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Most wanted stocks

R Shree Ram     August 26, 2010

Patience pays, especially when it comes to stocks. Any investor will vouch for this. If you give stock investments enough time to grow, they will churn out bountiful returns. But patience alone isn't enough. You also need solid research and analysis to pick the right stocks.

However, most retail investors skip these crucial steps of the investing process and leapfrog into the final stage, basing their purchases on 'hot tips' from friends, colleagues and brokers. Result: they often buy high and sell low, the opposite of what investment gurus advise. Doing your own research is the best way out. But this is easier said than done.

There are 5,287 companies listed on the Indian stock exchanges. Sifting through brokerage reports on these stocks or poring over their balance sheets is not the best way to spend a weekend. Thankfully, there is a smarter way. Find out what the best minds on Dalal Street are buying and follow in their footsteps.

The 404 equity mutual funds in the country have invested roughly Rs 1.97 lakh crore in stocks. Each mutual fund has an army of equity analysts, which puts companies under the financial equivalent of an MRI scanner. Every strength is closely inspected, every weakness is studied in detail.

Opportunities are explored, threats are scrutinised. Only when a company is found fit is the investment team given the go ahead. Don't take our word for it. In the past one year, the Sensex has risen 25.65%, while the average diversified equity fund has climbed 38.42%.

Clearly, fund managers know what they are doing. For you and me, it means that we can rarely go wrong when we buy stocks in which these financial whiz kids invest. Following in the footsteps of smart money, however, is not as simple as it seems. Yes, mutual funds are choosy, but the universe they invest in is vast.

The latest data on mutual fund holdings shows that they hold shares of 705 companies. It's a heady mix of large-caps, mid-caps and small-caps. What do you buy? this is where our cover story will come in handy. money today teamed up with value research to conduct a comprehensive study of mutual fund portfolios and identify the stocks most wanted by fund managers.

However, a simple aggregation of the portfolios of all mutual funds yielded predictable results. reliance industries was at the top, followed by the software giant infosys, financial powerhouse sbi and private sector major icici bank. the bigger problem was the distorted picture that such a listing gave. bharti airtel is the eleventh most widely held stock by funds.

However, the funds were busy trying to get rid of the bharti shares in the past year rather than add more. the number of bharti shares held by funds has come down from 20.56 crore (adjusted for split in july 2009) in may 2009 to 9.86 crore in may 2010. while these blue-chips were widely held, some were not really the most wanted (see story on page 40).

Playing it safe with equity assets worth rs 1.97 lakh crore under their management, fund managers would want to play safe. they have parked around 37% of the funds in indexbased blue-chip stocks. This ensures that the navs do not drop below acceptable levels. "no fund manager will be criticised for buying an infosys or an icici bank," says value research CEO dhirendra kumar. even in the worst case scenario of a market meltdown, the returns will closely track the broader market indices.

The top 10 stocks held by mutual funds (by value) figure in both the sensex and the nifty. Investments in these 10 stocks add up to 21% of the total equity assets of the industry. even here, fund managers have been very choosy. in the past five years, the nifty has delivered an annualised return of 19%, while the top 10 stocks registered an average growth of 25%. in the past three years, the nifty grew by 7% per year, while the fund managers' top 10 picks grew by 14%. if you seek stable growth, pick stocks from this list.

Finding the next infosys is the ultimate dream of any stock investor, the holy grail of investing. but these top 10 stocks are already richly valued, commanding an average price multiple of over 24 times their 2009-10 earnings per share (eps). This is at a premium to the BSE-500 index, which is trading at 20 times. For better returns, investors need to look beyond the top 10 list. to do this, we tweaked the study to look at stocks in which mutual funds had consistently increased their exposure in the past one year (may 2009 to may 2010).

From the total 705 stocks, we were left with a more manageable 34 scrips, comprising 12 large-caps, 15 mid-caps and 7 small-cap stocks. large-cap stocks the 12 large-cap stocks, in which fund managers have consistently increased their exposure in the past one year, account for almost 7% of the total equity assets of the mutual fund industry. As on 31 may 2010, funds had allocated a gargantuan rs 14,456 crore to these stocks.

It is interesting to note that fund managers are betting on companies that have just come out of the earnings slowdown. seven of the 12 companies saw a strain on their finances during the past couple of years due to the economic slowdown, acquisition costs, operational difficulties or government regulations. as these companies went through a painful business reorganisation, their stocks lagged the broader market. However, with the economy back on track, these companies started witnessing robust sales. This made the fund managers lap up more of these stocks.

The 12 large-cap stocks, in which fund managers have consistently increased their exposure in the past one year, account for almost 7% of the total equity assets of the mutual fund industry. As on 31 May 2010, funds had allocated a gargantuan Rs 14,456 crore to these stocks. It is interesting to note that fund managers are betting on companies that have just come out of the earnings slowdown. Seven of the 12 companies saw a strain on their finances during the past couple of years due to the economic slowdown, acquisition costs, operational difficulties or government regulations. As these companies went through a painful business reorganisation, their stocks lagged the broader market.

However, with the economy back on track, these companies started witnessing robust sales. This made the fund managers lap up more of these stocks. A case in point is Ashok Leyland. As the industrial activity picked up, fund managers rightly guessed the demand for commercial vehicles and bought more Ashok Leyland stock. Their holding in this company has gone up from 205 lakh shares in May 2009 to 669 lakh shares now, a jump of 226% in one year. The company was struggling to sustain sales in 2008.

