Don't be lured by the doubling of such stocks! - The 5 Minute WrapUp by Equitymaster
Investing in India - 5 Minute WrapUp by Equitymaster
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Don't be lured by the doubling of such stocks! 

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In this issue:
» Retail investors make a come back
» Will abolishing the securities transaction tax help?
» BSE-500 companies' debt levels touch Rs 12.6 trillion in FY14!
» Bert Dohmen: The US stock market rise is phony
» and more....


00:00
 
The BSE-Sensex has been on a rage since August 2013. However, a week before the election results were announced, there was a very sharp rise in the index. It's almost been a month since then. The key change that we have seen in recent times is the preference for stocks of smaller companies. The BSE Mid Cap and BSE Small Cap indices have gained by 30% and 42% respectively in the year till date. In comparison, the Sensex has gained by 17% during this period.

As reported by the Economic Times, foreign investors have been quite active in the recent past, having invested about US$ 7.7 bn in Indian stocks so far in 2014. In 2013, they had invested a total of US$ 20 bn - with majority of money being allocated to largecaps. But this time around, the money seems to be flowing down the capitalisation ladder. A key factor for the same is the relatively cheaper valuations of smaller companies. And with high expectations from the new government, it seems the flavor of the season is infrastructure stocks.

Keeping that in mind, we thought it would be a good idea to check up on the top and worst performing stocks over this period. And the results were well... not so surprising. It is clear that the risk appetite for investors has risen.

Here are the results:

Top gainers* over a period of one month
Company MoM change
Sintex Industries 117.7%
Suzlon Energy 110.9%
GTL Infra 105.5%
GTL Limited 105.1%
IVRCL 99.2%
MTNL 96.8%
JK Lakshmi Cement 94.9%
Unitech 92.8%
HCC 92.4%
Gammon 91.1%
National Fertilizers 90.5%
Data Source: Equitymaster; * amongst stocks forming part of the BSE-500 Index

Apart from the fact that all of these stocks have gained by over 90% in a period of one month, the other thing common between them is their not so good financial conditions. Investors would do well to remember that while companies from the infrastructure space did very well during the market run up till 2008, the period thereafter would have eroded almost all of their gains as most of such type of stocks fell by as much as 90% to 95% from their highs.

We would like to take this opportunity to remind readers not to be lured by such stocks because of their short term returns. Sure, it is expected that infrastructure stocks will do well in the years to come. And for investors to ride this story over long periods, the best way to approach this would be to stick with the largest of companies, those which can survive through difficult times and are unlikely to be wiped out easily. In short, stick with the high quality companies in the sector.

What we also did was go through the list of the worst performing stocks over this period. We did this for the BSE-100 index to make the discussion more interesting. The results showed up as follows:

Worst performing stocks* over the last month
Company MoM change
Dr. Reddy's Laboratories -15.6%
Glenmark Pharmaceuticals -10.6%
Divi's Laboratories -9.5%
Lupin -6.7%
Infosys -5.9%
TCS -5.8%
Ranbaxy Laboratories -5.3%
ITC -4.7%
Sun Pharmaceutical -4.4%
HCL Technologies -3.9%
Data Source: Equitymaster; * amongst stocks forming part of the BSE-100 Index

One glance at this table and one can easily tell that investors are becoming aggressive, with their preference for defensive sector stocks coming down. But it should be kept in mind that such stocks led the market gains over the past few years. And in the process, became quite expensive in terms of valuations. Not to mention that macro economic factors (the strengthening Rupee in particular) have not gone in their favour.

Nevertheless, we reckon if such a trend continues it would not be a bad idea to look at such stocks given that they are good quality, stable businesses, growing at decent rates.

What approach should investors take to ride the highly expected upcoming infrastructure boom? Let us know in the Equitymaster Club or share your comments below.

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01:40  Chart of the day
 
Given the surging markets, it appears that households have begun to participate in the latest market rally in a big way. This we say because there seems to have been a considerable rise in trading volumes on the stock exchanges. When retail investors buy shares for short term trading, they typically take delivery of those shares. When compared on a year-on-year basis, there has certainly been a pick-up in delivery based volumes. This is evidence that households are moving a part of their funds into stocks. The shift away from Gold and bank deposits is quite evident. This recent surge of interest in stocks was triggered by the convincing victory of the BJP in the general elections.

Evidence that retail investor participation is back

However, we reckon it would be prudent for retail investors to be cautious at these levels. In times of optimism, stocks are rarely available at attractive valuations. Time and again investors have burnt their fingers by entering the markets during times of optimism, lured by the chance to make quick profits. More often than not, their hopes are belied when the market trend turns negative.

02:20
 
As someone has rightly said, there are only two certainties in this world, death and taxes. It so follows that once any tax is introduced, it is almost impossible to have it rolled back. How can it be any different for a form of tax known as the securities transaction tax (STT)? For the uninitiated, STT is a tax payable in India on the value of securities transacted through a recognised stock exchange. Of course there was a lot of clamor when the tax was first introduced back in 2004. And it these protests that led to its revision just last year.

Now, with a new Government at the centre, efforts are on to urge the Government to abolish the same. But if this is not possible, then the Government has been suggested to at least have a relook. One of the proposals that have come through is about a sharp cut in STT for cash equities and an increase for the equity options market. The aim behind this suggestion it seems is to encourage investment and discourage speculation. Well, if something as entrenched in human nature as speculative instincts could be curbed by a small tax charge, we would have been all for the move. However, that's hardly the case. And therefore we see no reason for the Government to undertake a major revision in STT. Especially in current times when it needs every rupee of the tax revenues it can muster. As a result, it's better to just abandon the thought of a lower STT we reckon. Actually, STT can be another reason why one needs to practice long term investing for it lowers STT outgo dramatically.

