The Leading Industries

Your search for the most rewarding stocks should start with the most favoured industries because the strongest industries often produce the best stocks.

By Devangshu Datta | Print Edition: December 28, 2006

India is a "bottom-up" stock market and that has nothing to do with the drinking habits of Indian investors. It means that day traders and fund managers focus on specific stocks; not on sectors or macro-economic variables.

Successful Indian businesses have always been "desert flowers" - companies, which delivered under adverse circumstances. This is because Indian policy-making and implementation has historically been poor.

The bottom-up approach is also driven by genuine concerns about the honesty and competence of managements in an environment where corporate governance is a new, little-understood concept.

However, whatever the focus of investors, any company by definition, runs a business. So, stocks can be classified and segmented into industrial sectors. And, if the macro-economic variables favour certain sectors, those will generate higher profits than the corporate economy at large.

Highly profitable companies are unevenly distributed - they are concentrated in sectors where things are going right. Hence, the smart money flows into sectors that are in the sweet spot.

This makes it possible to use a "top-down" approach - examine investments across sectors and focus on those that are attracting
more smart money. Some small investors do this in a haphazard way.

In our study, listed stocks have been classified into 15 broad industries. We have tracked diversified equity fund flows into these on a month-by-month basis in percentage terms. Our logic: sectors, which attract higher fund inflows, have something going for them. In other words, these sectors are "hot".

In fact, the table below is organised on the basis of sector "temperature" with sectors classified as hot and cold according to the percentage of fund exposure. An investor is less likely to find a "desert flower" in "cold" sectors. Perhaps the most interesting are the sectors which are "warming up" - one where fund exposures have increased over the past year.

India's most-wanted stocks
India's most-wanted stocks

These 15 sectors are not equal in size so it is simplistic to expect even distribution of investments. For example, there are only a few listed companies in consumer durables (the coldest) while energy (which includes both power and oil and gas) has by far the largest aggregate revenues.

Even keeping that in mind, the funds have been consistently overweight in technology, engineering and financial services. They are noticeably underweight in textiles and consumer durables. The aversion to consumer durables is understandable on the grounds that most industry leaders are unlisted. In textiles, there is consensus that macro-factors are unfavourable. In most other sectors, holdings haven't shifted too much - which implies that macro-factors haven't changed much either. Obviously technology, engineering and financial services are hottest, with over 35% of total corpus allocated between them. Engineering has been driven by the great boom in infrastructure spending.

Technology remains a perennial favourite as it is a high-growth, high-profile business. Also, by and large, technology managements have good corporate governance. Financial services has been driven by the focus on retail. Be it credit cards, housing loans, vehicle financing or personal loans.

India's most-wanted stocks
India's most-wanted stocks

Construction is a sector that's becoming hotter by the day. This has been a beneficiary of both the infrastructure boom as well as the real estate bubble. Several stocks have listed here in the recent past and the boom has also started to translate into higher market valuations for mid-sized companies.

Fund holdings have risen from 5% a year ago to nearly 8% by November. Once holdings in Parasvnath (listed in late November) are reflected in fund disclosures and DLF comes through with its long-awaited IPO, exposures will rise again. By January,
2007 we expect this to cross the 10% mark.

Energy is quite likely to become another "hot" sector on the basis of rising allocations and, unlike in construction, the universe of stocks hasn't changed much in energy. Are we stretching logic if we suggest that Cairn Energy will do well on the basis of the rise in energy sector allocations?

If these trends hold, we will see a concentration of 55%-plus of corpus within five sectors soon. That implies that the business cycle is narrowing. Even if the funds employ bottom-up stock-picking methods, their allocations are becoming increasingly sector-specific.

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