• Investment World
• eWorld
• Catalyst
• Mentor
• Life
• Canvas
• Praxis
• Urban Pulse
• Brand Quest

Suresh Krishnamurthy

THE continuous rise of `risky' stocks in 2003-04 endorses the need for a business risk-focussed investment strategy when an economy is gathering momentum. The higher probability of economic growth assures sales growth — be it in the form of increase in per unit realisations or in an increase in volumes or, as is most likely, a combination of both. Investors who bet on such an outcome in 2003-04 have been richly rewarded.

Focus on under-performers: Now that such stocks have appreciated, the returns from such an approach may be considerably limited in 2004-05. This calls for a change in strategy. The focus this time around could be the under-performing stocks. Such stocks should have:

High total and operating leverage

Profit growth in each of the last three years

A high leverage will signify that in the event of rise in sales, the rise in profits would be disproportionately high. Profit growth in each of the last three years is essential since the market values such growth. Some such laggards are 3M India, Camlin, Bank of India, Bayer ABS, ITC, BASF India, Asian Paints, Marico Industries, Sulzer India and City Union Bank.

The average of the profit growth in the last three years of these stocks is about 34 per cent. These stocks have, on an average, risen by 55 per cent in the past 12 months. This is lower than that of the average of 90 per cent for the universe of 1,000 stocks. In a few cases, such as Bank of India, City Union Bank and Asian Paints, these stocks have also under-performed their peers.

Declining earnings: Economic recovery does not mean that only profit-making companies will be able to improve their earnings growth rate. It may just be the time for companies to stem erosion in profitability. In this backdrop, a focus on stocks whose average profit growth in the last three years is negative may also prove rewarding.

Some of these stocks are Finolex Cables, EIH, Tata Tea, Swaraj Engines, Rallis India, Kinetic Motor, MTNL, Chambal Fertilisers, Rayban Sunoptic and Revathi Equipment.

The average profit decline of these stocks in the last three years is about 18.9 per cent, while they have risen an average of 42 per cent in 2003-04.

Other laggards: Then there are companies that have positive average growth in profits but have recorded a decline in profits in one of the last three years.

The volatility in earnings growth of these companies make them riskier than companies that have recorded growth in each of the last three years. A prognosis of sustained economic growth reduces the risks, however.

These stocks include TN Newsprint, Sutlej Industries, Cholamandalam Finance, KSB Pumps, Mastek, MRF, Munjal Showa, MIRC Electronics, HPCL and Deepak Nitrite.

The average profit growth of these ten stocks is about 38 per cent. These stocks appreciated in price of about 50 per cent in 2003-04.

Economic growth, the driver: While these three sets of ten stocks may not be outright buys, they may be worth a second look.

It may be worth investigating why investors have not jacked up the price of these stocks. It may be that the ruling valuations may already be too high.

These stocks may have hidden weaknesses that the financial performance does not reveal. In such an analysis, if we are able to spot two winners, the exercise may be worth it.

In addition, there is also the question of economic growth. If economic growth proves to be a mirage, the question of these stocks appreciating does not arise at all. The outperformance of these stocks is predicated on higher economic growth.

If the economy does grow at a faster pace, that would be time to catch up with this set of stocks. There is then a good chance that the prices of a few from this list of 30 stocks will gain momentum.

Article E-Mail :: Comment :: Syndication :: Printer Friendly Page

Stories in this Section
Quiz

Copyright © 2004, The Hindu Business Line. Republication or redissemination of the contents of this screen are expressly prohibited without the written consent of The Hindu Business Line