Equity: Stock Up On Sectoral Plays

The pre-election euphoria may not be ephemeral. Track the bulls to anticipate where they will strike next. Sectoral picks are your best bets.

Bulls and bears are certainly not like elephants. They have short memories. That, probably, explains why they don't think twice before going overboard about the stockmarket. Right now, in the wake of sustained Foreign Institutional Investor (FII) buying on Dalal Street, the punters are playing for a boom. How ironical! In April, 1999, the mood in the stockmarkets was lacklustre. Today, investment advisors and newsletter-writers-throw a stone anywhere in Mumbai, and you will hit a couple of them-are busy dishing out forecasts on how high the Bombay Stock Exchange (BSE) Sensitivity Index (Sensex) is going to climb in fiscal 1999.

Their estimates range from an over-the-top 5,000 to a more modest 4,000. But, at both ends, the mood is bullish. The stockmarket, they will tell you, is bouncing back. If they are talking sense, it is time for you to head back to the stockmarket, right? Hang on before you dash back. Let us first get the facts straight.

Hot tips for 1999-2000

With the slide on the bourses abating, it may be time to head back to the stockmarkets

Don't plunge blindly into the stockmarket. Be cautious, and pick your stocks carefully

The red-hot sectors to go for are software, pharmaceuticals, and FMCG this year too

Watch out for asset play stocks in sectors like cement, oil, and petrochemicals

For long-term returns, try spotting stocks in new sectors, such as media and telecom

What is really happening to the stockmarket? Where is it headed? As the Sensex crossed 4,000 on May 13, 1999, one thing seemed clear: there could soon be a correction. But rule out a big bust; that is, probably, not going to happen-at least, not till the general elections in September, 1999. Admits Manoj Murarka, 34, Managing Director, Batliwala & Karani: ''I am more bullish than bearish.''

For pointers, look at what the big players are upto. Like any other market, the stockmarket also depends on demand and supply, and players with big bucks make all the difference. The biggest players are the FIIs, and this is what they're doing: Buying. Foreign portfolio managers are increasing allocations of their clients' assets to select Indian equities and, more specifically, the cyclicals. It's a situation where surplus money is chasing select stocks. Explains Fergus Fleming, 32, Managing Director, hsbc Securities: ''At the end of the day, stockmarkets and share values are not a function of fundamental values, but of supply versus demand with respect to particular stocks.''

UB 99 has proved to be the proverbial trigger, though, spurring the FIIs to maintain their inflow of funds into India, at least at last year's levels. Between January 1 and May 6, 1999, the FIIs have been net purchasers of equity to the tune of Rs 2,121 crore ($496.70 million). And the cumulative net inflow may cross the Rs 3,927.13-crore ($9,284 million) peak reached in March 1998. India, although not the hot favourite it was 4 years ago, is, clearly, among the flavours FIIs are going for this year. There is a feeling that if there is going to be an Asian recovery, led by a commodity recovery, it is time to buy emerging markets cyclicals and commodity stocks. So, in April-May, 1999, more than $2 billion has been invested in the emerging markets.

Says Phil J. Roth, 32, a technical analyst on emerging markets at Morgan Stanley Dean Witter: ''India has been in the trading range for years. In the long run, India has big potential.'' Others are bullish too. Credit Suisse First Boston is hot about the Asian region, and its emerging market portfolios are over-weight on Korea and Taiwan, and neutral on Thailand and India. At a time that investment guru Barton Biggs of Morgan Stanley Dean Witter describes as being difficult and dangerous, the emerging markets, in general, should outperform the rest if the rally continues-even though India may only be a near-term winner.

MONEY FROM MONEY

Big boys play with badla. But then, Big Boys plus badla equals Big Returns. Like, 20 per cent-and your money back in 10-odd days. For the uninitiated, vyaj (interest) badla (carry-forward) finances carry-forward trades (a device that enables a buyer of shares on the stockmarket to settle a transaction without taking delivery of the purchase). Indeed, Vyaj badla has averaged a return of 17.50 per cent in 1998-99, the risk of default is low, and it is liquid within a fortnight. Says Ajit Surana, 38, Director, Dimensional Securities: ''It is an excellent avenue for parking both short- and long-term funds at variable rates of interest.'' Adds Amit Rathi, 25, Director, Anand Rathi Securities: ''In weeks when outstandings are high, you can earn as much as 30 per cent.''

