Apr 16, 2013|
Would these stocks be the most volatile?
Foreign institutional investors based outside of India would have many options of parking their funds. Amongst the many options, they would look at investing a certain portion of the funds in 'risky' equity assets such as emerging markets. The reasons for doing so would be various. Some include: Investment opportunities within the local country not being attractive; to diversify risks or spread the portfolio's risk; may be valuations of the stocks in emerging markets may entice them; funds following a top-bottom approach would look at the regions that are relatively growing fast; high required rate of returns of funds may lead them to increase exposure in high risk assets.
Latest FII holding across market caps
Data source: ACE Equity
And now the opposite - Funds may pull out of or stay away from such markets due to risk aversion; due to better alternatives - domestic or global; earnings not meeting expectations leading to profit (or loss) booking; profit booking due to expensive valuations; slowing growth of an economy; deteriorating health of economy; amongst others.
As leading business dailies have reported over the past few days, the YTD market decline has largely been influenced by foreign institutions. Amongst the many reasons cited for the same include: risk aversion; India's declining image due to the numerous scandals being released at regular intervals; better alternatives - money flowing to other markets like the US and Japan; slowing GDP growth rates; the not so great health of the economy (twin deficits), amongst others. Also, the uncertainty relating to the economy coupled with low expectations in terms of major reforms or overhauls due to the general elections next year are cited as reasons for the same.
If one sees the trend in buying Indian equities by Foreign Institutional Investors (FIIs) over the past year or so, a lot of money has gone towards buying high quality stocks and defensive plays. With the same happening, these stocks have outperformed the index by miles and in the process have become expensive; some of them touching new highs - in terms of absolute prices and valuations - frequently. Market valuations according to us are not very comfortable at this point in time for most of these so called defensive plays or high quality stocks! With valuations moving up, expectations in terms of earnings growth (and dividends) would have been built up as well. As we all know, at the end of the day, earnings are required to justify valuations. With broader market parameters - such a GDP growth, amongst others - slowing down, long term growth rates of such companies are bound to slow down, thereby putting pressure on earnings growth.
As Ajit Dayal had highlighted recently, Indian companies have invested substantial amounts towards building up capacities. This has been done in anticipation of high demand. A lot of these capacities are yet to come on stream. With a slowdown on an overall level, the possibility of overcapacities does remain. This would lead to eventual lowering of realizations (to fill up these capacities) which would lower margins. Companies' profits would be under pressure due to higher depreciation charges. Interest costs would also stop getting capitalized - due to capacities becoming operational - thereby reflecting in profit and loss statements in the form of interest costs. This would also add pressure to profits.
We thought it would be a good idea to list out some of the large FII holdings across different stocks - largecap, midcap and smallcaps.
We believe a mix of all the above factors could eventually lead to multiple revisions or portfolio churns. Given that FII action and involvement has been high, and that such investors tend to influence the Indian stock market to a large extent, volatility in stocks is expected to remain over the short to medium term.
We are not advising investors not to invest in stocks wherein FII holding may be in the uncomfortable zone. But it is a factor that needs to be taken into consideration. We reckon investors take into account the long term prospects of a company, along with the valuations and a considerable amount of margin of safety into account before making their stock picks.
||Devanshu Sampat (Research Analyst) has a degree in commerce and nearly 5 years of experience in equity research. He draws inspiration from successful value investors across the globe and constantly endeavours to refine his own unique stock picking approach. While a firm advocate of the principles of value investing, he believes in adapting a versatile investing strategy in response to varying market conditions. Devanshu contributes to our Megatrend investing service The India Letter.
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