Will I ever be able to buy the stocks?

Did you ever feel the déjà vu? You log on to a website or tune into the TV and hear the stock you wanted to buy has gone UP three days in a row. You quiz yourself if you should invest tomorrow. The next day, when you see the stock move up again, your consciousness seeks to reconsider if it is right to invest your hard earned money into the stock now. However, if the stock came down that day, your anxiety makes you wonder if it really has a story in it for you to take a position. Don't worry, you are not alone.

Asset classes are important. So are event classes. It is a well known fact that stocks over react, both on the upside as well as the down side. Without going back long into history let me take the instance of IFCI. When the 26% stake sale was on, the stock moved all the way from 50 levels to 120 levels. This was under constant circumspection of the analysts who were readjusting their fair value as the stock flew in the open blue sky. When the event busted, it retraced to 70 levels reacting sharper than the fair value deserved. Now, it has moved back to 90 levels. Wonder if one had invested in the selling frenzy? Ditto for Gammon India when the Hyderabad flyover incident happened and for Deccan Chronicle when the increase in debtor days was discovered by the market. These are the opportunities and one should always carry some liquidity to capitalize them. The event may be for a stock in particular or for the markets in general. Even if a person catches 80% of the volatility, that should make good returns.

Do such opportunities exist? The analysis supports it. Volatility of each of the 5000 stocks listed on BSE has been calculated. Though this volatility (change in 52 week high and low compared to the current stock price), is not the ideal one to see the stock movement, it is the easiest to understand. In 2003, there were 5 stocks above Rs 30,000 cr market capital, 18 between Rs 10,000 cr and Rs 30,000 cr and 2105 below Rs 10,000 cr of mcap which had volatility greater than 50%. For 2004, the numbers are 9, 20, 2176; for 2005, they are 9, 23, 2228; for 2006, they are 20, 40, 2446 and for 2007, they are 46, 64, 3824. Irrespective of a person’s penchant for market cap, the volatility of the stocks gives enough buying opportunities. As numbers indicate, 2007 has witnessed 57% increase in number of stocks that have volatility greater than 50%. Infact, there are 1531 stocks that provided opportunity every single year for the last five years.

Market falls provide the best opportunity for investment in a sound structural market like ours especially when factors that lead to the fall are non-Indian. Ever year, over the last five years, has provided such opportunities and these are increasing by the year due to increased volatility. In Feb-Mar of 2007, Nifty fell 13%; in Jul-Aug 2007, it fell 11%; in May-Jun 2006, it fell 30%; in Jul & Dec 2006, it fell 7%; in Oct 2005, it fell 12%; in Jan 2005, it fell 8% and in May 2004, it fell 24%. Therefore, there are buying opportunities that present themselves and it requires patience & courage to take advantage of them.

Is money chasing mid and small caps?

There is a popular belief that money is chasing small and midcaps. While this belief is true, the money is also chasing large caps. Let us consider two periods. One, when markets rallied for 2 months in Aug to Oct 2007 period. Two, when mid & small caps rallied from 23rd Nov onwards (till 17th Dec 2007). In period ONE, the returns of Nifty was 39%, midcaps was 29% and small caps was 24%. In period TWO, the small caps topped with returns of 18% while mid caps clocked 14% and Nifty a tepid 4%. Let us look at the parameter ‘Turnover per day’ in each category. Nifty saw Rs 8307 cr in period ONE vs Rs 9206 cr in period TWO, an increase of 11%. Midcaps saw Rs 2094 cr vs Rs 3227 cr, an increase of 54%. Small caps saw Rs 1698 cr vs Rs 2137 cr, an increase of 26%. This data indicates that while chasing increased in midcaps, the large caps still draw the highest amounts.

