Stay Balanced, Hold on to Stocks with Reliable Cash Flow

A sharp focus on companies cash flows could still help you pick winners

Published: Jan 29, 2010 10:55:31 PM IST
Updated: Feb 21, 2014 12:39:32 PM IST

The beginning of a new decade is a powerful elixir for the forecasting tribe. Most impressive, of course, is the pinpoint accuracy of the predictions spawned by their complex mathematical models. Thankfully there is still hope for most of us with “normal” mathematical ability. In thinking about the future, what matters is identifying likely scenarios and what they imply for investments. Equally important is to arrive at a robust, unbiased estimate of the likelihood that each of these events might occur. It is true that the essence of risk concerns the unexpected. Where does that leave us?

After the incredible rally in emerging markets since March 2009 and the emergence of China as the flag-bearer of a global revival in economic growth, three scenarios come to mind. First, India is clearly out of the woods and corporate India is perfectly poised to benefit from robust domestic consumption coupled with a slew of policy reforms. The lure of 8.5 percent GDP growth and a pro-active response by the RBI to keep inflation in check will keep international investors in good cheer. The promise of greater fiscal discipline by the government, accompanied by a renewed initiative to partly privatise high-quality public sector units, could ensure that 2010 is another banner year for the stock markets!

A second plausible scenario is that the US and Europe limp along and take longer than expected to recover from the impact of the Great Recession. Most Central banks remain committed to a lax monetary policy stance and “stimulus” prevents the blushes. However, the profligacy in public finance comes home to roost and quantitative “pleasing” leads to rising inflation and a debased currency. Closer home, the domestic economy continues to chug along but rising inflation forces the RBI to raise interest rates and international investors re-visit their love affair with emerging markets, leading to hiccups in liquidity flows. The market chooses to trade in a range but fails to breach the previous highs.

A final scenario that remains possible is “The Great Bust of 2010”. On this narrative, the Chinese economy is headed for a “hard” landing and markets bear the brunt of the credit bubble stoked by the response to the global crisis in 2008. Developed markets lapse back into crisis (commercial real estate in the US or a potential sovereign default) and the dollar takes a hitherto unimaginable pounding. Regional geo-politics is thrown into turmoil and conceivably either Iran, Afghanistan or Pakistan come close to imploding in our backyard. The Telengana situation, potentially, takes a turn for the worse and the economic agenda gets put on the back-burner. The perfect storm, leading to a market disaster and the prospect of re-testing the depths of March 2009!

So, which scenario comes to pass? The most critical determinant of how markets perform over a period is how expensively they are priced at the outset. By this yardstick, the lights are flashing amber. Market capitalisation to GDP is close to 1.1, dividend yield is at 1 percent and the trailing 12 month PE ratio is at 20. Looking at the list of new highs in the pink sheets leads to a strong sense of déjà vu — December 2007 re-visited! My guess is that the odds for the first scenario playing out are between 30 to 40 percent. The second alternative seems to be the most probable case — my guess would be even money, or 50 percent. Not surprisingly, the third option is a long shot but could conceivably lead to serious and lasting damage!

Where are the safe havens? Well managed sugar mills have never had it better with ex-factory realisations at Rs.40 per kilo and buffer stocks close to their all-time lows. Dwarikesh Sugar (Rs. 118) and Dhampur Sugar (Rs. 143) are among the cheapest in their peer group with the prospect of meaningful upside. Hawkins Cookers (Rs. 708) with metronomic cash flows, a PE of 11 times current earnings and management that has a proven track record of consistently rational capital allocation merits serious consideration from the patient investor with realistic return expectations.

The message clearly is stay balanced, hold on to stocks with reliable cash flow but build cash to cope with the consequences of what remains a risky world.


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(This story appears in the 05 February, 2010 issue of Forbes India. You can buy our tablet version from To visit our Archives, click here.)

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  • Subhankar

    Nice article. There is considerable confusion among investors about what constitutes 'cash flow'. Positive cash flow from operating activities is what investors should look at. Subhankar (tinyurldotcom/mobugobu)

    on Feb 3, 2010