Investment tips for crisis times

Ram Prasad Sahu, Jitendra Kumar Gupta in Mumbai

In an uncertain market where stock prices are witnessing a free fall, it is time for investors to rejig their portfolio to limit losses and opt for stocks that offer stability and decent returns.

Among the two key barometers of the Indian equity markets, the Sensex has fallen by more than half from its January 2008 peak of 21,206 points. The gradual decline over the last nine months, and the sharp fall over the last couple of weeks, have eroded a substantial chunk of investor wealth.

With the demand situation not looking good and liquidity problems persisting, investors are clueless as to where the markets would be headed over the next year.

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The Smart Investor spoke to money managers to assess what their outlook on the market is and what strategies one needs to adopt to tackle the meltdown.

The negatives

The main macroeconomic parameters, be it the GDP, interest rates, the fiscal situation, credit growth, the IIP numbers -- all point to a muted phase of growth over the next few quarters. The International Monetary Fund in its World Economic Outlook projections for 2009 has cut India's GDP growth forecasts to 6.9 per cent.

While this is marginally down from the estimated 2008 GDP of 7.2 per cent, it is substantially down from the nearly 9 per cent GDP growth rate experienced in 2007. Compounding this is the fact that advanced economies, which are engines of world consumption, are expected to grow at just 1 per cent in 2009.

Indian manufacturing activity, too, is down with IIP (manufacturing) growth restricted to 4.9 per cent during April-August 2008 (against 10 per cent in the previous corresponding period); it was just 1.3 per cent in August 2008. Credit growth to the consumer durables sector and autos, good indicators of spending trends are hardly encouraging.

While credit for durables has fallen by 33 per cent for the year till June 2008 y-o-y, auto loans have barely moved registering a growth of just 1 per cent in the same period.

India's current account balances too are precarious as compared to China's, which continues to attract investments on top of a huge trade surplus. While FIIs together own only 25 per cent of Indian equity, it is their high ownership of free floating stock that makes it difficult to stop the markets slipping down dramatically when they decide to pull out and which results in a worsening of the current account deficits.

While factors such as fund flows and economic growth are external, elections to state assemblies and to Parliament over the next six months are internal factors which will significantly impact sentiment. Pre-poll uncertainty, a vote-on-account Budget and a delay in investment and policy decisions mean that positive cues may emerge only in the third quarter of 2009.

The positives

However, all the information is not negative. Inflation, which has been responsible for the monetary policy tightening and subsequent rise in interest rates, and which has also brought spending and investments to a grinding halt, is trending down at 11.4 per cent for the week ended October 4.

A dip in commodity prices (crude oil and metals) means that the figure would dip below the double digit market much before the current fiscal runs through. A cut in interest rates, which is on the cards sooner than later, could boost business and consumer confidence and keep the sentiment quotient on the markets high.

Thus, analysts believe that while fundamentals might take some time to improve, sentiment (the other key determinant of equity prices) might improve as speed of response is much better now than in the past crashes. Says Nilesh Shah, deputy managing director, ICICI [Get Quote] Prudential AMC, "The response to the 1929 crisis came four years later in 1933 and was to the tune of $ 78 billion in value. The response to the current crisis has been much swifter. Governments across the world have swung into action and pumped more than $3 trillion so far."

However, the bounce back won't come in a hurry. Says Amitabh Chakraborty, president equity, Religare Securities "Don't expect a V shaped recovery, there is still pain left in the system." A more prolonged U-shaped recovery would mean that markets are likely to be move sideways for at least two quarters. While the fiscal situation due to high oil prices has worsened, Srividhya Rajesh, fund manager, Sundaram BNP Paribas, believes that India's growth numbers, though lower, will top most other markets.

Combined with cheap valuations, a 10 per cent downside from these levels and falling commodity prices, she believes, could make the markets attractive once more to domestic and foreign investors.

What should you do?

While the list of unknowns seem quite long and affect every company large and small, experts advise that you be prudent with decisions related to your equity portfolio.

While existing investors, who do not have need for funds, should not panic and exit their equity holdings as they are likely to book heavy losses, for new investors with a surplus to invest this is a good time to fish for quality stocks at reasonable prices. Says Hemant Rustagi, CEO, Wiseinvest, an investment advisory, "Adopt a bottom up approach and commit smaller amounts rather than make a lump sum investment at one go and time the market." Agrees Dinesh Thakkar, CMD, Angel Broking, "Invest 25 per cent of your surplus now and the remaining in dips spread over the next three months." This way you will not only benefit from an upside in stock prices but investment at these levels will also keep your downside to a minimum.

But, coming back to existing investors, they must also learn to book losses (reshuffle portfolio), if need be. That's because, if you don't, you may get stuck with companies that may be going nowhere, thereby losing an opportunity to make good the losses (by investing in a better company). Stocks like DSQ Software, during the dotcom rally in 1999-2000 are proof of the pudding.

Where to invest?