Further to this, Turnover per Day(tpd) for individual stocks will indicate which is in or out of favor. In case of Nifty stocks, RPL’s tpd increased by Rs 725 cr (161%), Sterlite by Rs 187 cr (196%) and GAIL by Rs 121 cr (234%). Incase of midcaps, it is Essar Oil by Rs 711 cr (2881%), Ashok Leyland by Rs 114 cr (404%) and HOEC by Rs 69 cr (1830%). This trend will indicate in which counters traders should be in to execute their trades.

PUT options - No indicator for market support in India

Analysts all across the globe watch the strike prices at which the puts are created to indicate support for the market. While it may hold true for other markets, it is not the case with Indian markets. This is because the options market is insignificant in India. It is about 15-20% of the total F&O market, that too on a lucky day. This is unlike that in other developed markets. Today, when we all expected 5900 to be the support based on PUT data. This level got easily broken and Nifty fell all the way to 5740 to take support at the 50 day moving average. If you calculate the Open Interest position at this strike price, it is hardly Rs 1000 cr. Remember, the option amount paid for the options, incase of both premium and on redemption will be fraction of this. What is Rs 1000 cr infront of a turnover of Rs 1 lakh crore on a daily basis? Hence, whenever support and PUTs are combined, take it with a pinch of salt.

Why did the global markets fall today?

Sensex down 3.8%, Shanghai down 2.6%, Russia down 1.5%, Brazil down 0.66% (on friday), Taiwan, Hang Seng, Straits Times, Kospi down over 3% each.
This sudden fall in global markets is because of the disappointing inflation data in the United States. The Producer Price Index (PPI) released on Thursday set the alarming tone. November PPI was up 3.2% vs a consensus estimate of 1.6%. When contrasted with 0.1% in Oct and 1.1% in Sep, November data is really of a concern. By the way, this was the most since 1973. Come Friday, the Consumer Price Index (CPI) brought about the mayhem. November CPI came at 0.8% vs an estimate of 0.6%. This is huge when compared to 0.3% for Sep & Oct months and this figure is the most in two years. What does increased CPI & PPI mean for US? This implies that the inflation is going up which will halt the fed from further rate cuts. If this happens, where will the stimulation to the economy come from at the back of weak credit markets and battered housing markets?

Weakness in housing markets will weaken the demand for resources like metals, oil and services. Moreover, the sentiment is turning negative due to two other reasons. Firstly, Bear Sterns and Morgan Stanley will come out with further write downs when they declare results this weak. Goldman Sachs is expected to do well. Secondly, there is further tightening expected in China. Remember, China has increased CRR rate only last week. The increase in interest rates is expected to be in December or January as the inflation touches the highest in 10 years. Though the economy has been growing at 11% in last two quarters, there are concerns that the demand for resources may soften due to monetary tightening.

More data flow is expected from US through housing numbers and the speculation on whether fed would cut interest rates in the light of Stagflation is to be seen. Till then the US markets along with the US dependent markets will be shaky.

Birla Sun Life Special Situations Fund Looks Attractive

Did you ever think that you should have invested in Reliance Industries before it demerged? Ditto for Television Eighteen and Zee Telefilms? Did you feel awful when you misread the Tata Steel-Corus deal and not invested your money after the deal? Did the price rise in Bata India surprise you only to later realize that this was due to restructuring in the company? For those who do not want to miss out on such opportunities, Birla Sun Life Special Situations Mutual Fund (BSLSSMF) may just be the answer.

At first this fund seems like an old wine in a new bottle amidst all the ‘me too’ funds that have been hitting the NFO market. Initially, it does look like an equity diversified fund. However, there is a twist. BSLSSMF only invests in companies that have undergone or going to undergo special situations. The special situations include merger, acquisition, demerger, restructuring, divesting, open offer, buy backs, new funding etc. The fund will focus on 40-50 stocks that fall under the special situations category. It may also invest in contrarian plays like Auto & IT that exist now.

