• DECEMBER 24, 2003

Stock market: The year that was

While investors who believed in fundamentals were hardly questioning the fact that the stock markets were poised for a upward correction the same time last year, it is for sure that the extent of the rally has caught many by surprise. Just to put things in perspective, the Sensex has gained 67% in the last one year (till December 24, 2003). Here in this article, we consider few factors that aided this rally and what should a retail investor do at the current juncture?

Firstly, consider the performance of stock market over the last one year and key events that shaped this trend. To start off with, during the same time last year, stock market was mired by the Iraq crisis, which had infused significant uncertainty in the minds of investors. This lasted till a large part of 4QFY03 and as a result, overall sentiment was that of caution even though select stocks from power, engineering, banking and auto sectors gaining ground. While Iraq concern was easing, Infosys announced its 4QFY03 performance and its guidance for FY04. While Infosys expected revenues to grow 24%, EPS guidance was lower at 12% for FY04, which came as a shock for the stock market. On the same day, the market corrected down by 3% with Infosys falling by more than 20%.

Key macro factors that typically lead to a upward correction like favorable interest rates, manageable inflation, promising long-term growth prospects and improving margins were all in place in April 2003, factually speaking. What was missing was a trigger. Starting late May, initial reports on monsoon started to flow in. The Indian Metereological Department (IMD) also announced that monsoons were likely to be normal and well distributed, and this acted as a fillip for the stock markets. Most of the economic research organisations like CMIE revised GDP growth estimates upwards, the RBI topping with expectations of 6.5% to 7% GDP growth in the mid-term monetary policy.

The fundamentals were well supported by increased flow of foreign institutional investor (FII) money into the country. The graph above highlights the monthly net FII investment in equities and the Sensex since January 1998. Since May 2003 till date, net investment by FIIs in equities stands at Rs 270 bn (US$ 5.8 bn), which is a positive sign. Amidst the rally, not all sectors have been outperformers on a relative basis. Sectors like software and FMCG have underperformed the benchmark index significantly, as is evident from the graph below.

The graph indicates the performances of key indices for the period between December 10th, 2002 to December 10th, 2003. Capital goods sector, comprising of engineering, power and construction, was the top performer with Rs 100 invested last year growing to Rs 252 as of December 10th, 2003. In light of the public infrastructure investment, recovery in industrial activity and passing of the Electricity Bill, prospects for this sector have improved dramatically and therefore, is reflected on the bourses. While there is no auto index per se, we have calculated returns based on top seven companies in the sector assuming similar sum was invested in December last year. As has been the case historically, the capital goods and the auto sector are lead indicators of improvement in economic activity and have posted impressive profit growth in the initial phase.

The winners…
Company Price (Rs)
Dec 24, 2002
Price (Rs)
Dec 24, 2003
Change (%) 52 week H/L
Sensex 3,330 5,575 67.4% 5,616/2,904
Nifty 1,076 1,786 66.0% 1,801/920
Sterlite 143 1,305 810.4% 1,630/137
Sesa Goa 71 605 750.2% 645/59
Hind. Zinc 18 119 570.4% 124/14
Lupin 131 717 447.1% 790/124
Oriental Bank 49 255 421.0% 270/47

While the healthcare index per se has outperformed the Sensex, if one were to separate the top rung companies from the mid-caps, a different story emanates. The likes of Cipla, Ranbaxy and Dr. Reddy's have underperformed, with smaller firms like Lupin, Matrix Laboratories and Divis Laboratories gaining significant ground. Having said that, select MNC majors like Glaxo and Aventis have rewarded shareholders impressively, as investors seem to be optimistic of the post FY05 scenario. The increased attention in the mid-cap pharma stocks could be attributed to the growth opportunities arising from outsourcing activities. As is evident from the table above, Lupin has gained 447% in the last one year.

