Should one only invest in large cap stocks?

Jan 10, 2012

In this issue:
» Auto sales do better in late 2011
» George Soros is positive on India
» The country to topple China's lead in manufacturing
» Not all is lost for India's power sector
» ...and more!
---------------------------------------- Did you miss the Webinar? ----------------------------------------

Equitymaster's Webinar on the Future Prospects for the Indian Economy with Mr Ajit Dayal was broadcasted on 30th of December, 2011.

The webinar answered questions that could be troubling any Indian Investor today. Where is the Indian Economy headed in 2012? Is Gold still a good investment? Could the Stock Market touch the 21000 figure in 2012?

If you missed watching the webinar, here is your chance to access the same.

Click Here to watch: Indian Economy - From Darling to Damned (Rebroadcast)

And let's understand what lies ahead for India and how could this impact your investments.


Does investment in large cap stocks always yield strong returns? An article by the Economic Times (ET) points out that it may not always be the case. The ET Intelligence Group as per its analysis has opined that 2 out of every 3 stocks, which had a market capitalization of over 10,000 crore at the end of the bull run in 2007, failed to earn returns at the end of 2011.

Investors would do well to recall that valuations in 2007 had reached astronomical levels. The important thing to note during that time was that companies across market capitalizations were trading at much higher prices and thus even businesses with good fundamentals were looking quite expensive in the overall bull run in that year.

Therefore, we believe that generalizations such as companies with higher market capitalizations do better than those with lower market caps may not be the right thing to do. There are certain parameters that have to be given their due consideration. This means that if a company has a strong balance sheet (good return ratios, not too dependent on debt with strong cash generation), good competitive advantage (in terms of products, brands, market share, pricing power) and more importantly reasonable valuations, there is no reason why such companies should not reward investors in the long run. In these scenarios, it does not really matter if the stock is large cap or midcap provided it more than adequately meets the above mentioned criteria.

Thus, a highly volatile market such as one that we are witnessing now provides a fertile ground to investors to do some research and invest in good quality stocks at bargain prices with a long term investment horizon.

Do you think that large caps always generate higher returns in all market conditions? Share with us or post your comments on Facebook page / Google+ page.

 Chart of the day
After quite a dismal performance for a larger part of 2011, auto volumes saw some respite in the latter part of the year. As today's chart of the day shows, volume growth was better in November and December 2011 as compared to October in that same year. The noticeable change was seen in passenger vehicles. This segment had been bruised and battered earlier on account of rising interest rates, fuel prices and the labour unrest at Maruti's plant. But passenger vehicles did well in November and December to log in growth rates of 8% each.

*Commercial Vehicles
Data source: SIAM

Just recently, we talked about how Jim Rogers does not see India in a very good light. But does his partner of yesteryears, the one with whom he formed one of the most successful investment partnerships aka George Soros also thinks the same way? Certainly not. Soros' views on India lie at the other end of the spectrum. "I'm positive over the long term about India and less optimistic about the US where we are in a political and financial crisis," Soros is believed to have said in a recent interview. He also went on to add that the global economy faces an even bigger risk currently than was the case during the 2008 financial crisis. While we do agree with Soros on the second point, a lot of positives will have to happen if his first prophesy about India were to come true. There is no question that India will continue to grow at a good pace in the foreseeable future on account of some strong structural tailwinds. But for that growth to be equitable and all inclusive, bold reforms will have to be undertaken and undertaken fast at that. Otherwise there is a strong possibility that Jim Rogers' view prevails over that of his equally illustrious former partner.

A recent report by Boston Consulting Group (BCG) put forth an argument that a certain economy could challenge China's status as the world's preferred manufacturing base by 2015. Can you guess which economy it can be? Alas, how much ever we may want, it is certainly not India. Instead, that economy is none other than the US. Surprising, isn't it? Even we were quite bewildered when we read this. And though it cannot be said with any certainty how things will turn out, it would be worth noting the arguments behind the view.

