Many startups have expanded rapidly in India. So much so that they are now bigger than much-older companies. In this column, part of VCCircle’s 10th anniversary celebrations, Ambit Capital’s Saurabh Mukherjea predicts that some of these new ventures will enter the Bombay Stock Exchange’s benchmark Sensex in the next few years.
Amongst the world’s 10 largest stock markets, the Indian stock market has the highest level of churn. Over the past 20 years, the churn in the market has been around 50 per cent, i.e., if we begin the decade with 30 companies in the Sensex, by the end of the decade only 15 are left.
However, this average churn of 50 per cent does not tell the whole story – Ambit’s analysis of the Sensex’s churn across 10-year windows reveals that the churn peaked at 67 per cent (or 20 replacements in a 30-stock index) in the years following the 1991 reforms (1993-1995). From those levels, the Sensex churn has fallen to a low of 27 per cent (eight replacements) in the latest 10-year iteration (2004-2014). Going forward, I expect a reversion to 50 per cent churn, implying that 15 companies will exit the Sensex in the next decade.
Entries into the Sensex over the next decade
So, how can we predict which stocks will be in the Sensex 10 years hence? Here is how my colleagues and I have gone about solving this puzzle.
First, given the Sensex’s history since 1991, we can see that the Sensex churn will be at least 50 per cent over the next decade given the reforms that Prime Minister Narendra Modi has kickstarted (attacking black money, attacking subsidies and shifting the subsidy system to Direct Benefit Transfer and attacking crony capitalism). This implies that at least 15 new companies will enter the Sensex over the next decade.
Second, an analysis of 25 years of Indian stock market data shows us the entrants into the Sensex come from the following sources:
- Half of the entrants historically have come from the top 100 stocks based on market cap as of the beginning of the decade;
- About 16 per cent of the stocks come from the next 200 stocks (i.e., beginning-period market cap rank between 101-300); and
- The remaining third of the stocks entered the Sensex on account of fresh listings.
Third, we can collect powerful clues from the fact that India’s per capita income (PCI) today stands at $2,000 and should over the next decade go to $4,000, provided we compound PCI over the next decade at the same rate as the last decade. Over the past 20 years, several other countries – Russia, China, Poland, Korea, Sri Lanka, Indonesia, Malaysia, Turkey, etc., – have made this transition from $2,000 to $4,000 PCI. By studying their stock markets we find that during these transitions:
- The weight of discretionary consumption stocks in the market rises sharply;
- The weight of financial services stocks in the market rises sharply;
- The weight of consumer staples falls sharply; and
- The weight of industrial stocks moves in a particular pattern.
Finally, having used history to give us clues regarding where Sensex entrants will come from (in terms of sectors and market cap buckets), we then use our proprietary stock picking tool – the Ambit “greatness” model which uses the last six years’ data to identify the companies which in specific sectors and market cap buckets have allocated capital with the greatest success.
So what comes out of the mix after we have applied these four layers of filters? History tells us that 10 out of the 15 Sensex entrants are likely to come from currently listed companies (the rest being IPOs). Our 10 entrants, segmented by sector, are:
- Consumer discretionary: Asian Paints, Nestle, Pidilite and Page Industries;
- Financial Services: Kotak Mahindra Bank and IndusInd Bank;
- Pharma and Chemicals: Torrent Pharmaceuticals and PI Industries;
- Auto: Eicher Motors; and
- IT: HCL Tech.
Predicting the IPO entrants is much harder because we don’t really know which IPOs will come out of the woodwork over the next decade but basis the names that are currently doing the rounds in the media, the four most likely Sensex entrants appear to be Flipkart, Paytm, Hindustan Aeronautics and ICICI Prudential Life. Each one of these companies is a market leader in its segment and barring Paytm, each of these companies is already big enough to occupy a place in the Sensex in the foreseeable future.
Exits from the Sensex over the next decade
Using Ambit’s proprietary methods such as The Coffee Can Portfolio, The Greatness Framework and the Ambit P-75, we identify a list of 15 stocks that we believe are the most likely Sensex exit candidates over the next decade. These companies include Tata Power, NTPC, Tata Steel, Hero MotoCorp, State Bank of India, Sesa Sterlite, Bharti Airtel, Reliance Industries, Mahindra & Mahindra, Oil & Natural Gas Corp, Larsen & Toubro, Bharat Heavy Electricals Ltd and Bajaj Auto.
For those who believe that giant market-leading firms are highly unlikely to be kicked out of the Sensex, we highlight that all of the following firms were in the Sensex in 1992 – Century Textiles, GSFC, Bombay Dyeing, GE Shipping and Ballarpur Industries. The disruption created by the end of the ‘License Raj’ was such that all of these firms were out of the Sensex by 2002. Similarly, in 2005, all of the following giants were in the Sensex – Ranbaxy Labs, Hindustan Petroleum, Satyam Computers, Grasim Industries and Reliance Infrastructure. No prizes for guessing what happened to these companies by 2015.
Saurabh Mukherjea is CEO – Institutional Equities, at Ambit Capital and the author of “Gurus of Chaos: Modern India’s Money Masters”. The views expressed are personal.