Look beyond Sensex for growth opportunities
7 Dec 2009, 1122 hrs IST, Krishna Kant,
Last few months have not been too kind to retail investors. While those smart enough to have invested in late 2008 or early 2009, are sitting on
a neat profit, for many retail investors, the current rally has been a wasted opportunity. Initially they suspected the sustainability of the rally and refused to risk their money in another "relief rally". And then in a matter of two trading sessions, the market jumped 20%, as the UPA government got re-elected in the general elections. And for last 5-6 months, most of us are waiting for a 'meaningful' correction to enter the market.
To the delight of the bulls however, all ensuing correction since of the middle of this year has been mild. The only meaningful correction was in late July when the market fell by around 16% in post budget sell-off. Since then, all market corrections have been modest with the Sensex never falling by more than 10%. This was too little to enthuse sceptics among us.
Currently the Sensex is trading at over 20 times its 12 months trailing earnings, making Indian stock market one of the most expensive in the world. This is enough to scare even the most aggressive of retail investors. But should the current level of the market be the only criteria to look at while making an equity portfolio?
There are two schools of thoughts on this. The first says that the equity markets behave like ocean and a rising tide lifts all boats (read stocks) and a receding tide lowers all boats. For the believers of this theory the only thing that should matter to equity investors is the market level. They say that all investors should take their cue from the benchmark index and should behave accordingly.
The other school believes that retail investors should not give too much importance to the market level. This is because you invest in a particular stock rather than the market. So what should matter to you the most is the valuation of a particular stock and its performance in recent past. You should make-up your mind about a stock and if it's current price meets your expectation then you should buy it irrespective of the market level. To put it simply, at any given level one can find stocks that are worth buying or selling.
So which theory one should follow? Well there are no fixed answers in equity market and there is a bit of truth in both schools of thought. It doesn't hurt anyone to keep a track of the broader market but giving too much importance to level of Sensex or Nifty would be akin to labelling all stocks with one brush. Quite often, many sectors or group of stocks behave differently than the movement in the broader market. And this opens up long-term opportunity for investors who are willing to be little patient.
In last 7-8 months, the Sensex has nearly doubled, but the rising tide has not lifted all boats equally. Rather the rally in the broader market has been accompanied by a poor stock market performance by companies in many sectors. While the recent meltdown in the stock price of telecom stocks is well known, the list of under performing sectors is quite long.
To the delight of the bulls however, all ensuing correction since of the middle of this year has been mild. The only meaningful correction was in late July when the market fell by around 16% in post budget sell-off. Since then, all market corrections have been modest with the Sensex never falling by more than 10%. This was too little to enthuse sceptics among us.
Currently the Sensex is trading at over 20 times its 12 months trailing earnings, making Indian stock market one of the most expensive in the world. This is enough to scare even the most aggressive of retail investors. But should the current level of the market be the only criteria to look at while making an equity portfolio?
There are two schools of thoughts on this. The first says that the equity markets behave like ocean and a rising tide lifts all boats (read stocks) and a receding tide lowers all boats. For the believers of this theory the only thing that should matter to equity investors is the market level. They say that all investors should take their cue from the benchmark index and should behave accordingly.
The other school believes that retail investors should not give too much importance to the market level. This is because you invest in a particular stock rather than the market. So what should matter to you the most is the valuation of a particular stock and its performance in recent past. You should make-up your mind about a stock and if it's current price meets your expectation then you should buy it irrespective of the market level. To put it simply, at any given level one can find stocks that are worth buying or selling.
So which theory one should follow? Well there are no fixed answers in equity market and there is a bit of truth in both schools of thought. It doesn't hurt anyone to keep a track of the broader market but giving too much importance to level of Sensex or Nifty would be akin to labelling all stocks with one brush. Quite often, many sectors or group of stocks behave differently than the movement in the broader market. And this opens up long-term opportunity for investors who are willing to be little patient.
In last 7-8 months, the Sensex has nearly doubled, but the rising tide has not lifted all boats equally. Rather the rally in the broader market has been accompanied by a poor stock market performance by companies in many sectors. While the recent meltdown in the stock price of telecom stocks is well known, the list of under performing sectors is quite long.