While all mutual funds seem to aim at alpha, this may just be aiming for ‘alpha plus’ above the benchmark BSE 200 index. The reason I say this is because of the kind of opportunities that are there in the market. Everybody understands that our economy is estimated to grow above 9% and there are immense opportunities for our companies to expand and diversify. There have been multi-billion M&A deals like Tata-Corus, Hindalco-Novelis, Suzlon-REPower among others. While India attracted Private Equity investment of $2bn in 2005 and $7bn in 2006, it lured $10bn this year with a few more days to go. This underscores the potential of Indian corporates and the value embedded in what they do. This fund aims to take advantage of that.

The BSLSSMF should be aiming to raise more than Rs 1300 cr, the amount raised in their previous fund, Birla Sun Life International Equity fund. Usually, it takes 3-4 months to deploy the funds. Hence, it would be better to start evaluating the fund only after a year.

The idea is interesting but the onus of making this successful is on the research team. It should be ahead of the curve to identify opportunities for the fund. The proxy for the capabilities of the team is the performance of the team in the past. The fund will be managed by Mr A Balasubramanian, CIO of Birla Sun Life. The past performance of equity diversified funds from the Birla Sun Life stable have been impressive. In three years, the BSL Equity Fund has given an annualized return of 59%, BSL Frontline Equity has given 53% and BSL Basic Industries has given 51%. Contrast this with 53%, the three year average annualized return of all equity diversified funds from various asset management companies. The benchmark BSE 200 has given an annualized return of 47%.

Finally, I like the Open Endedness of the fund. This shows the confidence of the fund on their idea and execution. This helps the investors to enter & exit on their will.

Strategies for stocks that are included in Benchmark Indices

I am going to sound caution on one startegy that is popularly believed to be working. At the same time, I shall attempt to give one that is working. The most popular strategy is to buy (or go long on) stocks when the announcement of introduction into indices is made. By the time they are introduced, the stocks should have appreciated. To check this, I have taken the last seven inclusions and put the theory to test. Incase of Unitech, Rcom & NTPC, the returns in the interim period have been phenomenal. Unitech gave 17%, NTPC gave 19% and RCom gave 21%. But when you consider Suzlon and Siemens, the stocks that lost about 30% in the interim period, the theory goes for a toss. Hence, caution is advised in this startegy.

I have looked at the five day returns of inclusions after they form a part of Nifty and this gives a strategy one can follow. Unitech has given a return of 4% in five days, NTPC 4.8%, Sterlite 6.2%, RPL 2.5%, RCom 5.5%, Suzlon 19.2%, Siemens 5.2%. This is said to be because of three reasons:
1. Buying from Index funds:
Index funds buy new inclusions so as to decrease the tracking error of the fund. The argument against it is that the total corpous of Index fund is just over Rs 3,300 crores which cannot significantly affect the pricing of the inclusions, especially when they have high free float (Cairn has 30% and Idea has 40%).
2. Decrease in Risk premium:
The risk premium on the inclusions would come down as analysts and fund managers, through their research, decrease information assymetry in the market.
3. Buying from broader market players:
Inclusion in a bench mark index is a positive signal for the stocks as they have gone through rigorous filters to end up there. The signal is taken by retail investors who flock to buy these stocks thus adding to the upward pressure in stocks.

Misconception about price retracement:
I have to add my observation about price retracement in index inclusions. The research paper from S. Gowri Shankar & James M. Miller titled “Market Reaction to Changes in the S&P SmallCap 600 Index” indicates that the price of the stock retraces in 60 days. This may be true for madcap & smallcap indices but for a benchmark index like Nifty. I have looked at the stock prices of Unitech, NTPC and RCom. They have never seen the prices they had on the announcement day.
Misconception about exclusions:
The belief is that the stock that is excluded from the indices udergoes a downward price revision. The reason popularly quoted is that the risk premium to hold these stocks goes up as the coverage on these stocks decreases. However, there is no evidence that such a thing happens.