Stick to disciplined investing and do your homework thoroughly before committing your funds or you will be speculating which is not advisable on both counts of managing risk and enhancing returns. Preferably, add companies that are leaders in their respective businesses. In that context, let there be no size bias. But, what is important is that the companies should have reasonably decent prospects, sound management and strong entry barriers, apart from healthy financials that will help them tide the current rough patch. Besides these qualities, there are some more factors that need to be considered. They are:

High cash, low debt: To benefit from your investment in the current environment, follow the traditional conservative principle of cash is king. Look for companies which have a record strong positive free cash flow as it can be used to buy out businesses at firesale prices or strengthen operations. Moreover, in a worsening situation where equity markets are down and debt comes at a high price, raising money is not only going to be difficult, it might stretch the balance sheet. Companies that are less leveraged can expand and do not have to cough up cash at regular intervals to pay for interest costs.

While software and FMCG companies bring in a lot of cash due to high margins and low leverage, investors need to keep an eye out on how global demand plays out before investing in the IT sector. While FMCG and pharmaceuticals are defensive sectors, within the sector one could look at ITC (a diversified play), Ranbaxy [Get Quote] (valuations) and Sun Pharmaceuticals (growth prospects).

Funding blues: Resources locked in a current expansion or funding of acquisition allow little flexibility in operations. Notice that the market is already punishing companies, which have taken up huge expansion plans and need funds to take them forward.

Here, an example could be Jaiprakash Associates [Get Quote] (50 per cent price erosion over the last month), which is building India's largest private sector hydroelectric project at a cost of Rs 5,600 crore (Rs 56 billion), tripling its cement capacity and has aggressive plans in the real estate sector.

The company's intention to raise funds through the rights issue route also indicates its need for capital and comes at a time when established names such as Hindalco [Get Quote] and Tata Motors [Get Quote] have struggled to get their pricing right for their issues in a bearish market.

In contrast, NTPC was sitting on a cash pile of Rs 15,000 crore (Rs 150 billion) at the end of FY08 and can fund its mega plans by a combination of internal accruals and debt. It is also generating a cash profit of about Rs 10,000 crore (Rs 100 billion) a year. The fixed return nature of the power sector and internal accruals will ensure it grows at stable rates irrespective of market conditions.

Substantial price decline=value buy?: A sizeable decline in the share price of a company does not qualify automatically for investments. Some also tend to look at stocks in relation to their valuations a few months back, indicating that after a 50-60 per cent decline, their valuations look cheap.

But, that does not necessarily hold true. Says P K Agarwal, president, research, Bonanza Portfolio, a financial services firm, "Companies (in the capital goods sector for example) which performed in the earlier bull run might not be the best bets due to high interest rates, large capex and muted industrial and economic growth." Avoid construction and realty stocks which have dropped substantially as they require large amounts of capital to sustain their business.

Another stock that looks cheap is Reliance Communications [Get Quote] considering the scorching pace of growth in telecom. The company, however, is in the middle of a pan-India expansion of GSM network and is expected to spend Rs 50,000 crore (Rs 500 billion) in FY08 and FY09.

Despite sound business potential and growth prospects, the markets have drubbed the shares by 35 per cent over the last month. If you can handle volatility and adopt an aggressive approach to stock buying, you could add this to your portfolio.

Among other sectors where one can find stocks that offer value are financials, believe fund managers such as Sandip Sabharwal, executive director-equity and CIO of J M Financial AMC. He says that, with a likelihood of interest rates easing, investors could look at companies in the banking and financial sector space (PSU banks) which are available at cheap valuations and will outperform the market.

Other parameters: Dipping equity prices also make high dividend earning stocks a good idea. Check for past dividend record and the cash flow situation in the first two quarters and you will get a fair idea of what the annual picture will be like to arrive at a list of companies that are likely to make higher payouts.

Bongaigaon Refineries and Chennai Petro with a high dividend yield are two names that come to mind and fit the high dividend yield criteria at current prices. For investors who wish to invest in markets but don't have the patience or time to track every company, try index funds.

The benefit? You get a diversified collection of the bluest of the blue chips packaged in one instrument which is not only easy to track but is the cheapest low cost mutual fund scheme available in the market. Here, the Nifty BeES from Benchmark Mutual Fund could be looked at.

Despite a gloomy outlook and uncertainty, the current levels offer a great opportunity to invest. Historically a price-earnings multiple of 10, or 50-60 per cent off the top signals a bottom. At a consensus FY09 EPS of Rs 980, you are getting the entire Sensex basket, at just a little over 10 times.

While an investment now could give a substantial boost to your equity portfolio over the next two years, expect the medium term (up to 12 months) to be choppy in light of the global turmoil (still far from having achieved stability), domestic slowdown and impending state and national elections.

Only the new government will be able to bring significant reforms aimed at bolstering economic growth. So, for the time being, give a higher weightage to safety and thereafter, ensure that you don't pay a high price for stocks, even if they are expected to report robust numbers.