What about risk? For one, the values of the 2 legs of the deal-the buy and the sell-are decided up-front. Moreover, the bourse takes care of the settlement risk: trades are settled through its normal clearing mechanisms, and securities are insured and held by its clearing house. There is even a guarantee against default in the sale leg by the bourse's trade guarantee fund. However, there is one note of caution. Warns Vijay Venkatram, 32, Manager (Private Banking, India), HSBC: ''The only risk, if at all, is the default of the financier's broker. In that event, the client, or the investor, gets the underlying shares from the clearing house, and is exposed to market and bad-delivery risks.'' Big Boys should know their brokers well.

What is it that makes the FIIs bullish? Surely, it isn't how corporate India will perform this year? After all, a cross-section of analysts that BT spoke to tend to be unequivocal about one expectation: only marginally-improved corporate profits in 1999-2000. So, don't expect to wish away the recession. Plus, there will certainly be the impact of the increase in the corporate tax. Calculates Rajshekar Iyer, 40, Head of Research, Kotak Securities: ''The increase in the tax-rate from 35 to 38.50 per cent will probably lower the fiscal 1999 earnings estimate of the 30 Sensex stocks by about 3 to 3.50 per cent.''

Yet, trackers expect earnings to fare better in some sectors. A close look at last year's corporate results will tell you why. A UTI Securities study of 29 large non-finance companies showed that earnings-growth in the infotech, pharmaceuticals, and FMCG sectors was maintained last year. With no major changes in the fundamentals for these sectors, you can expect them to perform well again this year. Which is bound to be reflected in the market's movements. Predicts Rukhshad Shroff, 29, Strategist, Jardine Fleming Broking: ''A mix of some growth companies in FMCG and software, some exposure to rural plays benefiting from a strong agricultural economy, and some commodity cyclicals will be ideal.''

The bulls will also sniff around for signs of a revival. Some corporate results are encouraging. Some economists are upgrading their external sector forecasts, since exports growth has turned positive since November, 1998, and is gaining momentum. The Centre for Monitoring the Indian Economy expects the cement industry to post a growth of at least 6 per cent in fiscal 1999. In February, 1999, car sales were up 3 per cent, but it is too early to predict an upturn. For utility vehicles, sales were down by between 2 and 3 per cent. So, the uncertainty remains.

There is also the usual set of imponderables. Will the monsoons be good this year? Will there be a stable government at the Centre after Elections 99? Opines Anup Maheswari, 28, Assistant Vice-President, DSP Merrill Lynch Asset Management: ''There may not be the immediate tangible signs of a recovery but, given the huge borrowings programme of the government, we need to track how it spends, and whether or not that will translate into substantial change.'' Adds Ajit Surana, 38, Director, Dimensional Securities: ''Markets are like a game of snakes-and-ladders. Even if the valuations are attractive, no one has the confidence in the economy because the political uncertainty remains.''

TREND-BUSTER PLAYS. So, as a savvy investor prospecting for gains on the stockmarket, what should your strategy be? Don't rush in, for one. Be selective. And remember a basic tenet: the indices may move up or down, but buying some stocks in some sectors could fetch you at least 25 per cent returns. Start by making a wish-list of stocks, and the prices you're willing to pay.

Going by their performance in the last few months, the list should include stocks in sectors like infotech, pharmaceuticals, and FMCGs. While these stocks may have another good year ahead, they are already high-priced. So, don't expect bargains. Says Amit Rathi, 25, Director, Anand Rathi Securities: ''No one has a choice today but to invest in sectors which have become defensive. Given the state of the economy, there is no gain in desperately being a contrarian in this market.''

Quite right. Stocks of these 3 sectors account for 60 per cent of the Sensex's market capitalisation today. Just 2 years ago, that position was enjoyed by the core sectors, such as steel, cement, and textiles. Adds Kotak Securities' Iyer: ''About 70 per cent of the market capitalisation of the BSE is residing in such companies, where you will see reasonable growth.'' Remember two things when you target these sectors: they aren't overly dependent on the government's policy-changes, and are relatively recession-proof.

