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Suresh Krishnamurthy

Some stocks are more equal than others. Their status is determined by the power of the idea that the company's business represents. Including such idea stocks may enhance your portfolio's returns over the long term.

MOST businesses can be broken down into simple ideas. Ideas backed by the right people usually find several takers among investors even if the business plan looks hazy early on. Stocks such as HDFC Bank, Infosys Technologies, Hero Honda and Ranbaxy Laboratories represent a few such bright ideas that attracted investors in the early 1990s.

Unmindful of the risks to growth, investors paid fancy multiples for such stocks in the 1990s. Their strategy — some would call it a gamble — did pay off handsomely. It is true of `idea stocks' even now. The valuations of such stocks, which are perceived as bright ideas by stock markets, defy conventional wisdom.

Several such stocks are available in the market even now. Some are large in terms of market capitalisation while others are smaller. Over a longer term, including such stocks, especially a few of the mid-caps and small-caps, could add several percentage points to your portfolio's return.

Identifying idea stocks: A simple way to prepare a list of idea stocks is to sort stocks on the basis of price-to-book-value ratio. Price to book value is computed by dividing the stock price by the book value per share. Stocks with a price to book value ratio that is significantly higher than 1 can be regarded as idea stocks.

If the stock price is several times the book value it may indicate that the profitability of the business is substantially high now or is likely to be so in the future; it may even be a combination of both.

The present or future returns of the business can be substantially high only if the business proposition is backed up by sound ideas. After you prepare such a list, you can then pick stocks from that list based on your preferences. If you understand the businesses of the stocks you have picked, the chances of picking a winner increase immeasurably.

As of now, several such stocks are available in the market. Large-cap stocks such as HDFC Bank, Infosys Technologies and Hindustan Lever, which have been around for a decade or more, may still make it to the list. This is because the stock market expects such business ideas to generate superior returns in the future too. You can add such time-tested stocks to your portfolio, as the risk in such stocks is limited compared to mid-cap or small-cap stocks.

Risky ideas: Mid-cap or small-cap ideas that are yet to be tested are more risky. The returns, though, could be substantially higher. They are, as such, more attractive. If you believe you have identified the next Infosys, would you not be thrilled?

Attractive mid-cap or small-cap ideas are, however, difficult to find. This is because venture capital or private equity firms usually incubate such attractive ideas. When such ideas make it to the market, they are usually mature businesses and consequently promise lower returns.

Or, worse, ideas that make it to the capital market at an early stage tend to be those that have been rejected by venture capital or private equity firms. Despite these caveats, it may make be appropriate to keep an eye out for such stocks because of the opportunity to earn big bang returns.

Mid-cap idea portfolio: More than one portfolio of idea stocks can be prepared now depending on investor preferences, skill and understanding. A possible list of ten stocks that appear attractive now is: Astra Microwave, Bharti Tele-Ventures, Centurion Bank, Financial Technologies, Geojit Financial Services, K Sera Sera, Matrix Labs, Pantaloon Retail, Power Trading Corporation and TV Today.

Astra Microwave claims that it is already the worldwide leader in microwave solutions. It expects its turnover to rise seven-fold in a span of four years. Centurion Bank promises to rise like a phoenix from its ashes. Financial Technologies and Geojit Financial Services are banking on a massive increase in derivatives trading.

K Sera Sera promises to mint money from film production. The ideas represented by other companies — TV Today, Power Trading Corporation, Pantaloon Retail, Bharti Tele-Ventures and Matrix Labs — are quite well known. If these ideas prosper, then over the next ten years, investors in these stocks will reap returns that are several times more than that of the Sensex.

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