Investors need to get back to basics of value picking

An article in ET says:

It is nature’s way that every spring is followed by autumn. Investors are finding out that the stock market is no exception to this rule. After four years of unchallenged stampeding on D-Street, the bulls have been forced to retreat by the resurgent bears.

The questions that both market experts and retail investors seem to be asking are: Is this the beginning of a bear market? How long will it be before the bulls are seen on the horizon again? The truth is that there are no clear-cut answers and the future, as of now, is up in the air. What is obvious, though, is that investors are unlikely to see their investments growing as fast as they have grown in the past four years. So, does this mean that it is time to stay away from the market?

Not quite. While the days of making easy money and double-digit returns within a few months in the market may be over, there is still scope to generate good returns on investments. For that, though, one has to forget about momentum and go back to fundamentals.

A rigorous analysis of data and extensive numbercrunching reveals that there are a host of stocks that are trading at cheaper valuations compared to their historical levels. We began by comparing the current earnings multiples (trailing 12-month P/Es) of the BSE 500 companies with their five-year average P/Es. There were over 77 companies which met this criterion and made the grade.

However, we decided that this, in itself, will not be sufficient, as the boom witnessed in the stock market in the past five years may skew the data. So, we adopted a filtering methodology to zero in on the stocks whose current P/Es are lower than both their five-year , as well as 10-year averages.

In order to mitigate the impact of this stratospheric rise in valuations, we calculated the 10-year average P/Es of the BSE 500 companies — there are 270 companies, which have been listed in the past 10 years or more. We then selected the companies that had current P/Es lower than the 10-year average.

Here again, there were some companies that had current P/Es lower than the 10-year average, but higher than the five-year average. This means that though these companies are apparently trading at historically lower valuations, these are still higher than their boomperiod valuations. This led us to consider only those companies which had current P/Es lower than both the five-year and the 10-year average.

We found that 55 companies from various sectors met this criteria (log on to www.etintelligence.com for the complete list). While the list is diverse in nature, it does not have any companies from the banking and real estate sectors. Also, it has just one telecom company, Tata Communications (earlier VSNL). The reason for this is rather simple, in that many of the companies in these sectors were not listed 10 years ago.

We then filtered the list on the basis of fundamental performance and future prospects of the companies. This led us finally to 10 companies (see table above) which investors with long-term horizons can consider. We are providing a snapshot of these companies grouped under their individual sectors.

PHARMACEUTICALS

Out of 12 pharmaceutical companies in our list, Dr Reddy’s Laboratories seems to be the dark horse in the pharma pack. It’s true that the company is currently going through a lean period. Its German acquisition, betapharm, is facing price cuts in its home market, which has increased Dr Reddy’s pay-back period.

This has also pulled down its profitability and margins. However, in the long term, pressure on pricing is expected to ease, as the company is transferring manufacturing of key products to India. Its new initiatives in custom pharmaceutical manufacturing services and biogenerics are likely to strengthen its performance.

INFORMATION TECHNOLOGY

Infosys Technologies is our favourite pick among the 10 IT stocks in the list. The second-largest IT exporter from India is grappling with global macroeconomic challenges. However, the company is yet to report any signs of demand weakness. It has been adding new clients at higher billing rates with bigger deal sizes.

Further, the US slowdown is expected to increase the outsourcing of non-discretionary projects, which will benefit Indian IT companies. Given this, Infosys appears to be a good defensive bet in times of market turmoil.

CEMENT

From the cement pack, we selected ACC and Madras Cement. Among large-cap cement makers, ACC is a strong value buy at its current market price. In the past, the company has gained from a policy of calibrated expansion and investment into cost-cutting measures such as captive power plants.

Madras Cement is one of the cheapest stocks in the sector, given its size and track record. The company has a good profitability record, backed by high plant efficiency. Apart from its key markets of Tamil Nadu and Kerala, the company is now expanding aggressively in Andhra Pradesh and West Bengal. It is planning to double its capacity to 10 million tonnes by FY09.

FMCG

Despite being a commodity company, Tata Tea has grown remarkably well over the past decade. And that makes it a good FMCG bet. Its growth is further accentuated by international acquisitions, foreign joint ventures and diversification in the beverage and packaged drinking water segments.

The restructuring of its tea plantation business is likely to result in increased profitability of its core business. Investors parking their funds in the company can expect a consistent appreciation of capital, as well as annual dividend income.


AUTO & AUTO ANCILLARY

Tata Motors and Sundaram Fasteners are our picks in this segment. Tata Motors’ recently-launched Rs 1-lakh Nano and new variants of Sumo and Safari will support its topline growth.

In the commercial vehicle segment, it is planning to launch a high-end brand called World Truck. Similarly, its Jaguar and Land Rover acquisitions, if successful, will give it a global footprint in the luxury car segment.

Sundaram Fasteners is an established auto components company with customers in India and abroad. Its global presence has helped it to reduce the risk of dependence on only a few customers. It has been expanding its operations aggressively.

METALS

The metals space, especially the non-ferrous segment, is suffering from weakness in global prices. The third quarter numbers were not encouraging for many players in this segment. However, we picked two stocks in this space, Hindalco Industries and Sterlite Industries, which have the ability to sustain through bad patches in a commodity cycle.

The acquisition of Novelis, the world leader in aluminium rolled products, has given Hindalco a global footprint. Sterlite enjoys a similar global presence.

Given the strong fundamentals of these companies, this can be the right time for investors to enter these stocks with a horizon of 2-3 years.

SHIPPING

It is one of the oldest sectors in India, but only one company, Varun Industries, makes the cut. The company transports bulk cargo of LPG, crude oil and petroleum products.

It is also expanding into offshore services since the pace in oil exploration activities has gained strength globally.

A combination of the lowest P/E and relatively higher dividend yield of 5.9% makes it an attractive investment.
It may be a while before the bulls are back in action, but we believe that there is still a lot of value left in the market — provided, investors remember that they must stick to basics.

As the saying goes, a judicious investor carries the weather with himself.

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