The laggards…
Company Price (Rs)
Dec 24, 2002
Price (Rs)
Dec 24, 2003
Change (%) 52 week H/L
Silverline 23 7 -69.3% 25/4
Pentamedia 25 9 -63.7% 26/6
HFCL 37 18 -51.0% 41/11
DSQ Software 20 12 -38.9% 21/5
Mastek 489 306 -37.4% 615/190

To know more about the reasons for underperformance of FMCG and Software sectors, please click on the corresponding links.

What to expect?

Having looked at what happened in FY03 and the major part of FY04, what should a retail investor do at the current juncture? Especially when one considers the fact that the Sensex has already rallied by 67%. We would like to approach this with a different perspective. While the case for equities in an individual's portfolio of investments has always been strong, the argument is further strengthened if one considers the relative returns on various instruments currently. Consider the graph below.

The yield on a 10-year government paper is below inflation with other investment instruments barely yielding satisfying returns to justify long-term needs. Not that investors should not invest in these instruments. But there is a strong need to consider equities as an investment avenue for the long term considering the aforesaid facts. If this is the case, how much return can one expect from equities in the long term. It is better to define long term here because 'long-term' is an mis-represented word in the stock market generally. By long term, we mean a investment horizon of three to five years.

The aforesaid chart highlights the CAGR return over varied time period on the Sensex. While the 10 year picture is not promising, the period is also mired by three stock market scams. Just as a benchmark, we expect a pure equity fund to yield an average annual return of 13.5% over the next three years. Is this return good enough? Yes, we believe it is, for two reasons. Firstly, the stock market has corrected upwards on valuation basis and further rise has to be accompanied by revenue and profit growth in the long term. Secondly, considering the meteoric rise, retail investors have to lower return expectations on equities from the current level. While we agree to the fact that there are still some under-valued stocks, from a broader perspective, the kind of return that we have mentioned above should satisfy investors (remember, we are talking only about investors and not traders). Long-term works!

Copyright © Equitymaster Agora Research Private Limited. All rights reserved.
Any act of copying, reproducing or distributing this newsletter whether wholly or in part, for any purpose without the permission of Equitymaster is strictly prohibited and shall be deemed to be copyright infringement.

LEGAL DISCLAIMER: Equitymaster Agora Research Private Limited (Research Analyst) bearing Registration No. INH000000537 (hereinafter referred as 'Equitymaster') is an independent equity research Company. Equitymaster is not an Investment Adviser. Information herein should be regarded as a resource only and should be used at one's own risk. This is not an offer to sell or solicitation to buy any securities and Equitymaster will not be liable for any losses incurred or investment(s) made or decisions taken/or not taken based on the information provided herein. Information contained herein does not constitute investment advice or a personal recommendation or take into account the particular investment objectives, financial situations, or needs of individual subscribers. Before acting on any recommendation, subscribers should consider whether it is suitable for their particular circumstances and, if necessary, seek an independent professional advice. This is not directed for access or use by anyone in a country, especially, USA, Canada or the European Union countries, where such use or access is unlawful or which may subject Equitymaster or its affiliates to any registration or licensing requirement. All content and information is provided on an 'As Is' basis by Equitymaster. Information herein is believed to be reliable but Equitymaster does not warrant its completeness or accuracy and expressly disclaims all warranties and conditions of any kind, whether express or implied. Equitymaster may hold shares in the company/ies discussed herein. As a condition to accessing Equitymaster content and website, you agree to our Terms and Conditions of Use, available here. The performance data quoted represents past performance and does not guarantee future results.

SEBI (Research Analysts) Regulations 2014, Registration No. INH000000537.

Equitymaster Agora Research Private Limited (Research Analyst)
103, Regent Chambers, Above Status Restaurant, Nariman Point, Mumbai - 400 021. India.
Telephone: +91-22-61434055. Fax: +91-22-22028550. Email: info@equitymaster.com. Website: www.equitymaster.com. CIN:U74999MH2007PTC175407