Investors intent on capital preservation will have to work hard to find opportunities
During the last couple of years, colleagues have often remarked to me that what we face is a stock-pickers’ market. Put differently, they expect the market to trade in a narrow range where those with superior stock selection skills will reap disproportionate rewards. More often than not, this borders on wishful thinking. Even when it is true, this “blissful” phase hardly persists for any length of time. Were stock-picking skills really necessary to spot and ride the amazing rally in 2009? Not really. What really mattered was that you were meaningfully invested in equities rather than trying to time the market in March 2009.
Even more interestingly, the trick was to pile into battered mid-cap stocks with little regard for either liquidity or corporate governance early in the game! The smart money was left bemoaning the recklessness of the herd. With the market up more than 75 percent in the last 10 months, the consensus view is that the “dash for trash” has run its course. Surely, large-cap quality stocks are ready to take centre stage again after a brief hiatus. While this would make life a lot easier for professional money managers, the available data suggest that such an outcome is not much better than the flip of a coin.
January 2010 was a torrid time for equities in most parts of the world, including India. Even though most companies reported earnings that beat expectations handily, a number of bellwether stocks (L&T, State Bank of India and Reliance Industries come to mind) failed to cheer investor sentiment. The hopes of recovery in the US were similarly bolstered by encouraging corporate results despite the absence of a corresponding improvement in the outlook for employment. The real focus of attention for the moment, round the world, seems to be heightened political risk and Central Bank action on tightening monetary policy. The drubbing handed out to the Democrats in the Massachusetts elections, the concerns relating to “grease” (Greece is more like it) and the posturing by Chinese politicians at Davos to dispel any thoughts of a hard landing suggest that caution is justified.
The current global economic environment is unprecedented in terms of the impact of fiscal stimulus, absurdly low interest rates in the developed economies and exceptionally high liquidity driven by the desire of central bankers to avert a systemic crisis. It is well nigh impossible to judge the impact on corporate performance in a more “rational” scenario where policy makers signal an end to their “siege mentality”. The risk of policy errors driven by political expediency is a terrifying threat for financial markets in 2010. But it is worth recognising that the nature of change that lies ahead is bound to be non-linear with unanticipated consequences.
The number of attractive opportunities for the disciplined investor intent on capital preservation has narrowed considerably. Tidewater Oil (Rs. 5,007) is a remarkable company – strong brand franchise, highly predictable revenues, pricing power and a robust balance sheet – that seems to have been completely put in the shade by its far larger and more illustrious competitor, Castrol. The main brand, Veedol, has a strong niche and a track record of steady growth reflected in its performance over the last few years. The stock is likely to post an EPS in excess of Rs. 625 for FY 2010 resulting in ROE north of 30 percent, yet it trades at just over 2.5 times book value and 8 times earnings.
GRUH Finance (Rs. 200) has impeccable pedigree (founded by HDFC), a dominant competitive position in its main markets and outstanding capital efficiency. While the stock is not cheap in absolute terms (a PER of 12 and dividend yield of 2.5 percent), it trades at a meaningful discount to its peers with a similar track record of consistent growth and high quality management!
It is likely that the markets will continue to witness high volatility in 2010 driven by the prospect of an earlier than expected recovery in the US, fears about spiralling public debt and complex posturing by policy makers. In such circumstances, not only is the outcome uncertain but equally it is imperfectly knowable! Aim to remain intellectually flexible and temperamentally balanced in coping with the twin demons of greed and fear to prosper in the markets this year.