02:55
 
The rally in the stock markets has not been restricted to India alone but has been seen in most of the global markets, the US being one of them. Now the rise in indices in the US has not been in line with the fundamentals of the economy, which continue to remain weak. It has obviously been more a product of massive money printing by the US Fed. This money has then found its way into various asset classes including equities, fueling the price levels. But that is not all. As reported in an article in Moneynews, Bert Dohmen, president of Dohmen Capital Research, is also of the view that the current bull market in the US is phony. But he has attributed this to the rising incidence of share buybacks. Indeed, according to him, traditional buyers have not been buying stocks. The big buyers of stocks in the last 5 years have been companies doing buy backs of their own stocks. Once a buyback is done, the earnings per share increases as the number of shares reduces. And so the stock options of the top management become more valuable. Once the buybacks cease, Dohmen expects the bull run to come to an end. Well, we believe that all of this only proves that there is a big disconnect between the economic fundamentals of the US and the performance of the stock markets. This should not really be the case as both - earnings and GDP growth - are supposed to move in tandem.

03:35
 
Over the past year, the fall in profit margins has not been the only concern for India Inc. The risk to balance sheets has also been too evident. Thanks to stalled projects and strain on cash flows, companies have increasingly accessed debt at higher costs to fund working capital needs. In some cases companies have also borrowed beyond their servicing capacity and ended up becoming defaulting borrowers for the banking system. The problem of irrecoverable loans from top corporate has been so acute that even IMF has warned of an impending debt crisis. Now the latest data shows that the overall debt for BSE 500 companies has gone up from Rs 7.2 trillion in FY11 to Rs 12.6 trillion in FY14! While the nearly 75% rise in debt may not have led to dramatic rise in leverage ratio. However, the same has certainly strained interest coverage in the wake of falling profits.

As per Livement, there is a silver lining to the incremental debt taken by Indian companies in recent times. The companies who have borrowed are the ones with leaner balance sheets. They therefore do not really pose significant risk to the system. We believe Indian companies are preempting a swift economic recovery and rapid improvement in business fortune. And that may the reason for their willing to borrow heavily. The big concern here is that if the economic recovery takes longer than anticipated, even the relatively healthy companies may have to suffer. Therefore the decision to borrow too much without enough proof of economic recovery is a dangerous move according to us. Investors would do well to stay wary of companies that are betting big on quick upturn in economic cycle.

04:10
 
High fuel subsidies have often been blamed for the poor state of energy sector and economic mess in India. While the UPA government has drawn enough flak for poor policy making in the last few years, it had taken some steps that have given some hope to the sector. One such decision was a phased hike in diesel prices. It is important to note here that diesel alone accounts for 45% of fuel under recoveries in FY14. Now that crude oil prices are relatively stable and rupee stronger, the phased hikes have led to a significant reduction in diesel under recoveries. Once hovering around Rs 9, the under recovery on diesel has come down to Rs 2.8 per litre. If rupee strengthens or crude prices ease further, the under recoveries on diesel may get totally wiped.

That said, diesel is unlikely to be let totally off the regulatory hook. As an article in Business Standard suggests, the Petroleum Ministry aims to have some administrative control on diesel price as under recoveries become nil. The reason cited is its wide usage and hence the cascading impact on the overall inflation levels in the economy. The final decision on the matter will be taken by the Cabinet. And it is quite likely that the Government, keeping in mind the widespread use of diesel, will not allow its full deregulation. However, to be true to its pro reform image, what the government really needs to do is introduce more transparency in how petroleum products are being priced and rationalize fuel taxes.

04:50
 
In the meanwhile, the Indian stock markets recovered from morning losses as buying activity picked up during the post noon trading session. At the time of writing, the benchmark BSE-Sensex was up by 67 points (0.3%). Barring banking stocks, all sectoral indices were trading firm led by metal and power stocks. Most of the Asian Indices were trading in the green with China and Taiwan being the major gainers. European markets opened the day on a mixed note.

04:40  Today's investing mantra
"The idea of a margin of safety, a Graham precept, will never be obsolete. The idea of making the market your servant will never be obsolete. The idea of being objective and dispassionate will never be obsolete" - Charlie Munger
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2 Responses to "Don't be lured by the doubling of such stocks!"

Thirupathi Rao

Jun 8, 2014

I agree your opinion in the article.Stocks of those companies analised in the article wentup sharply ahead of fundamentals that their performance improve substantially.Is it possible to build a 20 stries apartment with in a short period?.How much time it takes to complete a 6 way road of 100 KM. I request to See financials of various companies before taking a final call before investment. It is sure that fundamentals of infrastructure companies will improve during a course of time not over night or within three or six months. Investors taking wrong steps curse the Industry after some time for their over enthusiasm over looking fundamentals.I request the investors think twice before taking a long term decision. For deriving a profit 20% on Rs 100/-, after incurring a loss of 20% due to wrong decision, has to earn 50% which is very risky.Investors with a stable investment styl will be benefited more when compared to short time euphorians. Beware of speculation also. I request investors to be cautious for a healthy growth of the Industry.The following few lines are not for instilling fear in investors minds.I remember an article stating that at present 20% floating stock of selected companies are held by FIIs. Profit booking may happen whenever their economies improves.I firmly believe that the present Govt will take care of this problem by policy changes favoring Indian savers with tax breaks
for long term savings.But is it possible to effect changes overnight? Investors please understand and act accordingly for their best interests. I solicit readers views for a change in my communication.

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ajay kr agarwalla

Jun 5, 2014

Very informative and useful

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