Big story: Which stocks to pick in 2020

As we step in to the New Year, there is a feeling of gloom caused by an economy that seems to be spinning out of control, political unrest and equity portfolios smeared with red.

But it needs to be remembered that market bottoms are typically formed when there is an all-pervasive gloom. As mentioned in the piece ' Will stocks recover in 2020?' , the ongoing correction that has already lasted two years has created some great buying opportunities for the long-term investor.

While volatility is likely to persist in the next few quarters, investors can use this phase to buy stocks. Here are some themes that can be considered for 2020.

Cyclical large-cap stocks

The demand dynamics of the listed stock universe has undergone a sea change over the past five years, with excessive demand for large-cap stocks, which are the top 100 stocks based on market capitalisation. The steady demand limits the downside risks in these stocks, while stocks that have reported decent earnings growth have been accorded rich premium by investors.

The top 100 stocks grew their market cap by 13 per cent in 2019, and the top 10 stocks have witnessed 20 per cent growth. But there is opportunity in this space, too.

While stocks with robust near-term prospects are trading at rich valuations, some cyclical stocks with near-term growth concerns are available at far cheaper prices.

For instance, Power Grid Corporation is trading at a trailing PE multiple of 7.8 times, compared with its three-year average PE of 15.3 times due to lower electricity generation in 2019 and a fear of greater competition going ahead. But considering a large project pipeline, superior execution capability and good revenue visibility, it continues to be a good long-term bet.

Similarly, the infrastructure behemoth, Larsen and Toubro, is currently trading at 20.8 times trailing PE multiple, below its three-year average of 26 times. While the ongoing economic slowdown has impacted the company’s order-book accretion, the growth in its order book is still far superior to its peers. It will also be the first to benefit if the Centre begins its capital spends in earnest.

In the same vein, large-cap auto stocks such as Maruti Suzuki India, Eicher Motors and Hero MotoCorp are trading at valuations far below the long-term averages, making it an apt time to begin accumulating them in corrections. With auto majors indicating that the consumer’s intention to buy passenger cars and two-wheelers is improving, and if the BS-VI hump is crossed in March 2020, the prospects can begin to look up.

The base-effect will also aid the earnings of these companies in FY21.

Large-cap metal companies can also be a good hunting ground for value investors with a long-term horizon, with stocks such as Tata Steel, JSW Steel and Hindalco Industries trading at very attractive valuation.

Follow the dividend

Buying stocks that are consistent high-dividend payers is another good idea in volatile markets.

There are many PSU listed stocks that have consistently given high dividends to shareholders. Many IT companies are also good at using surplus cash to reward shareholders.

Hindustan Zinc is among the most generous dividend payers with an average dividend yield of 7 per cent between 2015 and 2019. Concerns over a fall in production, following the transition to closed mining from open-pit mining and the ongoing US-China trade war, had depressed the stock price. But the sustained deficit in zinc and lead in the global market and the company’s near-monopoly in domestic market, places it on solid ground from a long-term perspective.

BPCL is another good dividend-yield stock, with an average yield of 3.7 per cent over the past five years. But it is recommended only for the more adventurous investors, given the overhang due to the Centre’s resolve to do strategic sale of its stake in the company.

HPCL, another PSU oil-marketing company, can also be considered; the average dividend yield for the stock has been 4.6 per cent over the past five years.

For those who want to take it steady as far as returns go, NTPC is also a good option. The stock had a dividend yield of 5.26 per cent in 2019, and an average yield of 3 per cent over the past five years. It is also a value-buy at this juncture, with its current PE of 7.5 times, far below the three-year average of 11.6 times. Despite a strong project pipeline that will go on stream over the next two years and good revenue visibility, the stock has been hit by the uncertainty surrounding its merger with other PSU entities such as NHPC and SJVN.

What MFs did

If you are one of those constantly on the look-out for new stock-picking ideas, you can scan the portfolios of equity mutual funds to see what the funds have bought in recent times.

Since the fund managers are privy to news that is not always in the public domain, this strategy is quite sound.

We scanned through the stocks added afresh and stocks whose holding was increased substantially by all categories of equity mutual funds between July and November 2019 to look for ideas.

ICICI Lombard General Insurance seems to be a hot favourite across fund categories — dividend-yield funds, large-, mid- and small-cap funds — in this period.

The company’s leadership position in the category, sound prospects and a good business model seem to be attracting fund managers.

Many funds also seem to be looking for bargain buys in the beleaguered auto sector.

Stocks such as TVS Motors, Ashok Leyland and Eicher Motors have been favoured by fund managers in the last few months.

Besides some of the recent IPOs, old war horses such as 3M India, Gujarat Fluorochemicals and Astral Poly Technik were other interesting additions by MFs in recent times.

You can keep these on the radar in 2020.

Bargain hunting

If you are a seasoned investor in the stock market, you will know that in every broad-based sell-off, many fundamentally sound stocks also tend to get punished along with the bad apples.

We screened stocks that had plummeted sharply over the last two years, resulting in sharp de-rating of their valuation, but having a decent operating margin and ROE (return on equity) over the past two years. There are many stocks that seem to have been pushed lower due to the steep valuation they were accorded in happier times. Also, near-term growth concerns, which can prove to be transitory, seem to have played a part in the decline in their stock prices.

Thyrocare Technologies is one such stock whose price declined 23 per cent and the PE multiple corrected 37 per cent to 28.5 times since the beginning of 2018. Due to scarcity premium, this stock had been accorded a steep PE multiple of 55 times in its IPO.

But the stock still has a sound business and healthy financial metrics that hold good promise.

Similarly, the stock of real-estate developer Sobha has declined 35 per cent over the past two years, while its PE has declined 65 per cent, making the stock trade at 11 times the trailing 12-month earnings.

A robust project pipeline, presence in the relatively resilient Bengaluru market and healthy financials place this residential real-estate player in good stead.

Cummins India, manufacturer and distributor of diesel and alternative fuel engines, is another stock that has been de-rated, with its PE multiple correcting 36 per cent in the last two years. While the company has been impacted by the slowdown, it still holds promise for the long term.

Jyothy Labs is another sound stock that has taken a knock in the recent past, taking the valuation to attractive levels.

Consumption likely to revive

There were a lot of concerns raised about slowing consumption last year.

But these may be overdone, with the possibility of many of the factors leading to the consumption slowdown easing in a quarter or two. While commercial vehicle sales are linked to the economic activity and could take time to revive, passenger-car and two-wheeler sales are likely to look up in 2020.

Already, an improvement in retail volumes and a favourable monsoon point towards a possible revival.

The Centre is making all efforts to revive the credit growth in banks and NBFCs; this, coupled with an improved transmission of the RBI’s rate cuts, can spur consumption demand for consumer durables as well. Rural income is likely to improve with the sharp increase in food prices since September 2019.

If the Centre and the States resume their capital expenditure in 2020, that can boost rural non-farm income further. While the urban wage growth has been slowing, urban consumption is showing signs of picking up in the last quarter of 2019, as evidenced by consumption of petroleum products, air passenger traffic, auto sales at dealer outlets and demand for office properties. While this space needs close monitoring over the next few quarters, given India’s demographic profile, consumption as a theme will continue to dominate for a few more decades.

It is, therefore, best to keep an eye on the good stocks in auto, real estate and ancillary products such as paints, tiles, plywood, media and consumer durables, to pick up in broader market corrections.

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