Prices may be high, with multiples ranging from 36 times for ITC to 74 times for Infosys Technologies, but stocks in these sectors are a must if you are a long-term player. For, the growth in these businesses tends to outpace the economy. Points out Sanjeev Mohta, 33, Director & Head of Research, HSBC Securities: ''Software and pharmaceuticals have been recognised as priority areas, giving them a sentiment boost.'' As for consumer non-durables, growth is ensured by strong demand from the farm and services sectors. Rationalises investment analyst Deepak Mohoni, 44: ''If the rally is expected to continue, these stocks aren't likely to stop rising. And if the rally gets scuttled, they will fall, but not as much as the laggards.'' So, whichever way the market goes, your infotech picks will remain winners.

If you're wondering by now if the market is only about FMCG, pharmaceuticals, and infotech-and nothing else matters, our apologies. It is only that these are the hottest sectors, hogging the limelight and delivering a high return. But don't overlook the opportunities elsewhere in the market. At the bottom end, for instance. According to Anup Maheshwari, 28, Assistant Vice-President, DSP Merrill Lynch Asset Management, ''at the lower end, there are stories emerging where the prices have gone to rock-bottom levels. And if there is some positive news on the economic front, money will start moving into these areas.''

ASSET PLAYS. As corporate India grapples with increasing competitive pressure, new opportunities are constantly being thrown up for the investor. Companies emerge fitter and leaner after restructuring. And their stocks often become more attractive for investment. Last year, when the Tata Group's Voltas got out of businesses that were a drag on its bottomline, the payback came quickly: investors got high returns on their investments. Says Sanjay Agarwal, 32, CEO, EuroAsian Securities: ''We feel that an emerging theme this year could be the restructuring of companies. As managements adopt to the globalised environment, this could throw up interesting opportunities.''

Perk up your antennae when you see companies and industrial groups begin to hive off businesses or restructure. M&As will be the new theme for investment strategies during this year. At least one mutual fund is being launched to specifically target such stocks. Given UB 99's tax-incentives for restructuring, many more may be round the corner. Predicts Narendra Nagpal, 32, Head of Research, UTI Securities: ''We expect heightened activity in M&As. And that is positive for stock-prices, particularly asset-plays.''

Manufacturing sectors will be in the forefront because that is where much of the restructuring is happening. Watch out for the cement, steel, chemicals, and petrochemicals industries. Last year, the cement industry was centre-stage, with a number of acquisitions by players like Grasim Cements, Gujarat Ambuja Cement, Larsen & Toubro, and India Cements. Now, global giants are eyeing the Indian markets. For instance, the acquisition of TISCO's cement division by French major Lafarge would have improved the former's valuations if it were not for the bad steel market.

Expect more such deals, and spot the winners: companies that emerge stronger after selling out divisions, or those that improve their economies of scale by acquiring capacities. According to Dimensional Research's Surana, refinery stocks like Bharat Petroleum and Hindustan Petroleum-quoting at price-earnings of 4 and 4.8 times, respectively-are asset-plays, market-plays, and value-plays all together. Says he: ''They are cheap and, at these levels, nothing could go wrong with them.'' Also attractive are the Public Sector Units (PSUs) that are ready for strategic plays like IBP, BML, and CMC.

MEDIA & TELECOM PLAYS. Watch out this year for some other kind of action as well. Media stocks are hot once again. With the shake-out settling down, the focus is on possible winners like Zee Telefilms. Extrapolates Vijay Baoney, 30, Analyst, Jardine Fleming: ''Given the 20 to 25 per cent growth in the adspend of Indian corporates, we are positive on media software companies.'' Don't forget, companies like Zee Telefilms will also benefit from UB 99's tax-sops for exports of TV software.

However, in the short term, there are risks associated with this stock because of a contingent tax-liability of Rs 55 crore on account of its sale of software to ATL (Hong Kong), which is not deemed as exports. If Zee has to pay this amount, it will erode the net worth of the company by 25 per cent. The focus is on other sunrise sectors too. Suggests Nikesh Shah, 30, Head of Research, Triumph International Finance: ''The market could also look at new ideas such as telecom, where growth is expected to ride the infotech boom.'' He particularly likes stocks like Global Telesystems in this sector, but other stocks, like Tata Telecom, Vindhya Telelinks, and Himachal Futuristic, have also started moving up.

