Time for a portfolio clean-up

AARATI KRISHNAN | Updated on March 12, 2018

Should I jump ship, join the party or just cruise along? That is the question many people seem to be asking after this New Year rally. But the profile of the top gainers shows that picking winners in this stock market move has been nothing short of a lottery.

Penny stocks have shot up faster than index heavyweights. Companies with high debt have been avidly bought, while those with tonnes of cash have been cold-shouldered. And sectors that are up against a bevy of regulatory or other problems have been eagerly lapped up as ‘value' buys. Backed as it is by foreign institutional investor (FII) flows, it is difficult to say if this up-move pre-empts better days for India Inc or is merely a pull-back from rock-bottom prices. After all, who can argue with liquidity? But irrespective of whether this rally continues or fizzles out, it offers investors a golden opportunity to de-risk their portfolio. Here is how they can do it.

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In a usual bull market, it is blue-chips that lead from the front. But this rally has been completely different. The BSE Midcap and Smallcap indices gained 23-24 per cent trouncing Sensex gains of 16 per cent. Thanks to this trend, the valuation equation has turned topsy-turvy. Today, while the Sensex sports a moderate price-earnings multiple (PE) of 18.5 times, the BSE Midcap index trades at 19 times, with the BSE Smallcap index poised at 20 times. Now, there appears to be no fundamental reason to accord smaller companies such a premium today. With the economic troubles within India far from over and interest rates still hovering at high levels, small and midsized companies are far more vulnerable to business risks than their larger counterparts.

Moreover, whenever valuations of mid and smallcap stocks have caught up with the Sensex in the past, it has always spelt trouble (or bubble!). This makes it a great time for investors to make switches in their portfolio. If you own small or mid-cap stocks that have run up sharply, switch into large-caps within the same sector. Looking at the recent set of gainers, this would mean switching from a UCO Bank to ICICI Bank or from a BGR Energy into BHEL.

Go for quality

Then there is the phenomenon of investors indiscriminately bidding up all ‘cheap' stocks trading below their book value or at single digit PEs.

Now, any true-blue rally usually begins with ‘value' stocks outperforming ‘ growth' stocks. But when investors completely ignore business risks that threaten the core operations or brush aside governance issues that had them paralysed just two months ago, it is certainly time to be cautious. After their 60-130 per cent gains in barely two months, it may be time to sell stocks such as Lanco Infratech, Indiabulls Real Estate, Jai Corp and Reliance Communications.

Even if recent expectations about improved coal supplies to the power sector, or a revival in real-estate demand do come about, investors can play these themes through better-quality stocks in the power or realty sectors. You may not get a better opportunity to replace such choices with safer names such as NTPC or Bharti Airtel.

Tread carefully on debt

A third trend in this rally is the sharp rerating of debt-laden companies — the same ones which bore the brunt of the market meltdown last year. Now, even if factors such as moderating raw material prices and a strengthening Rupee reduce the cost pressures on India Inc, it will be some time before companies with high leverage, foreign currency loans or FCCB out-standings will be able to clean up their balance sheets. For one, while interest rates have flattened out they are showing no signs of falling steeply from current levels. Two, with the global and sovereign credit crises still holding sway, refinancing existing debt at lower cost will also remain quite difficult for anyone but top-rung companies. While stock markets investors may be in the mood to take on risk, lenders may not immediately follow suit.

This again argues for investors to go for quality in their portfolio. Here, the so-called defensive sectors such as FMCG or pharma may not be an ideal choice, given their high PEs. But investors could switch from high-debt companies to those with lower debt levels within the same sectors. That may call for swapping Unitech with Oberoi Realty, Wockhardt with Lupin or a Shree Renuka Sugars with Balrampur Chini Mills.

A shift to quality on the above lines may not ensure quick gains if this rally carries on in the current vein. But it surely will protect your wealth better, if the FIIs decide that they will go thus far and no further.

Published on February 25, 2012

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