Let's first understand what led China into becoming the global manufacturing hub. There were three main reasons: cheap labour, cheap currency and robust government initiatives to attract foreign capital. However, the Chinese yuan has appreciated by about 20% against the US dollar over the last five years. During the same period, China's annual inflation has on an average been 1% higher than that of the US. What is also worth noting is the fact that between 2005 and 2010, pay and benefits surged by 19% annually for average Chinese factory workers.

Compare that with a modest rise of only 4% for US workers. By 2015, BCG estimates US manufacturing to be just as economical as Chinese for many goods made for North American consumers. In fact, after hitting a low of 8% in 2008, the US share of global exports has been on the rise. This means good news for the US dollar but bad news for emerging economies including India. Many believe that the Indian rupee has been beaten down mainly due to the Eurozone crisis and will regain lost ground once the crisis eases. However, if the US economy does make a comeback, and the Indian economy continues to suffer from a high current account deficit and high inflation, the rupee may remain depressed for much longer than we think it should.

Not all is lost when it comes to the future of India's power sector. All that is needed is some proactive policy changes and path breaking reforms in the sector. India's Rs 1 trillion plans to adding capacities in the electricity generation sector hinge on fuel cost-based tariffs and shorter power-purchase pacts. These together can help the government resolve most of the issues hindering the sector's growth. The government is already revising bidding documents and framing mechanism for local equipment sourcing for the large plants called ultra mega power projects (UMPPs). India has awarded four UMPPs of the identified 16. However, costly imported coal from Indonesian and Australian mines is threatening to make projects unviable. Tata Power has expressed its inability to profitably run Mundra UMPP in Gujarat, while Reliance Power has stopped work at Krishnapatnam project in Andhra Pradesh. The sooner the government acts on the reform measures the easier will it be for India's power sector to brighten the economy's future.

The party may soon be over for investment bankers. Most global investment banks are set to announce relatively disappointing year-end results for 2011. Thus, big bonuses may not be in the offing for their employees. 2011 is set to be the worst year for bonuses since the 2008 global financial crisis. Ultimately compensation is tied in with market performance. With global equity markets in a flux, it is not surprising that bonuses were also hit. Goldman Sachs partners are expected to see their 2011 salaries halve while Morgan Stanley is expected to see a 40% cut according to the Wall Street Journal. Seems like fat cat bonuses and larger than life lifestyles are over. We hope that this is for good.

In the meanwhile, the Indian stock markets uilt on their opening gains and traded strong throughout. At the time of writing, BSE Sensex was up by 280 points (1.8%). All the sectors were trading in the green. Asian stock markets too displayed positive sentiments with China (up by 2.7%) and South Korea (up by 1.5%) gaining the most.

 Today's Investing Mantra
"The primary test of managerial economic performance is the achievement of a high earnings rate on equity capital employed (without undue leverage, accounting gimmickry, etc.) and not the achievement of consistent gains in earnings per share." - Warren Buffett

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3 Responses to "Should one only invest in large cap stocks?"


Jan 11, 2012

You have put it rightly. If a company has good balance sheet, good competitive advantage and also reasonable valuations, it should certainly reward the investor in the long run, irrespective of the fact whether the stock is large-cap or mid-cap. Anyone with good market experience will unhesitatingly agree with this view.


sunilkumar tejwani

Jan 10, 2012

I will not be surprised if big fat cats called investment bankers loose their jobs also, instead of getting fat bonuses, they may get sacked for causing billions in losses to clients and their organizations for whom they work.I am of the view that organizations like Goldman Sachs should be declared as financial offenders and it's top executives be sent to gallows.


sunilkumar tejwani

Jan 10, 2012

not necessarily the large caps can give better returns across all cycles. If a sector does badly, then a large cap in a particular sector can fall badly, take the case of DLF, it never recovered to previous highs of 1200 odd from the lows of 125, even though the index recovered fully from the lows of 8050 to 21K. Investment in any stock requires a due diligence, just like when some one buys any other asset. The most important factor being price: 'cause price is the king. The same old principle, buy a good fundamentally sound company stock during market collapse, to reap a good harvest when market gets euphoric.

Equitymaster requests your view! Post a comment on "Should one only invest in large cap stocks?". Click here!