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Caution while investing

May 20, 2003

Markets seem to have taken a turn for the better. However certain sectors still remain volatile to say the least. The sectors in question here are the banking and the software sectors. Banking stocks have been in the limelight due to different triggers. Software stocks on the other hand have been battered on the bourses post their March quarter results, but a slow recovery is being observed, however not without hiccups. If one were to look at the performance of banking sector stocks we can observe that after the initial euphoria of the asset reconstruction bill being passed, there has been a second rally in this sector in the last one month. However the rally seem to have corrected already. There are ample triggers like the asset reconstruction act, government buyback program and cost cutting initiatives by public sector banks that is likely to keep the sector buoyant going forward. However the rally seen in the recent past did not seem to be prompted by these triggers.

No doubt there are the above-mentioned triggers for the banking sector that will change its fundamentals going forward, but these are long-term triggers. What we mean is that these positive changes in the banking sector will take time to show results. Investors need to look very carefully in to the performance of these banks under the new environment, because the benefits to different banks will be different in magnitude.

For example, the benefits of the buyback will be apparent only after one knows the intention of the various public sector banks in this regard, especially because certain banks have second thoughts regarding this scheme. Also, while these banks have made large investments in technology and initiated other cost cutting measures (VRS), investors need to wait and watch whether public sector banks are indeed successful in improving efficiencies post these initiatives.

Coming to the software sector, the initial disappointment was caused by Infosys, which gave a subdued guidance for FY04. Since then the sentiment towards this sector itself has been rather bearish. This is however not without reason. Indian software companies have relied on the low cost model to sustain their growth, however with increasing international competition this model is no longer sustainable. Thus the strong EPS growth seen in the past may just be a thing of the past unless these companies are able to garner enough volumes. In his regard too the indications are not all that negative. The larger software companies are still able to garner healthy volumes and are seeing healthy topline growth. From here on volumes, net margins are likely to be the drivers of the bottomline.

In both these sectors one aspect is getting increasingly clear. Investors need to be careful while they pick their investment options. Large entities in both these sectors are likely to be the biggest beneficiaries, in case of an improvement in economic environment (global economic environment in case of software companies). Caution needs to be exercised.

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