|»5 Minute Wrap Up by Equitymaster|
On This Day - 24 JUNE 2015
Should you only buy Sensex based companies?
In this issue:
Does that mean that the stock of Lupin automatically becomes a Buy and that of Tata Power is a Sell?
For that one needs to understand the criteria that the BSE considers when it comes to including stocks in the Sensex. One such has been the company's free float or non-promoter holdings. Thus, stocks with higher liquidity have assumed bigger weights in the index and stocks with lower liquidity have fallen in the rankings. That is not all.
The BSE, in the last decade or more, has made quite a few changes to the Sensex. One such change has been to make it more diversified. Thus, no individual stock gets a very large weight in the Sensex. Plus, the dependence on a single business group has also reduced.
What this essentially means is that the BSE has its own set of criteria for adding or removing stocks from the Sensex. These are quite different from what an investor should look for while investing in stocks.
For instance, we recommend a more bottom up approach while investing in equities. So what an investor needs to focus on are factors such as the strength of the business model, competitive advantage that the company enjoys, good growth prospects, sound management and also whether valuations are reasonable.
These are hardly factors that the BSE takes into account.
Indeed, stocks such as Castrol, Colgate and Nestle India, which were once part of the Sensex, are no longer part of it. However, these stocks have amply rewarded investors in the last decade as compounded returns for each of these stocks has averaged at around 24% during this period.
So for the value investor, just as predicting the next Sensex level should be taken with a pinch of salt, so do stocks moving in and out of the Sensex hardly be given much importance.
What more, ultimately the BSE Sensex comprises 30 stocks, which can hardly be considered as the best representative of the overall Indian markets. There are many good quality companies in the midcap and smallcap space as well, which have gone on to do well when it comes to generating shareholder wealth.
Ultimately, it makes sense to have a selection of stocks from the largecap, midcap and smallcap spaces by following the principles of asset allocation.
Today's chart of the day shows the year on year change in sales volumes for the past two year and the first two months of the current fiscal across various segments.
If one was to look at the volumes of individual companies, the performance has been quite mixed with certain players completely outshining the industry. Well timed and successful product launches have been key reasons for the same. What is disappointing is that sales volumes of certain segments are still far behind their all time highs recorded a few years ago. For instance, in the passenger vehicles segment, sales volumes stood at 2.6 m in FY15; the highest annual sales volumes of 2.68 m units were clocked in FY13. In the CV space, the peak volumes were seen way back in FY12, with the same coming in at 348,000 units then. In FY15, the figure stood at 232,000 units.
As per us, notwithstanding the short term fluctuations, a good way to gauge the long term demand cycle of auto demand is by normalising the volume growth for each year (and each segment) and comparing the same to the actual volumes. If the latter shoots up way above the normalised line, then one could expect the volume factor to slowdown. The same would hold true in the vice versa situation as well.
Indeed, there have not been too many takers for the precious metal from China atleast. Chinese appear to be favouring stocks and the rise in the Chinese stock market is testimony to that. No such scenario in India though as demand continues to remain healthy while the appetite for stocks may have waned a bit.
The Modi government would have been happy had Indians also followed the Chinese. Indeed, gold imports in recent times have put immense pressure on the country's trade deficit. The government, in the meanwhile, has been looking at various means to bring down import demand by looking to monetize idle gold lying with households or issuing bonds against gold.
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