Cairn, Idea to Join Nifty from 12th Dec 2007

It is going to be a fifth change this calendar year and eighth in two years. Cairn India and Idea Cellular are going to replace HPCL and MTNL respectively on the 12th of December 2007. The announcement wad done on 30th Oct. Nifty considers market cap directly unlike Sensex that considers free float market cap. The market cap is going to go up from Rs 33.7 lakh cr to Rs 34.2 lakh cr due to the inclusions. The wieghtage of Cairn will be 1.1% and that of Idea will be 1% in contrast to the weightage 0.3 for HPCL and MTNL. The increase of weightage of new constituents will reduce the weightage of other stocks by 1.5%. RIL that contributes 12.17% to Nifty will not contribute only 12%, down 17 bps. ONGC's contribution will decrease by 11 bps while that of NTPC will decrease by 9 bps.

IT stocks – A value buy?

Time has finally come for IT stocks this year. After they have been beaten to death literally, there are voices, particularly from financial institutions, of VALUE BUYING. When did you last see the stock price of Infosys in 1500s? When did you last see the two year forward PE of Infosys trade below Grasim, inline with metal stocks and just a tad in premium to ONGC. Market participants are finally talking about how IT majors have managed to grow at 20%-25% against a rapidly appreciating rupee. They are now of the opinion that appreciation will pause or at worst slow. This gives an opportunity for IT companies to show how they run their companies.

The first sign of this was seen on Friday when not only the volumes traded on IT counters were robust but also the delivered quantity. When compared to 50 day averages, Infosys traded 1.5 times in volume while the delivery statistic was 1.6 times. The corresponding figures for Satyam were 1.9 & 2.2, Mphasis was 2.1 & 1.9 and Tech Mahindra was 2.8 & 2.

I was looking at another technical indicator, the average of 200 day stock price. Infosys was at a 12% discount to its 200 day average of Rs 1921. The discount of TCS was at just 7%, Iflex was at 26%, NIIT Tech at 29% and Tech Mahindra at 11%. Wipro, Satyam, HCL Tech and Mphasis were around their 200 day stock price averages.

Another interesting trend is that TCS & Wipro have closed in on Infosys’s valuation. While 2 year forward PE for Infosys was 17.5, that of TCS was 17.5 & of Wipro was 18. This is because of the aggressive inorganic growth strategy employed by latter two and the market likes it.

Finally, brokerage firms like JP Morgan & Edelweiss have given a VALUE BUY signal of IT majors in general and Infosys & TCS in particular. After Fed cuts interest rate tomorrow, the situation will be clear which way the liquidity flows and which way the rupee moves. I expect the IT stocks to start off the New Year celebrations.

Should Holding Companies trade at a discount?

The answer is ‘it depends’.
Controlling Stake: With the controlling stake in the portfolio companies, the holding company can take many decisions like cross-subsidizing, cross selling, saving taxes by taking optimal debt etc. Internal group companies know each other better and hence can raise money amongst them at fair value. Depending on these synergies created, the holding company is valued.

Taxation: Sometimes, the holding companies have to additionally ‘leak’ tax to the government which will decrease the stock price. For instance, the long term capital gains tax has to be paid for all off market transactions. While this might be a negative, there is a positive. If someone wants to hold a stake in holding company without knowing when the company would sell its holdings and pay capital gains tax, she pays less option price as the volatility of the portfolio is less than that of the constituents.

Agency problem: There is a possibility that the management of the holding company may take bad decisions which will undervalue the holding.

Management fees: As the management is actively managing the portfolio, their management costs are higher than that of mutual funds but less than that of hedge funds.

Diversified risk: If a shareholder were to buy the portfolio companies individually, she would incur transaction & portfolio costs. As she achieves the same through the holding company she would be willing to pay more.

Undervalued Assets: If a holding company chooses assets that are undervalued, then it commands better valuation than its networth. The best example in this regard is Berkshire Hathaway. The opposite situation is when the company chooses bad assets.

