EQUITY. Be a discerning stock-picker

India Inc would be glad to bid adieu to 2015, a year in which it saw its earnings come under severe pressure. It would be foolish to expect a sea-change in the environment just because we’ve changed the year in the calendar. While there are signs of revival in some sectors, offering opportunities for the discerning stock-pickers, for the Indian equity market as a whole, 2016 is not expected to be too rosy.

Both revenue and earnings of companies have been steadily declining in the last three quarters and hit a nadir in the September 2015 quarter. For the Nifty companies, sales contracted -4 per cent and net profit grew 6.3 per cent in the quarter ending September compared to the year-ago period. The performance was weaker for the larger set of companies in the Nifty 500 group. Revenue contracted -5 per cent and earnings fell -2 per cent for this set.

Many brokerages had pencilled in strong double-digit earnings towards the beginning of FY 2016 and these numbers have had to be adjusted lower. At the current value of 7,861, the Nifty trades at a Price to Earnings multiple of 20.6 times based on trailing 12-month earnings. This is slightly higher than its five-year average of 19.3 times but within the five-year band of 16 to 24.

That said, the problem arises when we try projecting the forward earnings of the Nifty. Given the current conditions, it is hard to expect earnings growth to exceed 15 per cent next year. If we project 10 to 15 per cent growth in earnings, Nifty should trade between 8,647 and 8,776 (assuming current PE multiple). That translates to an upside of 10-11 per cent for the Nifty the next fiscal.

If we run through the valuations of stocks in the Nifty basket, most of them seem to have already priced in the positive factors. While stocks do tend to move away from their intrinsic worth in many phases, at current prices there appears to be little scope for large-caps next year.

With the large-cap universe appearing fully priced, well-run and promising mid-caps that have not yet caught the market fancy will continue to be the best way to generate alpha in your portfolio. Investors can keep an eye on sectors that show some sign of revival and latch on to the better stocks in these sectors.

Urban consumers are continuing to spend and the Seventh Pay Commission and the one rank one pension (OROP) payments will only give a leg-up to this theme. Sectors, such as auto, auto components, consumer durables, media and entertainment, hotels, aviation, tourism and retail could draw investors.

Industrial production is slowly edging higher and manufacturing PMI has also been holding up over the last few months. It will pay to take a closer look at the under-researched stocks in the capital goods sector that are showing an uptick in their order book. Similarly, power generation, road construction and coal output are moving higher. Watch the companies in these areas.

Any economic recovery is predicated on a pick-up in lending activity. While credit growth has not shown any improvement yet, you can zoom in on banks that are showing robust growth in their loan book and have fewer stressed assets.

The stragglers? It is best to avoid the temptation to bottom-fish in the metals complex as the drivers here are global demand, especially from China. With no light at the end of the tunnel as in the global slowdown, there is likely to be a lot of pain for metal producers. The logjam in real estate will not be resolved unless prices are brought down by developers, and until that happens, it is best to avoid this segment.

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