Consider the adjoining chart, where we have plotted the relative movement in the valuation of the Sensex and the cement sector. As is evident in the chart, while the Sensex has recouped most of its losses it suffered in 2008 and is not far from its all time highs, cement stocks are 50-60% cheaper than they were three years ago.
With the average price to earning multiple of around 9 times their net profit in last four quarters, cement stocks have never been cheaper except at the height of the meltdown during the last quarter of 2008. For analysis we have only considered the 11 pure-play cement manufacturers and have excluded diversified companies such as Grasim, Century Textiles, Jaiprakash Associates, Dalmia Cement and Shree Cement among others.
The recent behaviour of cement stocks is in complete contrast to their movement in the previous rallies. As the chart shows, in the past, cement stocks were at the forefront of the rally and enjoyed high price to earning multiples. In that sense, cement stocks acted like other high beta (read market sensitive) sectors like metals, banking and real estate. There is an economic basis for this. Cement is an essential building material with no real substitutes. Faster economic growth means more construction of houses, offices and factories, which in turn means greater demand for cement. So the financial fortunes of cement firms closely mirrors the level of economic activity in the country.
Given this, what should investors take away from the recent behaviour of the cement stocks? One thing is clear, there has been no slack in the demand for cement as visible in the chart where we have also plotted the growth in cement despatches on annualised basis. In fact the demand growth seems to have accelerated in the last few quarters. The stock market, it seems, is worried about the pricing power of cement firms. This is important because given the high fixed cost of cement production -power & fuel, raw materials, outward freight, interest and depreciation -firms profitability is largely driven by prices rather than volumes. And given the spate of capacity additions in recent quarters, many experts believe that a price war is imminent in the industry as smaller firms fight to maximise their volumes.
However, the industry's financial performance in recent quarters suggests that the fear of a price war is exaggerated. The industry has learnt its lessons and there is a surprising degree of price stability across the country. And many firms reported double-digit improvement in sales realisation in the September '09 quarter. This makes the sector a right choice for those who rue missing the current rally.
At their current price, there is little downside risk given that many firms are available at attractive dividend yields. The only worry is the high debt to equity of many cement firms but that should not worry investors as long as these companies continue to generate copious cash flows from their operations.
With the average price to earning multiple of around 9 times their net profit in last four quarters, cement stocks have never been cheaper except at the height of the meltdown during the last quarter of 2008. For analysis we have only considered the 11 pure-play cement manufacturers and have excluded diversified companies such as Grasim, Century Textiles, Jaiprakash Associates, Dalmia Cement and Shree Cement among others.
The recent behaviour of cement stocks is in complete contrast to their movement in the previous rallies. As the chart shows, in the past, cement stocks were at the forefront of the rally and enjoyed high price to earning multiples. In that sense, cement stocks acted like other high beta (read market sensitive) sectors like metals, banking and real estate. There is an economic basis for this. Cement is an essential building material with no real substitutes. Faster economic growth means more construction of houses, offices and factories, which in turn means greater demand for cement. So the financial fortunes of cement firms closely mirrors the level of economic activity in the country.
Given this, what should investors take away from the recent behaviour of the cement stocks? One thing is clear, there has been no slack in the demand for cement as visible in the chart where we have also plotted the growth in cement despatches on annualised basis. In fact the demand growth seems to have accelerated in the last few quarters. The stock market, it seems, is worried about the pricing power of cement firms. This is important because given the high fixed cost of cement production -power & fuel, raw materials, outward freight, interest and depreciation -firms profitability is largely driven by prices rather than volumes. And given the spate of capacity additions in recent quarters, many experts believe that a price war is imminent in the industry as smaller firms fight to maximise their volumes.
However, the industry's financial performance in recent quarters suggests that the fear of a price war is exaggerated. The industry has learnt its lessons and there is a surprising degree of price stability across the country. And many firms reported double-digit improvement in sales realisation in the September '09 quarter. This makes the sector a right choice for those who rue missing the current rally.
At their current price, there is little downside risk given that many firms are available at attractive dividend yields. The only worry is the high debt to equity of many cement firms but that should not worry investors as long as these companies continue to generate copious cash flows from their operations.
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