Investors buy blue-chip stocks with twin objectives — they want to ride the India growth story and prefer the lower price volatility they offer. However, these may not always hold true. How else would you explain the tumbling down of some blue chips by 10% or even more if you go by some recent crashes?
For example, in the past year we have seen this happen to stocks like Maruti, LIC Housing, Hero Honda and more recently to Infosys. The reasons behind the mighty fall could be as varied as corporate governance, poor performance in a quarter or management restructuring, among other things. But the first question that arises in the mind of a retail investor is: "What should I do?"
HOW THE MIGHTY FALL
The situations we are talking about are tricky. To start with, there is no one reason or any corelation for the fall in price of the blue-chip stocks mentioned above. Every story is a different case and needs to be viewed separately. Each stock has to be looked upon on a case-to-case basis. One could be fundamental — a change in the business model, or a lower demand for the product. The second reason could be classified as external reasons, which need not be related to the business.
Look at these three recent examples: On November 24, 2010, LIC Housing Finance lost 22.4% after the news of the 'bribes for loans' scam broke and its CEO was arrested. There was fear that it would be difficult for the company to raise funds at reasonable prices. For a housing finance company, the cost of funds matters the most and any adverse impact on that front is detrimental to future earnings. The stock, a blue chip, disappeared from portfolios of domestic funds as well as foreign institutional investors in no time.
On July 26, 2010, Maruti Suzuki fell 14% on the back of poor quarterly numbers due to high royalty payments and rising input costs. "Had Suzuki increased the dividend payout of the company, investors would not have objected it. But taking home money in the form of royalty payments, was perceived to be a non-minority shareholder-friendly move by markets," explains an analyst with a life insurance company. Hero Honda lost 9% during the day when the stake sale news by Honda Japan hit the market, though it recovered to close at a loss of 5.4% towards the end of trading on December 15, 2010. Recently, the Infosys stock fell from . 3,306 on April 15 to . 2,881, a fall of 14.75% in a span of three trading sessions on weak performance, muted guidance and management restructuring.
AFTERMATH OF THE FALL
It would be interesting to note what happened to these stocks after the fall. A month later, things were back to normal for LIC Housing Finance. A research note from IIFL recommended a buy on the stock at . 182, with a target price of . 237, as the company had kept its full-year growth guidance at 30% unchanged. One way to look at the situation would be to check if the business is affected or not.
The fate of Infosys is no different either. A number of broking houses continue to give buy and hold recommendation on the stock. For instance, PINC recommends a buy on the stock, with a target price of . 3,690. When we talk of blue-chip companies, we must realise that their valuations are rich and the margin of error is low. Infosys Technologies was quoting at price-to-earnings multiple (P/E) of 30.9 before the results were declared, as compared to the broader market which was quoting at a P/E of 21. Clearly, the valuations were high, which indicates that analysts expect an above-average growth rate for the company. If it does not deliver on those expectations, it is bound to be punished by the markets. So in the case of Infosys, since the growth guidance was a mere 6%, it was bound to disappoint the market and, hence the stock fell.
Maruti Suzuki also recovered the lost ground after the management issued clarification on royalty payments. The story of Hero Honda was no different. The exit of Honda, Japan was seen as a reason by some investors to dump the stock. However, some investors believed in the ability of the Hero Group to take the business to the next level without Honda as a partner. Naturally, the stock bounced back in the later part of the trade.
THE ACTION PLAN
Clearly, investors may come across such cases now and then in the market. As one can see from the above instances, the fall need not be the end in most cases. Naturally, that is why it is important to find out the reasons behind the fall before taking a sell call. As for the age-old strategy of buying the stock during the plunge, experts say one should tread with caution and pay attention to valuations. Something which is in favour of these stocks is that they have managements which have a long, proven track record, something that is given a lot of weightage by equity investors. If the management is proactive and the damage is a one-off situation it would work in favour of investors. If investors are confident of buying these stocks, they could buy them on a piecemeal basis. He explains that the uncertainty surrounding a stock will not be resolved in a day or two. At times, it could persist for quite some time. That is why buying over a period of time is advisable. Also, such stocks could take more time to rebound, as investors will come back only when they have confidence again. Hence, it may not be worth a gamble if you are a short-term investor. Since they are blue chips and among the top players in their respective industries, most of these stocks merit attention from a long-term perspective. When the uncertainties fade out, the returns could be great.
