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S. Vaidya Nathan

AS YOU track the ticker of equity prices, either on television or on the Internet, there is an adrenalin surge as equity prices rise. With the market picking up from mid-August, there is now a buzz comparable to that which prevailed during the last six months of 2003, though the current rise in prices is not as pronounced as it was then. Macro-level economic factors are also very different.

Crude prices, which are 75 per cent higher on a year-on-year basis, a deficient monsoon, higher inflation, an end to declining interest rates, and the go-slow on disinvestment all , put the bull phase in a different setting. All these factors can spook the economy's growth rate and the market.

A more bullish undertone

Yet, the market is more bullish now, compared to the trends in January, when indices across the board reached record levels. Only the CNX IT Index is at its all-time high. The CNX Mid-Cap did get close to its high, but has settled a tad lower.

The Nifty and CNX 500, which track large-cap stocks and the broader market respectively, are 10 per cent and 8 per cent adrift of their highs. But, then, the indices do not present the full picture.

Market capitalisation is at record levels of about Rs 12.5-lakh crore. The number of stocks trading at record levels is also higher. This is attributable to a greater number of mid-cap stocks enjoying yet another bout of re-rating, the fourth since 2002. The listing of Tata Consultancy Services also boosted market cap levels.

About 500 stocks are less than 20 per cent off their highs. In contrast, just 20 are within a similar range from their lows.

Given below is a list of ten stocks that are close to their 52-week highs, and another set trading at close to their 52-week lows, that offer scope for appreciation.

Over a one-to-two year horizon, we believe both sets could outperform the broad market, which may move in a narrow band after the recent gains.

Picks from the highs: Alfa Laval, Nagarjuna Construction, Hindustan Sanitaryware, Gujarat Ambuja Cements, Ramco Industries, Tata Steel, Lakshmi Machine Works, Nicholas Piramal, MICO and Cipla.

The choice is driven by growth prospects and possible investor interest. Barring Ramco Industries, liquidity is not a problem in other stocks. In Ramco Industries, retail investors should not have a problem transacting in lots of 100 or less. To buy one share of each company would cost about Rs 13,000.

The portfolio trades at a forward price earnings multiple (PEM) of 11 times its likely FY05 earnings and less than 10 times FY06 earnings, based on a conservative estimate of growth rates.

The portfolio would be less expensive if one considers the growth rates these companies posted in the April-June quarter and the likelihood that they would largely maintain the pace in subsequent quarters, even if profitability is hit by higher crude prices.

MICO and Cipla, which trade at PEMs in excess of 20, have a growth story to back up the valuation levels.

This portfolio has a distinct bias towards stocks of companies from the construction material space. Mid-cap stocks dominate the list.

Companies such as MICO, Nicholas Piramal, Alfa Laval, Lakshmi Machine Works and Nagarjuna Construction can become large-cap stocks over a three-to-five year period. Stocks such as Hindustan Sanitaryware and Ramco Industries are bound to scale the mid-cap ladder.

Gujarat Ambuja Cements may be the prime beneficiary of the emergence of a finer balance between demand and supply in the northern and western regions, and the enhanced interest the sector may attract from institutional investors.

As exports are likely to account for 15-20 per cent of revenues, earnings will get a fillip as global prices have almost doubled.

The riskiest exposure in the portfolio would be Tata Steel as steel prices may not rise as sharply as in the past year; the downside risk would be linked to trends in China's economy and the possibility of government intervention if steel prices rise further.

Official estimates indicate that China's economic growth rate is expected to slow down from 9.6 per cent in FY 04 to 8.9 per cent in FY 05. If the fall is sharper, it could dampen the commodity market, and steel would lead any such decline.

The next couple of years may see at least stable steel prices; this coupled with improving cost efficiencies could pep up Tata Steel's earnings growth.

The downside risk to the portfolio would be the effect of rising crude prices. This is, however, a risk at the macro-level. Its impact can be neutralised by adding to the portfolio, a basket of stocks such as HDFC, Infosys and Satyam Computer.

Picks from lows: Goodlass Nerolac, Elgi Equipment, Shanthi Gears, Chambal Fertilisers, Ranbaxy Labs, Dabur India, Tata Motors, Kotak Mahindra Bank, State Bank of India and Bank of Baroda.

To buy one share of each company would cost Rs 8,300. This portfolio trades at a PEM of about 12 times the FY04 earnings. Forward PEMs for FY05 would be closer to 10, even if one factors in flat or negative growth from the banks that figure in the list. This aspect has, however, been largely priced in, with the Bank of Baroda stock taking a knock after top management indicated that operating profits could be lower by 15 per cent in FY05.

Chambal Fertilisers is the risky exposure in this portfolio. But as a small-cap stock that trades at about Rs 25, any downside would have but a marginal effect on returns.

On the upside, it could act as a trigger that could drive returns up a percentage point or two. Kotak Mahindra Bank is an emerging story in the banking space and has substantial upside potential over a two-to-three-year period.

Risks in this strategy

If the market moves into a phase of steady decline, 52-week highs tend to be a good sell indicator; 52-week lows need not necessarily be a buying opportunity as prices could fall further.

Essentially, a call on the market is a must. Or, you should have a two-to-three-year (if not longer) perspective so that the effects of different market phases get evened out.

Even if we assume that there is going to a substantial decline, the portfolio picks from the `close-to-highs' list could weather such a trend and deliver returns over a longer timeframe. The risks may be greater in the picks from `close-to-lows' list.

If the government puts in place a mechanism — perhaps on the lines of oil bonds issued in the late 1990s — that could partially insulate the economy from crude prices of over $50, the downside risk to equities may be limited.

If one goes by the indications provided by the US Federal Reserve Chairman, Mr Alan Greenspan, on crude price, in a speech a couple of months ago — drawing upon prices of long-term futures — higher prices are here to stay, though not at the present levels.

The economy and corporate India will have to adjust to higher average crude prices than in the past.

The swiftness with which this is done, and in a manner that does not affect growth rates would be crucial in driving profitability levels. This is an aspect that needs to be tracked closely by equity investors.

An aspect that is shared by the companies that figure in both the lists is that they would figure at a relatively higher level as far as quality of corporate practices is concerned. Management-related risks are marginal and the stocks would continue enjoy a premium for this element.

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