance of him being accepting enough to pay taxes. Apart from is there are going to be businesses from abroad that come in and start to do different things.

So I think they will start to set up their own plans. They will set up plans for manufacturing in India, because now the manufacturing rate is only 15%. And this starts literally on October 1st. This is right now. And that will change the game as it goes on. I expect board projects to be announced. I expect more of these companies to come to India. I hope we see lower interest rates, as well, because the businesses, once they’re set up, they need to make sure that they earn enough ROEs after paying taxes. Remember if inflation is low and industries are much higher than inflation, you can’t really run a business. So you need inflation and industries to be roughly equal, or ideally around the same level, so that if you got 5% inflation, we will borrow at 5.5 maybe six, but I shouldn’t have to borrow at 12, which is the current situation today. So I hope that happens as well. That’ll balance out the fiscal math if more businesses come in.

Aditya: So when we talk about manufacturing, let’s talk about the Make in India Initiative that was announced in 2014. So it was roughly about five years ago, but I believe what they have done right now, like 15% tax rate for new manufacturing forms is the real Make in India push. So I was reading a report, which says that the average wages in China are now three times that of India. So now with the ongoing trade war do you believe this is a very great time to move and we can compete with not only China, but Bangladesh, and Vietnam as well?

Deepak: So I think without this move would not have any will to compete, because not only does Bangladesh and Vietnam have a structure that’s more useful for people from abroad to set up plants, but also that Thailand and Indonesia have actually cut tax rates and boosted local manufacturing through in initiatives like subsidies and tax cuts also. So we are literally going to have to do this just to stay in the same place. The question now is whether India is large enough to be exciting for a manufacturer to say, “Listen, I will come here, I will set up shop and not only will I serve the rest of the world as an exporter, but I also will serve the large Indian retail population. So if Apple were to make iPhones it won’t make iPhones only for the world. It will also make iPhones for Indians, but Indians can’t afford them.

Chinese couldn’t either, but now China is one of the largest buyers of iPhones, because their per capita income has gone up to a point where they can afford iPhones. If you have enough companies are coming, our per capita income will go up high enough to be able to buy the same toys, devices, goods that these foreign manufacturers want to produce at a relatively lower price from the countries they currently produce in. But they now get access to the Indian market, which they otherwise might have had to pay 10%, 15% duties on. India, by the way, has 10% duty on everything. Anything you import from abroad, whether it’s manufactured in China, Sri Lanka, Bangladesh is subject to a 10% minimum import duty and there’ll be all the surcharges and all that other stuff. You manufacture in India, you have no import duties.

So an importer will pay import duty plus GST. So 28% GST for a car, or a car part, even an air conditioner imported from Korea costs 10% import duty plus 28% GST. So effectively you’re paying 38% for it. They have to manufacturer it that much lower to be able to sell to India at a reasonable price. So if you were to manufacturer that air compressor in India, physical, in company, I’d say, “Listen, this is manufactured in India. I will then be able to use that lower manufacturing base to even service the rest of the world, because Korea itself is becoming expensive and I can’t expand anymore in Korea. So maybe I’ll set up another plant in India to service not just India, but the rest of the world.” So this process might help the Make in India Initiative.

17% is a very competitive rate, very competitive rate. So it’s super attractive for someone to come in and say, “I have three years to build the plan. 17% rate is phenomenal.” Now what this doesn’t do is address the fact that these companies are going to come in and compete with Indian companies who are doing the same thing.

Aditya: That’s the most important part.

Deepak: This is actually good for us as a consumer, because their consumption goods will help, but it does mean that foreign competition will come in and perhaps because they’re of a higher efficiencies, they may be able to beat us substantially, because of their much lower interest rates, also abroad. They could borrow from abroad, set up a plant in India and pay much lower taxes here and therefore earn much higher returns on equity than any Indian company could hope to simply because their cost of debt outside of India is substantially lower.

You can do some return on equity by taking debt. Now in India, that is 8% and outside the rate is 3%. The guy is making the 5% differential. More money that comes into India it keeps the exchange rate in check. So net net somebody from abroad earns more money. So yes, this is a problem if it happens, but I think it’s a good problem to have, because at the same time, I think India should open up Indian companies by getting more debt from abroad, so we can equalize the debt costs of this equation as well.

Aditya: So let’s talk bout markets. Morgan Stanley and UBS both are turning positive on Indian corporate earnings and are talking about a cyclical recovery. This back tax credit is a permanent thing. It’s not a temporary phenomenon, right? So is it going to lead to a… Does this calls for a re-rating of the Indian market as a whole? Because we would be seeing an ROE expansion and a profitability jump.

