It is back to Fundamentals

The Indian Stock market is now reacting to fundamentals, therefore, money making is going to be selective. The Year 2008 will see to it that money is not made on tips or hearsay. This is not the year of 'Momentum Stocks', so one should focus on 'Value stocks'. The current uptrend/relief rally or whatever you may like to call it, is based on the fundamentals of the companies on the basis of quarterly/ annual results for FY 07-08. The market will reward those who do their homework well. There are three levels of analysis to take stock of the market moves. It is known as EIC analysis (Economy, Industry and Company).

• Let us first analyse the Economic situation. The ngative factors are a high inflation rate and high commodity prices. Although, with the prospects of a good crop foodgrain prices are likely to cool off soon, but high crude prices are here to stay, and this may hurt the Indian economy very badly in the long run. But the positiove side is, that Indian economy is still growing, and even a slower growth rate of 7.5-8% will not hurt the sentiment badly. The CRR hike is already behind us. The credit policy on 29th may announce a Repo rate hike of 25 basis points, which has been factored by the markets. If the hike is higher it might effect the sentiment negatively. It is unlikely that the RBI Governor will resort to a steep hike, which might kill the India growth story. If no surprises are there in the credit policy the markets are likely to maintain their uptrend in the near future. Valuations of the overall markets at 17000 level BSE/ 5100 on Nifty are in line with the historical trends (PE of 20 trailing basis, and 17 for one year forward basis). The markets are not likely to move past the earlier tops in the next 6-9 months, because of the uncertain economic/ political environment. The range for the markets could be 15% on either side of the fair market value i.e. 14500-19500 for the sensex. Broadly this range may be utilised by long term investors: Buying at the levels of 14500-15500 and booking partial profits above 18500 levels.

• The next level of analysis is the Industry Analysis: Although the benchmark indeces give us a direction, all stocks within the index do not move in the same direction. The sunrise sectors of last year which have given super normal returns will no longer lead the uptrend. We need to divide sectors into three catagories: First the ones which have long term value at current levels and are less likely to be affected by an economic slowdown: Pharma & Healthcare, FMCG, Retail, Media & Entertainment. These sectors are more or less insulated from the economic slowdown. Selective purchases can be considered in stocks from these sectors. The next are the sectors that get negatively impacted by the slowdown: Capital goods, Auto, Banking & Finance, Realty & construction. Auto & Banking (especially PSU banks) are still quoting at reasonable PE multiples and can be bought on declines. But refrain from investments in Capital goods and Realty as most of the stocks from this sectors are quoting at ridiculously high PE's. Case in point are the stocks like ABB and Siemens. I would consider even L&T and BHEL expensive at current levels. The sectors falling in the third catagory are those which get affected by Govt. policies. These sectors are Oil & Gas, Telecom, Basic Metals. PSU Oil/Gas companies like ONGC, Gail, IGL, IOC, HPCL, BPCL are all quoting at reasonable PE multiples, but the Govt. policy is responsible for keeping them at subdued performance levels. Telecom sector is highly dependent on spectrum allocation. Diversified companies like Bharti still hold good value from this sector. Basic metals like Steel and Aluminium, and even commodities like Cement are currently under the scanner of the Govt. in its bid to control inflation. So, a prudent investor should stick to the first catagory of stocks for buying. Partial profit booking is advisable in the second catagory, whereas a wait and watch approach is advisable for third catagory of stocks.

• The last level of analysis is the Company Analysis: Generally the markets tends to give a thumbs down to certain sectors, and even individual 'Gems' from the sector get punished alongwith the market sentiment. Intelligent investors are those who are able to identify these gems from the beaten down sectors, these stocks ultimately turn out to be multi-baggers. One such beaten down sector in the current scenario is the IT sector, where lot of good growth stocks are languishing at ridiculuosly low valuations.

Year 2008 will prove that there are no short cuts to make money on the stock markets. Do your EIC analysis properly before taking an investment decision. Otherwise it will be better to park a large chunk of your money in fixed income instruments for atleast one year.

Markets poised for a turnaround: RIL is the key

Indian markets last week gave a thumbs up to the results announced by the corporate sector, with Infosys providing the initial fillip. All the indeces including midcap and small cap indeces ended with gains of 3-5%, with strong advance decline ratios. There is an aura of cautious optimism amongst the market players. The negatives have been overplayed in the marketplace, but the results announced by the companies may dispel some of the negative feelings. Some events of the next week are being looked upon by the bears to make a killing: continued high inflation, hike in repo rate by 50 BPS by RBI on Thursday, introduction of short selling from Monday 21st, and the F&O expiry on Thursday 24th. Most of these factors will be taken by the markets in their stride.

The earnings announced by the various companies will decide the future course of the markets. Reliance Industries will announce the results on monday which will decide the direction of the markets for good part of the week. The global indeces have performed well on Friday, both DJIA and NASDAQ putting up strong gains during the week. The Indian markets are likely to cross their 200 day moving averages shortly. We can look forward to a period of optimism with the sensex attempting to cross a major resistence at around the 17200 level. Long term investors may hold on to their stocks, and profit booking, if any, may be considered only close to sensex level of 18000, once the earning season is over.

