Stockmarkets: Perform or Perish

As Warren Buffet once said, it’s only when the tide goes out, you know who’s been swimming naked. And the tide in the Indian stockmarket has just gone out

by Manas C & Rachna M./ BWI

Lights Out? Markets have become discriminating now.

Investors had little need to exercise their grey cells during the three years from mid-2003 to March 2006. All they had to do was invest money in some asset or the other, and sooner rather than later, the price of that asset would go up. Investors in stocks, real estate, bonds, commodities and gold saw the value of their holdings multiply, thanks to a tsunami of liquidity that swept over global markets, lifting asset prices across the board. Investors in all kinds of Indian stocks, including many shady small caps, saw their fortunes rise. You hardly needed to analyse anything to make money in stocks. But as Warren Buffet says, it’s only when the tide goes out that you know who’s been swimming naked. Now that the tide of liquidity has receded, markets have become more discriminating.

Value investing is back in favour.

Consider how the markets have reacted to the latest quarterly results. Let’s take a few examples. On 6 July, the Mahindra&Mahindra (M&M) stock rose 6.6 per cent, comfortably beating the Sensex that went up by 1.9 per cent. M&M’s net profit for the quarter was well above the consensus estimate. Bharti Airtel, whose net profit, too, beat expectations, but not by as much as M&M, saw its stock rise 3.7 per cent on the same day, outperforming the Sensex.

Or take Ranbaxy and Reliance Industries. Ranbaxy showed a net profit of Rs 121 crore, better than the Rs 104 crore expected by analysts. RIL had a 10.7 per cent rise in net profit y-o-y, slightly below expectations. The upshot: the RIL scrip was at more or less the same level on 26 July as it was on 20 July, while the Sensex rose 4.2 per cent over the period. The Ranbaxy scrip, in contrast, has gone up by 7.8 per cent over the period. Clearly, the market is rewarding performance. To drive the point home, Raymond Ltd, whose net profit fell 38 per cent, saw a fall of over 14 per cent in its share price in the five days after declaring its results.

The charts accompanying this story show how corporates like Infosys, Gujarat Ambuja and ICICI Bank, all of whom have delivered first quarter results above expectations have seen their shares outperform the Sensex, while stocks of Reliance Industries and Bajaj Auto, whose results disappointed the markets, have underperformed. That’s true of smaller companies also. For instance, the stock of Areva T&D has jumped up sharply after it reported that its net profit trebled in the June quarter.
The market is now also more news driven. Stocks of companies that report acquisitions, or companies that declare large new orders are rewarded instantly. The fundamentals of a company now matter much more than earlier. Investors would accordingly do well to go back to the basics and study the prospects of earnings growth before investing.
The bear market has also weeded out the momentum and speculative players from the market. Stocks no longer hit the upper circuit at the mere mention of it being a real estate play, as used to be the case earlier. Most of the real estate stocks are now quoting at just half the price of their peak values hit around April-May. DS Kulkarni is down from Rs 426 to Rs 204. Ansal Properties is down from Rs 988 to Rs 330. So is the case with several engineering stocks also. It is because these market excesses are no longer present that broker Motilal Oswal’s new India strategy report is titled ‘Purged and Ready For Another Dawn’. When that dawn will come is uncertain but there’s little doubt that there has been a massive purge.

Of course, the ‘fundamentals’ alone are not enough — valuations also matter. Indian corporates, for instance, may have solid fundamentals, but Indian valuations continue to be high compared to its peer markets. The ‘purge’ may have been drastic but all this has done, as per the latest Merrill Lynch survey of Asia-Pacific fund managers, is to reduce the underweight for the Indian market. But it remains under- weight because of its comparatively high valuation. The Motilal Oswal report points out that the valuation premium is the result of a higher RoE, the diversity of corporate earnings, and so on. But FIIs aren’t buying that argument, as the MSCI India Index has underperformed both the MSCI BRIC Index and the MSCI Emerging Markets Index. As on 25 July, while the MSCI India index was down 2 per cent this quarter, the MSCI Emerging Markets index was down 1.1 per cent while the BRIC index was lower by a mere 0.1 per cent.

That’s why the sectors that had gone up the most during the bull run are also the ones that have fared the worst during the bear phase. The BSE Metals index and the BSE Capital Goods index, which had gone up the most this year, have also been the worst performers after mid-May, when the market meltdown occurred. Technology stocks —the biggest underperformers during the first five months of the year — have been the best bets during the post-May market. The truly defensive player has been the FMCG sector, an outperformer earlier, it has only marginally underperformed the Sensex in the bear phase.
It is also clear that liquidity has been a major factor determining the performance of stocks, which is why the midcap and small cap stocks have been hurt more than the frontline ones. And finally, in an environment where interest rate increases are almost certain, interest-rate sensitive stocks like banks have suffered. Also, as Rajat Rajgarhia, head (institutional research), Motilal Oswal, put it, midcaps are more sensitive to higher interest rates, particularly since many of them have borrowed abroad.
Simply put, the days when a rising tide lifted all boats are long gone. Investors will now have to check out the fundamentals, the valuations, the liquidity and the defences against a downturn of the companies they put their money in.
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