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The picks of the bull

The great India market story has returned to its booming ways. Stocks are making new highs, but there are enough places where you can still spot a good stock.

A few months ago, the stock markets faced a major hurdle and not many were willing to wager that the Sensex would cross the 15,500 mark in four months. But the great Indian market story has returned to its booming ways. The Sensex raced to an all-time high of 15,683 last week-a 19 per cent return since its March lows.

The optimism has percolated down to the mid- and small-cap stocks, including the micro-cap stocks. Both the BSE's mid- and small-cap indices have increased 26 per cent since March, outperforming the Sensex by 700 basis points. Major IPOs that hit the market have sailed through. In short, this has been one of the most exciting periods of the market.

Now, market watchers say, market valuations have got back to the fair to high levels. With the stock market expected to clock an EPS growth of around Rs 840 in 2007-08, the one-year forward earnings stands at 18.5 times. On a historical basis, the valuations have topped 22 times earnings, which is still lower than 22.76 hit in the month of December 2006. Says Lalit Thakkar, Director (Research), Angel Broking: "We are definitely near the high range.

But we are looking at a GDP growth of 8-9 per cent and reducing long-term interest rate scenario. If you factor these in, the market's at fair valuation." But over the long haul, the stock market still trades at comfortable levels. Says R. Sreesankar, Head (Research), IL&FS Investsmart: "I continue to believe that there's enough momentum. If the earnings growth is good at 20 per cent, we are looking at a p-e of 14 one year from now. If it continues for another year, we get a valuation of around 11 times two years from now."

A few months ago, the stock markets faced a major hurdle and not many were willing to wager that the Sensex would cross the 15,500 mark in four months. But the great Indian market story has returned to its booming ways. The Sensex raced to an all-time high of 15,683 last week-a 19 per cent return since its March lows. The optimism has percolated down to the mid- and small-cap stocks, including the micro-cap stocks. Both the BSE's mid- and small-cap indices have increased 26 per cent since March, outperforming the Sensex by 700 basis points. Major IPOs that hit the market have sailed through. In short, this has been one of the most exciting periods of the market.

Now, market watchers say, market valuations have got back to the fair to high levels. With the stock market expected to clock an EPS growth of around Rs 840 in 2007-08, the one-year forward earnings stands at 18.5 times. On a historical basis, the valuations have topped 22 times earnings, which is still lower than 22.76 hit in the month of December 2006.

 

Says Lalit Thakkar, Director (Research), Angel Broking: "We are definitely near the high range. But we are looking at a GDP growth of 8-9 per cent and reducing long-term interest rate scenario. If you factor these in, the market's at fair valuation." But over the long haul, the stock market still trades at comfortable levels. Says R. Sreesankar, Head (Research), IL&FS Investsmart: "I continue to believe that there's enough momentum. If the earnings growth is good at 20 per cent, we are looking at a p-e of 14 one year from now. If it continues for another year, we get a valuation of around 11 times two years from now."

Perhaps this market is vulnerable to a small correction or a major sell-off if the quarterlies are below expectations, or if there's an unwinding of the derivative positions. But, reckons Sreesankar, if you are a long-term investor, "it does not matter if you get in a 15,600 or 13,500. It does not make much difference to your returns." As of now, the writing on the wall pretells a favourable bull market. Market watchers are looking into the future and also forecasting the 2008-09 numbers. Only if the market still continues to run away should investors tread with caution and buy selectively. Says R. Rajagopal, Head (Equities), DBS Cholamandalam Mutual Fund: "If the p-e ratio goes over the growth rate, then it will begin to look worrisome. As of now, I am still comfortable with the valuations."

Look Long

Investors in the market, however, may want to consider their investing horizon. As of now, the market has moved out of the cheap and attractive valuation zone to the higher trajectory trading zone. For now, investors must look at a much longer horizon while investing in stocks. Says Shah: "In the short term traders take a view, but in the long term investors take a view. This market is an investor's market now." Shah reckons that if you are looking at the market from an 18-24 month perspective, you should do fairly well for yourself. "You are not buying undervaluation now, you are buying growth," he says. "There are always times in the market when stock pickers can find bargains."