Deepak: I think the ROE expansion is going to come primarily in financials and some in the auto sector as well. Because in financials you won’t see people cutting rates because tax rates have come down. Rates often remain the same. They will earn just higher net profits after tax. Many of them pay 35%. Now even if you look at the government data, they also say that financial companies pay the highest tax as a proportion of their revenues, out of their book profits. So in effect, I think the market is going to get favored by higher profits in some sectors. But look at IT, IT, a company like TCS for instance, has so many subsidiaries abroad. They pay tax in every individual jurisdiction, mostly the US. The US has 30% plus tax, or now 22% recently. So there is a significantly different tax regime for them.

They have to pay their taxes in the jurisdictions they have businesses in. The Indian business will only pay tax or income received in India, so they will be a lower tax, yes, but the impact for them is substantially less. Second, they are located in the SEZs, where they don’t want to pay tax in India, so they located themselves in the SEZs. Now they can’t, because if they do they will no longer have any benefits to be able to claim the lower taxation rate. So they’ll pay the 33%, or stay in an SEZ. Or like Wipro, whose exemptions expire, they will move to another unit, where the exemptions are not there, but then they’re not there at the SEZ location either, but it combines their operations into one unit. So I think really that conceptually the move here from our taxation perspective will affect a few companies positively and a significant number of the larger corporates negatively.

Another example, MAT credit, you asked legal minimum alternate tax and that exists, because if you have a 100 rupees and you have a 100 rupees of exemptions, you have to pay no tax, because you have no income. The government said, “Oh, no, no, no. Let me back out the exemptions, see how much profit you make. 100 rupees? Then you pay 20 rupees of that as a minimum alternate tax.” But you say, “Well, I wasn’t… You give me the exemption.” No, take the 20 rupees, put it in a reserve called a tax credit, or a deferred tax asset. So you say that this 20 rupees are available to you to use in the next year.

Now what do you do in the next year? You make another 100 rupees profit and now you have no exemptions, because of some reason. Now you are to pay 30 rupees as entire profit, right? Because it’s 33% or 35 rupees you are to pay. But you say, “Listen, I had MAT credit last year, I will take that MAT rate of 20 rupees. I will pay a tax of 15.” The government says, “No, no, no, no. Wait, wait, wait. You have a MAT of 20 you can’t pay 15.” So you are to pay 20 at least the remaining five, again, you take that back as a MAT credit.

So you took out, out of your 20 rupees of previous MAT credit, took out 15, you added back five, so you have 10 left. You know, in a way. So MAT credit keeps getting added up, so in this case exactly five will be added, but MAT credit keeps adding up. Now, if you have an exemption every year, every year this MAT credit is going to be added to your deferred tax assets and you will have this huge deferred tax asset of, say, 7000 crores, 4000 crores, 5000 crores. And some of the large corporates have that much. Now, in NBCC, for instance, last year showed a huge profit because it had 7000 crore MAT credit availability and because one of his exemptions had gone away, it had the same problem where it could use a past MAT credit and reduced it.

Now any company with a large amount of deferred tax assets or MAT credits will not pay 22%, because it says, “Listen, I have to use this MAT credit. If I go to 22% this MAT credit is useless,” because the law says MAT credit can only be used where MAT is applicable. And guess what is not applicable in the 22% tax rate, MAT. There is no MAT. And the simple wording of the law that says the MAT credit is not applicable makes sure that you can’t use a MAT credit against the tax payable, which means any MAT credit any company has today is a complete, we say toilet paper, it’s completely useless. You have to just throw it away. If it’s a large enough number, I will say, “Listen, I preferred it with 33% tax, but please let me keep the MAT credit.” So this is the split, Biocon, for instance, we say, “I have research related tax exemptions. I don’t want to take the 33 or 22% tax rate.”

Take Sun Pharma, take all the pharma companies, all of them have research related expenditure that’s exempt and they don’t want to do that. There are a bunch of others who have exemptions related to news industries, to petroleum exploration, to something else. All these exemptions are no longer valid, so you take the 50 companies in the top, or the top 100 companies in India, at least 25 to 30% currently pay less than this 25% tax rate, which you mentioned. So, in effect, if every company spent 25%, or how many, if many companies are being less than 25% already, they don’t not going to want to pay 25%. Many other companies that are paying more actually have some of these furloughs, MAT credit, this, that, exemptions on research, SEZ, they will also not want to take it.

So the impact is much lower than we think it is for the largest Indian companies, which is why I’m surprised that FMCG companies continue to go up because this is not going to spur people to buy soaps. It’s actually going to spur people to buy cement. And cement companies, by the way, pay a significant amount of tax. It’s not going to push IT companies up, but IT companies went up in the market. So this is a shift in congruence between what I think the market should react to, which is, you should actually be buying auto companies, should be buying cement companies, infrastructure, capital goods. But on the other hand… and financials, but you should actually be shunning the ITs, and the pharma companies of the world, because they’re not going to benefit quite as much from it. So markets may have over thought this one perhaps. And I think we’ll notice in the next few financial results which part of this camp is true.