Liquidity: If the holding company wants to sell its stake, there is a chance that the price of asset reduces as it is a bulk deal. In this case the stock price of holding company is at a discount. However, if the holding company has a controlling stake, the buyer could pay a premium for that stake which will help the holding company to get a premium.

Noise Traders: The traders who think they know the value of the company may take the asset prices high or low depending on the market which creates a deviation from the holding company’s fair value of the asset.

Private Benefits: If the holding company has a larger stake, depending on their ability to take decisions, the market views positively or negatively.

Be LONG on Sensex!

It is always a good strategy to be long on Sensex. This is for two reasons. One: BSE regularly makes changes to the Sensex constituents, usually, dropping the laggards and including the performers. Two: The value of index depends on individual stock free float market capital. In the last three years, stocks like DRL, MTNL, Hero Honda, HPCL, Tata Power & Zee Tele have been dropped to give way to DLF, M&M, Rel Com, TCS & NTPC. If the stock composition in Sensex is unchanged the returns would have been 9%. This indicates that the exchange is going portfolio management for us. Another good way to identify sectors is to see how their composition has changed. In last three years, Capgood stock's contribution increased by over 7% and that of Telecom & Bank by over 5%. Also, IT stocks have reduced their contribution by 7.6%, Pharma by 6% and FMCG by 5%. Realty has shown its presence through DLF's addition in Nov 2007. Its contribution now is 1.8%. Another point to note is Media, one of the fastest growing sectors now, has no representation with Zee Tele out of Sensex. It is just about time for some big media boy to get in. This indicates the sectors one should be long & short on.
Concept: Haresh Soneji, my colleague at CNBC-TV18

Seasonality of IT stocks

There is an interesting article that I hit across that highlights the seasonality of behavior of IT stocks. From 2001-2006, the Swift companies (Satyam, Wipro, Infosys & TCS) have given negative returns absolutely and relatively (wrt Sensex) in first half of calendar year and outperformed in second half. Infosys has given negative return in all six years in first half but delivered strong returns in the second. Similar story for the other companies. The reason is that the financial out performance of IT companies is only clear in Q2 & Q3 of the financial year. Added to that, there were not many sectors that gave returns as IT did and the money would flow there. A similar result could be expected even in 2008. Though positive news against US recession & rupee weakening can add life to the beaten down stocks.

Essar Oil – Is it over valued?

It is very tough to value a company that does not have earnings to show currently and that goes into production much later. Added to that, the underlying, in this case the Oil, is seeing huge volatility. I attempt to compare two apples that are in the same dilemma.

Before looking at valuations, lets look at some figures. At status quo, Essar Oil is going to produce 0.21 mn barrel per day compared to 0.58 mbpd of RPL. The Nelson complexity of Essar Oil is 12 compared to 14 of that of RPL. With these figures: The EV of Essar Oil is 10,000 cr vs 28,000 cr of RPL; The EV/bpd of Essar Oil is $46,700 vs $48,000 of RPL; The EV/comp bpd of Essar Oil is $3900 vs $3430 of RPL. The above stats indicate that Essar Oil at stock price of Rs 270 is valued at par if not more than RPL.

However, if you consider the statements made by the Essar Oil promoters, the situation becomes complex. Promoters are pumping in $2bn at a stock price of Rs 200 and will further raise $4bn to triple the capacity from 10.5 to 34 mn metric tons per annum. This additional capacity will be at a better Nelson complexity taking the overall complexity to 12.8 and entire capacity will kick in only in 2010. Based on these estimates, the EV/bpd of Essar Oil is $14,800 vs $48,000 of RPL; the EV/comp bpd of Essar Oil is $1160 vs $3430 of RPL. The numbers make Essar Oil look definitely cheap compared to RPL and a reasonable logic for the stock to flare up 17%-20% day after day. So, it basically depends on how much information one would want to discount.