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The Core, Stars and Flyers… - Views on News from Equitymaster
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  • May 7, 2001

    The Core, Stars and Flyers…

    The Nasdaq has fallen by almost 46% in the last one year. The benchmark BSE-30 has also fallen by 35% in the same period. The valuations of key software scrips have been found wanting at the current levels (despite a short recovery) after having been battered due to concerns of the slowing US economy. Apart from this, the recent stock market scam and the subsequent erosion of wealth did not augur well for the retail investor. But at the same time, this has provided an opportunity for the investors to understand that “All that glitters is not gold”. Given this backdrop, what is an ideal portfolio for an investor?

    We had created a model portfolio in the equity component of the “Asset Allocator” last year. Depending upon the risk profile (i.e. aggressive, balanced and defensive), the “Asset Allocator”, helps a user establish the avenues for investments available. These include a mix of equity, debt and real estate. In this article, we compare the performance our equity portfolio with that of various other benchmarks in the last one-year.

    We had bifurcated the equity component into three portfolio namely core, stars and flyers. We had invested Rs 100,000 in each of the scrips as on 1st January 2000, when the benchmark BSE-30 was at 5,400 levels. Before proceeding any further, let us understand what are core, stars and flyers.

    CORE: These have been defined as stocks that can be held by investors across most age brackets and status. These stocks represent companies with very good management and strong financial performance over the years. One criterion that we applied to these stocks was how they fared in the recent downturn in economic activity. Other issues considered included - position in sector, prospects for the sector itself. Click to see our stocks

    STARS: Companies that have good managements, sound financial track record and good prospects but not without risks. These companies, to put it in a way, are not in the core list because there are certain issues that have made them more 'risky' than the core stocks that have been identified.

    FLYERS: This group represents stocks that have high risks associated with them. Nevertheless, they are in a situation where they can leverage on their present position (like national presence for ACC) to generate returns much in excess of their peers.

    A comparative performance
    Jan 2000
    Core -7.0% -11.0% -6.4% -13.8% -16.3% -7.1%
    Stars -19.7% -22.8% -13.1% -22.9% -18.9% -18.5%
    Flyers -14.6% -21.6% -9.9% -25.0% -14.1% -18.3%
    BSE-30 2.7% -1.0% -20.3% -3.6% -25.9% -34.5%
    S&P CNX Nifty 2.6% -0.5% -18.6% -2.0% -18.4% -29.3%
    Nasdaq 5.6% 15.0% -1.7% -18.5% -37.8% -46.3%
    Dow 1.3% 8.7% 2.3% 3.1% 2.0% -1.9%

    The performance of these scrips is compared with their price as on 1st January 2000 (we had deliberately entered the price as on 1st January to analyse the worst case scenario). Let us analyse the performance of each of the groups respectively. To start with:

    Though the recent month performances of our core portfolio is not encouraging, it has outperformed almost all other benchmarks, except for Dow, since 1st January 2000. Despite Sensex declining by 35%, the value of our core portfolio has declined only by 7% since January 2000. This is indicative of the inherent strength of these companies in terms of commendable market share, sound business model and a management, which has delivered during rough periods.

    The major losers in our core portfolio are Glaxo (down 53%), Infosys (down 50%), Gujarat Ambuja (down 48%) and Indian Hotels (down 28%). We believe that the some of these scrips have declined primarily on account of temporary concerns. For example, Gujarat Ambuja is one of the most cost efficient producers of cement in India with economies of scale unmatched by its peers. But the scrip has fallen by more than 48% primarily on account of subdued cement demand as well as the incremental debt it took to fund its acquisition of ACC.

    This is true across our portfolio. Take Infosys. Despite reporting more than 100% growth in net profits, the share price dropped significantly in the current year in light of a slow down in the US economy. Besides, the company lowered its earnings forecast for FY02, which added to the downfall. But, as we had said earlier, these companies have been consistently growing above the industry growth rate and one can expect the same in the long run also.

    Having said that, there are also clear winners like HDFC (up 90%), Nestle (up 24%), Asian Paints (up 15%) and BPCL (up 2%). In fact, average rate of return from HDFC and Asian Paints have been in the positive territory since 1st January 2000.

    The TMT's performance…
    Category Core Stars Flyers
    No. of TMT scrips 1 2 2
    Total scrips 11 17 18
    TMT (% of portfolio)* 64.7% 32.3% 19.3%
    Performance of TMT** -50.2% -81.5% -81.7%
    * As on 1st January 2000     **Since 1st January 2000

    Even our stars have outperformed the BSE-30, NSE Nifty and the Nasdaq since 1st January 2000. While our star portfolio has declined by 18.5%, the indices have declined by 34.5%, 29.3% and 46% respectively. The basic characteristic of this portfolio is that the stocks are fall under the “medium risk and medium return category”. The number of scrips from the TMT sector is just two, namely NIIT and VSNL.

    The major losers are NIIT (down 89%), Punjab Tractors (down 48%), Smithkline Consumers (down 30%) and Colgate (down 23%). While NIIT fell due to slow down in the US economy, other old economy scrips have fallen because of subdued demand primarily account of less than average monsoons. But, if one were to exclude the only software scrip in this category i.e. NIIT, the overall returns have declined just by 14.1%, which means in the long-run, even our stars portfolio has outperformed almost all the benchmarks. The winners are VSNL (35%), HDFC Bank (33%), Hero Honda (16%) and EIH (9%).

    Interestingly, our flyers portfolio has outperformed BSE-30, Nifty, Nasdaq and even the stars since January 2000. Understandably so, because the basic characteristic of this portfolio is “high risk and high return”. These are typically ‘dark horses’. If there is a slight change in the business environment, these are some of the companies that would rise to the occasion. But they are in the flyers category (read high risk) either because they have a less dynamic management or due to inadequate corporate governance practices. Example Pfizer, which has a wholly owned subsidiary and works against the interest of investors. Other like Telco and ITC find place in the flyers due to their diversification concerns.

    Take a closer look. Over the one-year horizons, the flyers have outperformed almost all the benchmarks. First lets talk of the key gainers. Leading the group is ICICI Bank (up 114%) followed by Tata Power (up 57%), Reliance (up 36%), ITC (up 17%) and Pfizer (up 2%).

    Zee is one of the top losers. The scrip is down 91%. The other prominent losers, which brought down the overall returns, are TVS Suzuki (down 84%), L&T (62%) and Novartis (down 60%). While TVS Suzuki declined due to a slow down in two-wheeler sales, L&T was also battered due to the delay in the cement demerger.

    To conclude, where should an investor invest? Given the attractive valuations of some of the old as well as the new economy scrips at the current levels, is this the right time for a common investor to enter the markets? If so, which sectors should an investor invest?

    As per the recent budgetary estimates, services contributed to more than 50% of the Gross Domestic Product (GDP) of the country. By services, we mean, software, banking and pharmaceuticals. India’s basic strength, when compared with other developing countries is its enormous intellectual wealth, which are key for both the software and the pharmaceutical sector. The current slow down in these sectors are typically short-term in nature and in the long run, don’t be surprised if Infosys makes it into the Fortune 500 lists. Infact, Infosys at the Rs 4,000 levels is cheaper in terms of forward earnings perspective than Hindustan Lever Limited (HLL)! Apart from this, given the current low per capita consumption levels, the FMCG segment, led by none other than HLL, could also be a safe bet as well.



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