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Braving risks for investing in overvalued equity markets

Braving risks for investing in overvalued equity markets
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First Published: Sun, Oct 18 2009. 10 28 PM IST

Bull run: The Bombay Stock Exchange’s benchmark Sensex has gained some 112.32% since the beginning of the bull run in March. The broader market represented by the BSE 100 index has gained 119.4%. Puni
Bull run: The Bombay Stock Exchange’s benchmark Sensex has gained some 112.32% since the beginning of the bull run in March. The broader market represented by the BSE 100 index has gained 119.4%. Puni
Updated: Sun, Oct 18 2009. 10 28 PM IST
Mumbai: In a research report published 10 days ago, Enam Securities Ltd likened investing in today’s equity markets to the “Tiger bird” strategy—the small bird feeds by picking up scraps from the predator’s mouth. In effect, the Mumbai brokerage was referring to the high-risk, high-reward scenario of investing in equity markets now.
Not without reason. India’s bellwether index, the Sensex, has gained some 112.32% since the beginning of the bull run in March. The broader market represented by the BSE 100 index has gained 119.4%. But at least three-fourths of these gains came by July.
Bull run: The Bombay Stock Exchange’s benchmark Sensex has gained some 112.32% since the beginning of the bull run in March. The broader market represented by the BSE 100 index has gained 119.4%. Punit Paranjpe / Reuters
Valuations are rich with the Sensex trading at 20 times the estimated earnings for fiscal 2010, leaving investors who missed the bus at the start of the bull run with fewer options now. And yet, those who still have appetite for equities as an asset class do have options, if they can brave the risk.
“Not every company has had dramatic gains since March,” said Seth R. Freeman, chief executive, EM Capital Management, a San Francisco-based foreign institutional investor. “There are so many mid- and small-cap Indian companies waiting to be discovered with shares that can be purchased at prices providing substantial upside.”
Analysts and fund managers are busy churning new themes and selling sectoral stories to clients who want to invest in the current market. The starting point for these are eternal investment themes. For instance, a focus on fundamentals and low price-earnings multiples—an indicator of attractive stock valuations.
“You look at the business plan, the quality of management,” said Abhay Aima, head of equity and private banking at HDFC Bank Ltd, India’s second largest private lender.
Financial services firm Noble Group prescribes what it calls the “discrimination trade” strategy. Saurabh Mukherjee, Noble’s head of Indian equity, explains that first-generation businesses and those run by entrepreneurs from outside traditional business communities are not given the benefit of the doubt during bad times. These stocks trade at a discount to start with and rise sharply later.
The institution back-tested this hypothesis for the past nine years and found that these so-called outsiders (a group of 22 stocks) outperformed established businesses in six of those years, taking a beating only during bearish phases.
Noble advises a long-short strategy, where investors buy both these stocks and short Nifty futures. Examples of such stocks are Lupin Ltd, which has risen 54.48% since July, and MphasiS Ltd, which has gained 64.18%. In comparison, the Sensex has gained 18.89% since July.
Other champions are of the non-glamorous kind. G. Chokkalingam, head of equities at Barclays Wealth India, recommended old private sector banks to investors a couple of months ago. These include Bank of Rajasthan Ltd, Karur Vysya Bank Ltd and Dhanalakshmi Bank Ltd, which are overshadowed by bigger rivals such as HDFC Bank and ICICI Bank Ltd, and traded at a discount.
Chokkalingam says these banks not only have comparable operating metrics such as low net non-performing assets, or NPAs, but are also ripe for a phase of consolidation because of a road map prescribed by the central bank.
In 2005, the Reserve Bank of India had mentioned permitting mergers or acquisitions of private banks with or by foreign banks after April 2009.
Another favourite theme for fund managers is government spending. After a $3 billion (Rs13,890 crore) fiscal stimulus, the government has pledged to spend big money on building roads, low-cost housing and power plants through various schemes.
Fund managers such as A. Balasubramanian of Birla Sun Life Asset Management Co. Ltd prefer the power and infrastructure sectors as these are in a “growth phase”, where stocks, typically, make multiple gains. In comparison, sectors such as telecom are in the stabilizing phase, Balasubramanian said.
A sub-theme within this is that of the supplier industries. Shyam Sekhar, 40, an independent investor in Chennai, likes the pipes sector. His reasoning: Irrespective of the how the economy performs, there are big plans for increasing gas and water supplies.
Companies in this sector have made significant investments. Because of high leverage, institutional investors are not eyeing them, but these have a potential for multiple gains over the next five years, said Sekhar. He refused to give examples of stocks citing low liquidity (which means stock prices can swing wildly with low volumes traded).
But for every stock pick or theme, someone has an alternative theory.
Chandrakant Sampath, a veteran high net-worth investor, says he has put his money in nationalized bank deposits and has been doing nothing for the past one year. He says the market continues to exhibit what billionaire investor George Soros calls “dynamic disequilibrium”.
“Things have not changed. Today, the global economy is driven by short-term impulses from the capital market. The unlimited printed money is getting diverted to the capital market,” he said. “This money recognizes momentum, not value. Even central bankers are getting carried away. This is not real capital formation.”
ravi.k@livemint.com
Ashwin Ramarathinam contributed to this story
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First Published: Sun, Oct 18 2009. 10 28 PM IST
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