Try cashing in on the World Cup Cricket fever too. That could boost CTV sales, making consumer electronics companies attractive buys. Shankar Sharma, 37, Director, First Global Finance finds Mirc Electronics (the owner of the Onida brand) attractive. Says he: ''Onida is, clearly, set to ride the boom in CTV sales in the rural market, where the transnational brands are absent.'' The scrip's market cap is Rs 140 crore, and it is available at just 1.30 times its fiscal 1999 book value and 5.40 times its earnings. Other such picks include BPL and Indo Matsushita.

SMALL- & MEDIUM-CAP PLAYS. Between 1996 and 1998, as the indices flirted with the bulls and the bears, there was outright carnage in a large number of stocks; medium- and small-cap, in particular. For instance, United Phosphorus and Alembic Glass. Skittish investors had gravitated towards the largest, best-known, and, presumably, safest names. As money poured into only a small number of larger companies, small companies' stock-prices languished.

Since large-cap stocks are overvalued, investors with a little more appetite for risk will find better bargains in small- and mid-cap stocks. Agrees DSP Merrill Lynch's Maheshwari: ''Companies with large market caps don't necessarily give you high returns on capital.'' Moreover, the market's momentum is favouring small-cap companies. On an average, in the B-1 group of BSE stocks, the advance-to-decline ratio is around 3:1.

Reasons investment consultant Sanjoy Bhattacharyya, 38: ''Small-cap stocks have been badly-neglected, and that in itself is a good enough reason to look at them.'' In his view, there is a large number of small-cap companies, with sound management and attractive business niches, that deserve attention. ''Stock-picking has little to do with market cap. It concerns the people who run the business and the intrinsic business, economics.''

He has many supporters. Bharat Shah, 37, Chief Investment Officer, Birla Mutual Fund, follows a strategy of cherry-picking stocks with a basket of attributes-including best management, best business, and reasonable valuations. ''It is irrelevant whether it is a small- or a large-cap stock, or whether it belongs to a particular sector,'' says Shah. When you are looking at investing in companies where the current market cap is small, the long-term rewards can be disproportionately high once the market discovers the stock.

But there is also a risk of liquidity, and of these stocks staying cheap for a long time. Management quality is the single-most important factor, which includes the management's power to manage innovation, change, and knowledge. And high management quality would include high competence and high ethics. Since all of this is in the realm of intangibles, that is what makes it difficult to quantify.

Don't let small-cap stocks confuse you. You must try and differentiate between the potential winners, which could grow into tomorrow's giants, and the hopeless laggards, who could remain small forever. It is a tough nut to crack, though. Take a random sprinkling of small stocks: Navnit Publications, Mirza Tanners, Zodiac Clothing, Bausch & Lomb, and Amara Raja Batteries. You can't routinely spot a 4- or a 6-bagger, can you? Unless, of course, it belongs to the golden triangle of software, pharmaceuticals, and infotech.

Small company stocks are fraught with risks, but for some die-hard small-cap investors like Bhattacharyya, searching through the rubble is a risk worth taking. Suggests Paresh Kandwala, 42, Director, Kandwala Securities: ''Investors should know how to take back their capital investment when sailing along with the market.'' Kandwala's strategy is zero-cost investment: book at least 75 per cent of the profits when the stock price moves up, and, thereby, retain 25 per cent of the stock at zero-cost, which works well.

Whether you use return on capital or any other analytical tool, the message is the same: in this market, if you have to make money, you have to do so stock by stock. So, invest in stocks-not in the stockmarkets. And remember, when you are playing the Indian stockmarket, you can't afford Warren Buffett's luxury of investing in stocks-and forgetting about them. Here, you have got to keep a close watch on them, and see what is happening to your money. If you are prepared to do that, go join the dance of the bulls.

LOGGING INTO INFOTECH 2000

What's the best time to buy software stocks? ''Three in the afternoon on Monday in the week of Thanksgiving Day,'' wrote Forbes columnist Michael Gianturco, in his book, Market That Beats The Market. No one really knows why it happens, but the winter rally has proved a reliable play on Wall Street. Comments Ajit Changude, 30, Analyst, Anand Rathi Securities: ''Between April and November, software stocks move in a narrow range, and then rally hard.'' But such tricks of the trade are for later. First, ask a simple question: are software stocks worth it? For one, aren't they mighty expensive? Price-to-earnings multiples in the software industry average at 50-that's nearly 4 times the stockmarket's average multiple of 14.

