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Stockmarkets: Where to invest?

Apr 25, 2006

With Indian indices at their all time highs, and valuations overly stretched even from a medium term perspective, it is of immense importance for investors to understand their risk appetite and accordingly determine their exposure to equities. Also important is to understand the nature of industries, which are being invested into. In this write-up, we delve on this very issue of classifying industries into broad categories so as to make it easy for readers to take investment decisions accordingly.Cyclicals: These are the sectors that have the highest variance in the earnings and hence stock price movements. Due to higher element of fixed cost, there exist a higher delta of operating leverage. Stocks from these sectors are 'outperformers', both in an upturn as well as in a downturn! Thus, the right time to enter such stocks is when the economy is likely to come out of a bad patch and the right time to exit is when economic growth is at its peak and things are more likely to go wrong than right in the medium term. However, what is this 'right' time is a billion-dollar question! Commodities are the best examples of cyclicals.

Growth stories: These are the sectors that have a clear visibility of volume demand and hence are expected to perform well in the future (say, five years). Similarly, these sectors are relatively less likely to be affected by an expected or a sudden downturn in the economy. In the Indian scenario, retailing is one of the growth sectors, considering the fact that organized retail accounts for a mere 3% of the total retail market in the India. Similarly, another growth sector is telecommunication (mobile phones). In the current scenario, it is hard to imagine that people will stop talking on the telephone if times turn bad. No wonder stocks from these sectors trade at relatively higher valuations as investors expect sustainable and strong growth in earnings.

Defensives: These are the sectors that are expected to grow consistently, generally in line with the growth in the GDP. These are also the companies that were once the growth stories. Over a period of time, these industries have matured and have developed the size that restricts the extraordinary growth of the earlier years. FMCG is an example of the defensive lot. It is hard to think that people will stop consuming or reduce the consumption of biscuits, breads, soaps or detergents. These are necessities and their demand is les likely to be affected vis-a-vis discretionary spends like travel and entertainment.

Laggards: These are the sectors that were once the growth stories. However with the changing dynamics of the economy, they are no more in demand or there has been easy availability of substitutes. The best example of this would be the fall in the demand for fixed-line connections with the advent of mobile telephones. Similarly, in the automobile sector, the shift from scooters to motorcycles is another sound example.

To conclude...
At the current juncture, where Indian equities are being treated as a long-term growth story, it is pertinent for investors to determine the sectors where they want to invest. This should be based on their risk appetite and investment horizon.


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