Earning season kicks off on a Positive note

The earning season has kicked off on a positive note. IT major 'Infosys' has provided the long awaited booster doze to a rudderless market. For the next one month or so the focus will be on the FY '08 numbers, and global signals will take a back seat. The earnings of majority of the companies are expected to be robust, dispelling fears of an immediate slowdown. Other factors of significance for the markets will be:

• Inflation Data: Friday's inflation numbers will provide an indication of the steps taken by the Govt. to curb inflation. The regulators as well as the Govt. must learn to live with a slightly higher rate of inflation between 6-7%, as this rise is due to global factors. As far as the WPI figures are concerned it is shocking to learn that the figures are not being updated regularly, and provisional data is being used to dish out inlation data which is far off from the ground situation. For example, index of iron & steel having a weightage of 3.7% in thr WPI, was first revised in 2008 only on 8th march 08, leading to a sudden spurt in figures. The boom in commodity prices continues unabated, and surprised everyone in the midst of news of a global slowdown. The commodity cycle may be nearing its peak. In India food prices are likely to soften as the Govt is hopeful of meeting its procurement targets for the Rabi season.
• Short selling: From 21st April '08 the six year ban on short selling is being lifted. How is it likely to impact the markets? In the long run it will lead to efficient price discovery and will improve liquidity in the markets. To begin with short selling is being introduced in stocks that are already being traded in the Futures market. It will help in curbing extreme volatilty. Mutual Funds are likely to be the biggest beneficiaries of the new order. mutual funds may be able to earn more than 5% higher returns by churning their idle portfolio through stock lending. This augers well for Mutual Fund investors. It is also likely to bring back arbitrageurs to the market, leading to higher volumes. Some people fear a 'Bear Raid' by taking short positions and spreading rumours to benefit from the measure. However, this view is unsustainable, on the cotrary short selling may avoid excessive price rigging, which augers well for the markets.
• RBI Credit Policy: 29th April will see the unveiling of the RBI's quarterly credit policy. A 50 basis point hike in CRR to contain liquidity is already factored in by the markets. There is a wide expectation that the RBI will not tinker with the interest rates. The CRR hike may lead to raisng of interest rates by the banks, marginally.

Overall market sentiment is likely to be positive for the next one month.

How to identify Stocks?

Stock selection is a very tricky job. The euphoric rise of the markets for the past 2 years till January 2008, gave an opportunity to make easy money on the markets. The steep fall of the past 2 months has again brought to fore the importance of proper stock selection for steady long term gains. In the past one week we have seen a sharp decline in the price of some blue chip stocks like BHEL and L&T. Does it mean that these stocks do not merit investment? There is no doubt that these stocks are excellent stocks with huge growth potential, but their prices had run-up too far as compared to their fundamental strength, hence the steep correction in their prices. Let us examine a few parameters of selecting value stocks for ones portfolio:

• HISTORIC DATA: Book Value represents the net worth of the company, comprising its paid up capital plus free reserves and surpluses. Companies with a high book value instill confidence among the investors, and are viewed as potential bonus candidates. Although declaration of bonus does not materially effect the balance sheet of the company, it often gives a fillip to the stock price as the liquidity improves. Another way to look at the strength of a company is the Replacement Cost of its assets and liabilities. To establish a new manufacturing plant is a capital intensive proposition, so it gives advantage to the existing established players over new players. However, one must take into account the 'technology obsolence' factor while evaluating companies on the replacement value parameter. Another related benchmark is the Price to Book Value ratio (PBV). A higher earning capabilty in terms of return to equity (ROE) tends to increase PBV. Let us take an example: L&T for most part of 2007 was quoting at a PBV ratio of over 25, and a company like HPCL was quoting at a PBV of around 1. But in the long run a very high PBV is not sustainable unless the growth is spectacular. So the moment maket got the signal that L&T's growth is slackening its stock started declining, giving it a discounting of a more reasonable PBV of around 20. On the other hand HPCL merits investment both on the low PBV ratio and a strong replacement cost scenario, but the stock remains subdued because of the govt. policy on pricing of petroleum products.

Which sectors will outperform?

Its time for long term investors to build their portfolio. If you intend to hold stocks for a minimum one year it is the time to invest, because blue chips are available at bargain prices. The markets are clearly in a consolidation mode. Despite the fall on Monday 31st March, the trend remains positive. Which are the sectors that will lead the markets in the next uptrend:

• OIL & GAS: India is determined to find a solution to its energy crises. The news on new oil & gas discoveries is encouraging. The companies that are going to benefit from the new discoveries are: ONGC, RIL, Cairn India. Refining/Distribution companies in the sector will also benefit in the long run. Companies to watch out will be RPL, IGL. Even the public sector refiners IOC, BPCL, HPCL merit investment at these levels.
• FMCG: With consumer spending continuing to increase, FMCG companies with large distribution networks are likely to reap rich benefits. Stocks that merit investment are HUL, ITC.
• Pharma & Healthcare: The fillip given by the budget to the healthcare sector, augers well for the gerenic suppliers with a strong R&D back up. One can find merit in Ranbaxy, Sun Pharma. The healthcare sector comprising of hospitals is going to reap the benefit of tax holiday announced in the budget. Stocks to watch out are: Apollo Hospitals, Fortis Healthcare.

Banking (especially the large Public sector pack) and the Auto pack is beaten down quite a bit. But inflation is playing a spoilsport in their recovery. Once the inflation issue is settled these sectors will start outperforming the markets. A contrarian investment could also be made in the frontline IT stocks like Infosys, TCS, Wipro, which are likely to give reasonable returns over a one year period.

Short term hiccups will continue, but the market is poised for a smart recovery in the month of April.