Aditya: So NIFTY is up about 7-8% since the announcement. And the mega-caps are moving as if there’s no tomorrow. I would rather say there’s madness. Asian Paints is trading at P/E multiple of 75, Bmart at 115, Britannia at 64, and not just consumption stocks. Take Bajaj Finance. It’s trading at around 12 to 13 times its book value. So my question is why is this happening? Is it like suddenly their DIAs have been enlightened and they are willing to pay top dollar for quality companies or is this clearly mispricing?

Deepak: Well, you know in the US there was a talk of a something called the Nifty Fifty in the 1970s, early seventies. A lot of those talks also created these ridiculous P/Es and people were told that, “Listen, these companies will never die.”

Aditya: Okay.

Deepak: Just six years later this portfolio of stocks, of these 50 stocks, which was supposed to be never die was down some 60% simply because… not because these companies died and some of them took many years to die and some of them never died or actually merge with other companies and even became bigger. But the point was that when you overpaid for the valuation of these stocks at that time, you ended up having too high in expectations. Nobody would have thought, Britannia has to reduce the price of its biscuits.

Aditya: Exactly.

Deepak: And now they do. So all the thesis around, “Oh, this is a mode, this is this, this is that,” will go away. Bmart is a great example of a phenomenal young company, but at a stock price that is difficult to justify why you should buy something like that for that kind of a P/E. Because if you don’t, if the company does not grow at a breakneck pace… And, by the way, it’s not growing at a breakneck pace. It’s growing at a certain pace, which is decent, 20, 25%, but you will not be able to justify a 115 times earnings for it.

Aditya: True.

Deepak: Bajaj Finance, one of the reasons why it’s stock prices are attractive to a lot of people is because of its growth. But I say this, you take a multiple of book and if the book values 20000 crores, you are giving it a valuation of 2 lakh crores. It decides recently, and it has, to raise about 8500 crores. That means its book is going to become 28500.

At the same market cap, the book is now instead of 10 times book. We are now talking of six times book. Just by the fact that it raised capital, we’ll give it a six times book valuation. So financials are little bit weird in that perspective. So you can actually reduce book value by just raising… reduce book value multiples by just raising enough capital. Bajaj Finances has actually done that. And it’s quite interesting, because I think people have factored that in when they gave it a 10 times valuation saying, “Listen, in six months these guys are gonna run out of capital, it will raise capital, so I’ll give it a valuation based on how much I think Bajaj finance will raise. And it’s gonna dilute 4%, but it’s going to get a six times book valuation versus a 10 times book valuation. So there’s a bit of a dissonance over that.

Having said that, it’s ridiculous to pay extreme values for a lot of stocks. I think being 15% asset for the EMC or 15% of assets for an EMC 50, or 10 times book for an MBFC is a little scary. Now, if you’re invested, I won’t say go and sell these stocks, but just be aware that the over valuation exists and you’re the children of a bull run in those stocks. Not necessarily because you’re extremely skillful, because in normal times you might not have seen such valuations and as long as you know that you’re walking on eggs, it’s easier to understand that you have to be nimble.

Aditya: That’s a very good analogy. Deepak, my final question to you, are the good times back for the portfolios? Is this the time when we start using the cash and the debt we had kept aside till the weakness was over?

Deepak: So I think anyone should an investment strategy that’s longer term in nature and you should have a very… We should have a focused approach towards building towards your longterm goals. Invest regularly if your income is regular. If you’re already invested, or you have a lot of cash and you got out into cash earlier, well, good for you. But I don’t think it’s the right time to say, “Listen, I’m going to bet the farm, or the house on all kinds of stocks.” I think should buy good stocks. You should buy them regularly, build your portfolio over time. Don’t push the envelope. But also remember that because this tax change affects smaller and medium businesses more, the mid and the small cap should be the places where you should start hunting.

Aditya: Okay.

Deepak: And I think in the longer term that they will do well. Meanwhile, we have our debt crisis on the books right now. There is a potential situation with a number of banks, a number of non-banking financial companies, housing finance companies, this is going to cause the market to flutter and to give you negative volatility, which means it’s going to hurt you on the downside. So I think keeping that cash in hand is still worthy, because you can find deals where stocks are down 10% for no apparent reason and the stocks that you liked, but you didn’t buy because they were too expensive. So Dmart, hopefully it falls to three digits. And then all of a sudden buy it and say, “Okay, you finally bought into it.” But if it does happen, it’s a good thing. And I think cash should be retained it in portfolios and only deployed over a period of time.

Aditya: Thanks. Thanks a lot, Deepak. That was my last question. Thank you for taking your time and doing this.

Deepak: I think this is wonderful, thanks, all, for listening. We are at capitalmind.in/podcast. Please feel free to ask us questions on Twitter. I’m @Deepakshenoy. Aditya is @AstuteAditya. We’re @capitalmind_in. Do check out Capitalmind Premium, where we discuss a lot of these things on our Slack discussion channels with our premium members and let us know what you think. Lovely and thanks for listening.