Peter Lynch of Fidelity, used to mentally classify stocks as:
- Perennials
- Growth
- Cyclicals
- Utilities
- Perennials
Perennials like FMCGs offered predictable growth. Utilities (in the 1980s US context) meant power and telecom companies that offered stable dividends.
- Growth
Growth is self-explanatory and so is cyclical. His take was that growth stocks usually offered the highest potential returns but carried the highest risks. Perennials offered steady returns but ideally offered best value during bear markets.
- Utilities
Utilities, he felt were dividend plays or quasi-debt instruments.
- Cyclicals
Cyclicals offered great returns only if bought in downtrends.
Lynch's classifications are interesting in the context of India over the past two years, and especially, the past two months. The Sensex climbed from around 10,000 in February 2006 to a high of over 20,000 in December 2007. It has since corrected to a recent low of 16,608 and it's now trading at about 18,000. So we've seen a net return of around 75 -80 per cent. During that two-year period, perennials such as FMCG have offered poor returns, and so did cyclicals such as cement, non-ferrous metals, IT, etc. The biggest returns have come from real estate, capital goods, telecom, power, banks, private refiners, etc. Lynch's classification of power and telecom as utilities offering stable dividends scarcely holds in India. Telecom is a growth industry and power, a sick one hoping to recover on the basis of reforms. Real estate is a cyclical but one with growth impetus. Banks have grown on the basis of strong retail credit disbursal.
Earnings and turnover growth slowed over the past quarter (Oct-Dec 2007) and so did credit disbursal. Sentiment indicators such as real estate prices, auto and two wheeler sales and home loans flattened out. IT and pharma had bad times as the rupee appreciated against USD.
However until December 2007, a flood of liquidity pushed the stock market to a succession of new highs. Last year, (Calendar 2007) the Foreign Institutional Investors (FIIs) bought over Rs 70,000 crore while the Domestic institutional Investors (DIIs) bought Rs 5500 crore. In January 2008, that changed as the subprime crisis led to panic on the Wall Street. In that one month, the FIIs sold over Rs 17,000 crore.
The sell off caused 13% correction in index levels in just about a month. It caused the failure of three large initial public offerings as confidence evaporated. It's possible that India is now in the early stages of a bear market, which could continue indefinitely. It's also possible the correction is over. That will depend on the return of liquidity to the bourses, which in turn, depends on many unquantifiable global factors. The Sensex is now trading at an average PE of about 21 with average earnings growth reckoned in the same range (19% in Q3, 2007-8). Long-term growth prospects remain excellent - this is a cyclical low that is higher than most countries' cyclical peaks!
But where should the investor go to best exploit this price-dip? Cyclicals could be most tempting. Many of these stocks have not gained at all in the past two years. The entire IT industry has lost ground. Automobiles have been flat. These are high-risk but they should be close to rock-bottom. However, one could easily make a case for banks - a rate cut may be around the corner and credit growth softened in the past six months. Also the big banks and financial sector players have extra embedded value due to their insurance JVs. Brokerages however, are likely to see sell offs and may generate negative Q4 results.
In the highly-valued corner, capital goods and construction/ engineering remain good bets. Telecom has an overhang of policy uncertainty; power will be impacted by election fever that slows down reforms. Real estate could also be impacted by policy uncertainty.
This is a classic situation where the investor could confidently expect to make money in the context of two-three years. However, he may well lose money through the next several months or more.
