The markets continue to hit all-time highs, even as, at every rise, 'market experts' advise caution! As more and more FIIs buy into the India story, wanting to get a piece of the action, valuations keep on moving higher and higher. Consequently, finding value in stocks is becoming increasingly difficult. The large cap stocks seem richly valued at current levels (barring a select few) and it appears that most of the growth in the medium-term has been factored in.

In such heady times, where idea generation becomes more and more scarce and difficult, theme-based investing can make things a little easier for investors. In simple terms, theme-based investing means identifying a particular 'theme' in the country that is likely to become a strong growth story going forward, due to reasons such as increasing demand, favourable policy environment, nascent market to be tapped, and so on.

Examples of theme-based investing abound in the history of the Indian stock markets. Liberalisation, privatization, information technology, commodities and infrastructure are examples of major themes, based upon which the markets rallied in the past, of course, with the help of the FIIs.

This time around, it is the 'emerging markets' theme that has played out and continues to do so. This has actually been the major theme based upon which FIIs have poured in massive sums of money into the Indian stock markets and, for that matter, other emerging markets globally, like Taiwan and Korea. Of course, it must be noted that while this example is from the point of the view of the FIIs, on a retail basis, the theme could be sector specific.

Thus, one needs to first pick the theme that one likes and that one feels can deliver good growth over the medium to long term and then, of course, do the requisite stock picking. We believe that 2 themes have a strong chance of playing out over the next few years - 'domestic consumption' and 'outsourcing'.

Domestic consumption Given India's burgeoning middle class population, favourable demographics and increasing affluence, we believe that sectors that are focused on domestic-led consumption could benefit in future. Sectors that are expected to do well range from FMCG, two-wheelers, consumer durables, tractors, telecom, PCs and retailing. In fact, the rural market is highly untapped and this is undoubtedly where the future growth of India Inc. needs to come from if the country is to reach the next trajectory of growth.

To substantiate this with an example, in the telecom sector, India's cellular teledensity is just around 6.5% to 7%. Therefore, there is significant scope for growth. However, if we break this up between rural and urban areas, urban India's cellular teledensity is 32%, while that of rural India is just 1%! Thus, we believe that it is in the rural markets where the next phase of growth needs to come from, if India is to grow in a sustainable manner over the longer term.

Outsourcing India's attractiveness as an outsourcing destination is only too well known. Just ask techies in the US, UK and Europe! India's pre-eminent position in IT-BPO outsourcing is due to factors such as low labour costs, highly skilled engineering and management talent, enabling policy environment, mastery of the art of global delivery and execution excellence. Therefore, global Fortune 1000 companies and beyond are really looking very seriously at India for outsourcing/offshoring their work.

But while India's software exports story has been known for many years now, we believe that the time has come for India to stand up and be counted as a viable manufacturing destination as well. Of course, we need to ensure that we stick to our strengths. China has strengths in mass manufacturing, while India can carve a niche in higher-end products and design and development of products. Auto ancillaries, pharma and textiles are 3 major areas that have the potential to grow at an impressive pace in future and replicate the success of the software industry.

However... It must be noted that identifying a theme is easier said than done. Markets latch on to 'the next big thing' very quickly and very soon, the theme plays out. Investors must have the foresight to be able to identify themes. But then, the next step is equally important, if not, more so - that of stock picking. Investors in technology stocks were on the right track when they picked the theme (the fact that it turned out to be a huge bubble is another matter). But then, investors who went for stocks like Pentamedia Graphics and DSQ Software would have ended up losing most of their investments. This is because these kind of companies did not have stable and robust business models, unlike Infosys or Wipro, which is why they are still languishing at low stock prices.

The main point here is that, while theme-based investing is undoubtedly a good way to make money, one must first of all have the ability to spot a theme first that is likely to give good returns over a long period of time and then choose the right stocks that will benefit from this. If not, then relying on a good fund manager or research house would be the appropriate thing to do.

Posted by toughiee on Saturday, December 24, 2005 at 7:06 PM | Permalink