Investing in this market also entails looking at the growth stocks that are priced reasonably. Much of the smart money will be chasing companies with good valuations and scalable businesses in the next leg of the bull market. When the market declines-if they do-the companies with lower valuations could fall, and that will act as a cushion on the downside. On the other hand, it's possible that such stocks continue to climb, and there's a high possibility of such stocks or sectors getting re-rated. Look for companies that can scale up their operations in a big way over the next couple of years.

The Small and Undervalued

There's plenty of scope for the markets, and equally for compelling stock ideas. One must, however, invest in a staggered manner and whenever there's a correction, investors should grab the opportunity to increase allocations.

 
R. Sreesankar
R. Sreesankar
R. Sreesankar
Head (Research)/ IL&FS:
"If the earnings growth is good at 20 per cent, we are looking at a P-E of 14 one year from now"
For most investors, the small stocks story could be their best bet.

A recent study by Morgan Stanley India, Wealth Creators: The Story and Beyond, says that micro-caps or the bottom percentile of market cap were the best performing stocks, while the mega caps delivered the worst returns over the past decade. Says Desai: "Micro caps have delivered the best returns and investors can look at some of these stocks." The report further adds: "As investors look to pick the best stocks for the coming decade, the historical evidence would suggest that they should focus on small companies with strong earnings growth prospects and companies whose stocks are trading at throwaway valuations."

Look for investing themes in the market. The domestic growth will propel sectors such as power, consumption, banking, infrastructure, construction, etc., over the next couple of years. However, some of the stocks in these sectors are highly priced and their valuations are discounting the next three years' earnings.

Investors should also be aware that such high valued stocks could have a capped upside and therefore subject to a bigger correction if the markets tend to taper off.

Among the foremost sectors where there's rich valuations and good growth ahead is the financial sector. Many brokerage houses and fund managers are extremely bullish on this sector and even for long-term investors, market analysts are recommending an investment of up to 25 per cent in the financial stocks. In the financial sector, the PSU banks score over the private sector banks on the valuation and attractive price to book values. Stocks like State Bank of India and Oriental Bank of Commerce make attractive investments.

On the other hand, even the private sector banks will see a good growth ahead, but their valuations are nearly three times higher so there's not much of a valuation cushion. The PSU banks' comparative advantage over the private banking players-many of which are trading at higher valuations-isn't likely to falter anytime soon, say market analysts. "If the Indian economy is going to grow, then the banking industry has to grow faster. And the valuations of PSU banks are extremely attractive," says Thakkar.

The Bulls are Dancing

The stock market still offers plenty of opportunity, depending on where you look. 

Ridham Desai
Ridham Desai


The Markets Today...

Markets have zoomed to their all-time high and the momentum looks strong enough to continue. Foreign funds are flowing in and major stock indices are booming. Small and mid-cap indices have outperformed the major Sensex by 700 basis points since March this year

... Are at fair valuations

Forward valuations are still reasonable and stocks are expected to do well over the long haul. The Sensex is trading at a historical P-E of 22.2 and a forward P-E of 18.5.
Rashesh Shah
Rashesh Shah


 With the profit growth rates expected to remain high at 20 per cent, the price earnings to growth multiple still looks reasonable at 0.9 times

Look for themes 

Power equipment, capital goods, construction and infrastructure segments are all poised to take this market forward. The financial sector-especially PSU banks-are extremely undervalued compared to their potential. Look for growth, and buy more on a correction
 
The power equipment, construction and the capital goods sector have a strong growth ahead. Companies such as Reliance Energy are building good order book positions in their EPC businesses. There's a huge allocation in the power sector towards, generation, transmission and distribution. Many power equipment companies manufacturing distribution towers and transformers, too, have good prospects. Besides, the manufacturing sector can see a surge in growth since India has cost advantage on the labour front.

Lalit Thakkar
Lalit Thakkar

The real estate developers who have a big pipeline of developable projects over the next three years should also benefit in this booming market. Many strategists who are bullish on the industry say that the developer business has become big in scope and there are plenty of growth opportunities. Companies like Parsvnath are well poised to capture this growth. Other companies with a significant upside potential include Tata Steel.

The steel cycle is expected to stay buoyant over the next couple of years, and as global synergies play out with Corus, the company is only likely to get stronger. Besides, with big discoveries expected in the gas business over the next couple of years, distributors like Gujarat Gas could get a leg-up.