At the height of the economic slowdown in 2007-8, its EPS dropped from Rs 3.50 to Rs 1.40, a fall of 59%. However, sharp economic recovery helped the company improve its operational performance. By 2009-10, the company was back on track, reporting a 122% jump in EPS. In line with improving business activity the company reported a 140% surge in fourth quarter volumes (Jan-March), which led to a 21% growth in sales from last year. Its EBITDA margin of 12.9% (Jan-March quarter), is the best in six years.

With the commercial vehicle cycle clearly on an uptrend, analysts are pencilling a double digit growth in the company's sales for the next two years. "We raise 2010-11 EPS estimate by 45% and 2011-12 by 55% to reflect good CV demand outlook," says Anand Rathi. The research house expects the company to report a 30% rise in sales in 2010-11. Glenmark Pharmaceuticals is another stock that has seen a substantial rise in fund managers' interest. From 21.8 lakh shares in May 2009 to 1.08 crore shares in May 2010, fund managers have increased their stake by five times. The stock has been underperforming due to a series of setbacks on the research front.

The company was not able to sign substantial out-licensing deals for around two years. However, the recent Rs 1,447 crore out-licensing deal with Sanofi Aventis has come as a breather for investors. "In spite of the earlier disappointments, we remain confident about Glenmark's future prospects, both in relation to the scaled-up potential of its core generic businesses and its ability to monetise and extract value from its R&D assets," says Sharekhan. Glenmark's current portfolio consists of 55 products authorised for distribution in the US. With a valuation of 14 times the 2010-11 estimated earnings, the stock is currently trading at a discount to the sector.

With the business environment improving, analysts expect the company to register an average EPS growth of over 30% in the next two years. If the improving business environment made Ashok Leyland and Glenmark stocks attractive, smoothening out acquisition hiccups, business restructuring and improving profitability have raised fund managers' interest in Tata Motors and Dr Reddy's Labs.

Four years ago, Dr Reddy's had acquired Betapharm for Rs 2,250 crore. While the acquisition helped it access the German market, the subsequent regulatory and integration issues were a drag on its finances. Soon after the acquisition, the German market shifted to the tender-based model, making it difficult for the company to sustain sales. The company's revenues from the German market dropped 26% from Rs 985 crore in 2008-9 to Rs 730 crore in 2009-10. Subsequently, integration issues and erosion in market value of Betapharm plunged the company into losses.

Due to the re-valuation of Betapharm and low revenues, Dr Reddy's incurred a loss of Rs 917 crore in 2008-9. However, by early 2010, the acquisition issues smoothened out and the company returned to profits in the January-March 2010 quarter. For the entire 2009-10, it booked profits worth Rs 351 crore.

Angel Broking estimates Dr Reddy's Labs to see a sales growth of over 19% in the next two years. This is expected to boost the EPS to Rs 78 by 2011-12 from Rs 20.10 in 2009-10. Based on the current market price the estimated EPS works out to a PE multiple of around 15 times the 2011-12 estimated earnings. "We remain positive on the company on account of the robust growth likely in the US business, the alliance with GlaxoSmithKline, which is expected to start bearing fruit from 2010-11 onwards by providing Dr Reddy's access to newer markets, an up-tick in the domestic formulation business through the launch of biosimilars and chronic segment products and improving return ratios," says a report by Angel Broking.

Tata Motors is another stock that has caught the fancy of fund managers due to a turnaround in operations. Easing liquidity conditions and improving sales at JLR helped the company turn profitable in the last quarter of the previous financial year. The company reported a net profit of Rs 2,516 crore for 2009-10, against a loss of Rs 2,465 crore in 2008-9.

The income went up by 30% to Rs 92,519 crore, compared with Rs 70,370 crore in 2008-9. The high sales volumes turned the UK-based unit profitable in the January-March quarter. As the carmaker reduced its debt burden to around Rs 18,800 crore from Rs 23,750 crore, fund managers increased their exposure to the stock. From 86 lakh shares in May 2009, mutual funds increased their stake in the company to 1.44 crore shares. "We believe that the stock is currently undervalued given the recovery of JLR's profitability.

The key growth triggers for Tata Motors in the future are domestic CV volumes growth, margin expansion in domestic business and decrease in leverage to strengthen the balance sheet position. We maintain a buy rating on the stock," says IIFL. Financial services is the hottest sector for mutual funds, accounting for 18.36% of the total equity assets. HDFC is the only blue-chip stock that was consistently bought by the fund managers over the past one year. This is due to its consistent growth in earnings and dividend payout history. HDFC has pleasantly surprised the investors by reporting a 23% rise in the April-June net profits.

The company reported a robust growth in approvals as well as disbursements for individual loans, which is visible through the 17% growth in the loan book. Other financial stocks include Allahabad Bank, LIC Housing Finance and Shriram Transport Finance. There are two entertainment stocks as well. Zee TV has gone through restructuring and has bought six regional entertainment channels from Zee News.

This helped the company promote its channel more aggressively and improve the margins. During 2009-10, the regional entertainment channels generated a revenue of Rs 404 crore and an EBITDA of Rs 126 crore. This translates to an EBITDA margin of 31.2%, higher than that of standalone Zee TV. Analysts say the acquisition will enhance the earnings of the company.

Another aspect that worked in favour of these two stocks is the improving ad revenue and growing viewership. Despite intense competition from sports programmes and other Hindi networks, Zee TV continues to dominate the hindi general entertainment space with a share of 20%. It has maintained its dominance on the weekly rating charts with an average of 19 shows in the top 100 programmes. It also kept programming and operating costs under control. as a percentage of revenue, these costs came down to 40.1% in the January-March period from 43.4% in the December quarter.

-with Sameer Bhardwaj


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