Are stocks, therefore, avoidable? Doomsayers are already predicting a bust. As the Bombay Stock Exchange Sensitivity Index seesawed, software stocks slipped in April, 1999, by about 20 per cent from the peak levels in March, 1999. Says Shankar Sharma, 37, Director, First Global Finance: ''It is difficult to justify a 67-70 times book value for Wipro and 90 times Price-Earnings Ratio for Infosys Technologies. They are good companies, but unless one is missing something really huge in their earning streams, these levels don't make sense.''Of course, back in 1996, if you had bought 100 shares of Infosys for Rs 17,700, your investment today would be worth Rs 7,32,600. But few did. Most investors caught the software bus much later.

Still, it is true that the rapid growth of the industry has produced outstanding stocks. Also, for every star like Infosys or NIIT, there are scores of second-tier stocks that did well. More important, they aren't over-valued. But the burning question is whether software has played out its bull run. It's easy to get mislead. Analysts cite the US experience. Despite 100 per cent-plus growth rates in the last 4-6 quarters, US infotech stocks are now at their yearly lows. The reason: many of the companies are too dependent on Y2K solutions-a business that is bound to peter out this year. Does the same logic hold for Indian software stocks? Some analysts expect the trend in US markets to hit Indian companies. Says First Global's Sharma: ''Our guess is that the risk-reward equation is stacked way against you in most Indian infotech stocks.''

You could do the smart thing and pick companies that are not over-dependent on Y2K solutions. Yet, the bottomline is that software stocks don't come cheap. And it isn't easy to apply the ''value investing'' principle espoused by investment guru Benjamin Graham: ''Buy stocks at prices below their book values.'' If you applied that principle, you would end up buying none.

TWO HOT GROWTH PILLS

Like infotech, pharma and fast-moving consumer goods (FMCG) are the other hot sectors that punters today are crazy about. Pharma stocks are particular favourites because pharmaceutical companies can generate growth in any economic climate. In the US, the pharma sector has consistently generated the highest return on assets for the past 2 decades. That trend is showing up in the Indian market too. As incomes rise, consumers spend more on healthcare. Small wonder, then, that top pharma stocks-particularly of transnationals-are trading at high multiples (70 plus). Says R. Sukumar, 34, Fund Manager, Kothari Pioneer Mutual Fund: ''With earnings growing because of better fundamentals, prices should rise enough for investors to get annual returns of 20 per cent-plus over the next 5 years.''

Add to that good demand for pharma stocks and the fact that global pharma companies are not expected to expand capital. But take a cue from what some big investors are doing. Several foreign institutional investors are balancing their pharma portfolios by picking the next rung of stocks-Indian companies like Ranbaxy Laboratories, Dr Reddy's Laboratories, and Wockhardt. One good reason to park your money in Indian pharma stocks is that they are cheaper.The third of the hottest sectors-FMCG-has been in the forefront of the market's recent rally. FMCG companies are relatively immune to business cycles. That helps them keep their growth engines sputtering. But with price-earning ratios going up to 60, their stocks aren't cheap. Are they worth it?

Big investors say yes. Reassures Ravi Mehrotra, 35, Chief Investment Officer, Kothari Pioneer Mutual Fund: ''These companies always look expensive. But future projections for the sector are promising because current stock prices are yet to fully take into account the true potential.'' If you still feel that the prices are too high, go for the second-rung, smaller brands like Marico Industries, Pidilite Industries, Indo-National, and Godfrey Phillips. They are cheaper, but have the same potential.

No prizes for guessing why everyone is so bullish about the FMCG sector. Personal incomes and, therefore, purchasing power, of the 475 million-strong consuming class are growing steadily. That is the potential that the FMCG companies will tap. No wonder all of them are expanding their distribution networks and launching quality products at affordable prices. Projections say revenues will grow at about 15 per cent per annum, and profits by 25-30 per cent. If those figures are right, there is little chance of going wrong with the FMCG stocks.