Stocks to Look Out for

Investing is a unique kind of casino - one where you cannot lose in the end, so long as you play only by the rules that put the odds squarely in your favour." When British-born American economist and investor Benjamin Graham, who was also Warren Buffett's mentor, said this sometime early in the last century, he was guiding investors on ways to earn good returns while playing it safe. This is truer now than ever before in India where, in a volatile stock market, only a handful of stocks are driving the rally, while most others are refusing to move.

Graham was a proponent of value investing, the most reliable way to generate good returns in stocks markets. The idea is to pick good quality stocks trading at a discount to their historical valuation ratios. These, he believed, would be long-term wealth creators while also providing a margin of safety. With the current stock market rally built on weak economic fundamentals, it is even more important for investors to buy only value stocks with strong growth potential.

To save you the hard work, BT has crunched numbers to come up with scores of such potential wealth generators. We have drawn up the list (See Table) by comparing the current valuation ratios of the top 1,000 listed companies with their historical ratios and looking at the quality of their earnings and balance sheet strength (See Methodology).

Ideal Time for Value Picks

Value investing involves buying a piece of a quality company which is undervalued compared to its fair value. "In the current market scenario, a beaten down stock will enable an investor to compound his returns if there is a mismatch between its current price and fair value. The pandemic-led lockdowns have disrupted a number of industries and many companies are suffering. But a wise investor will look beyond that and pick companies that he feels will emerge stronger on the other side of this pandemic," says Nirali Shah, Senior Research Analyst, Samco Securities.

Ajit Mishra, VP - Research, Religare Broking Ltd, says markets have already run up significantly from March lows and some large caps are trading at stretched valuations. The BSE Sensex hit a three-year low on March 23 and closed at 25,981. Exactly three months later, it was at 38,435, up almost 50 per cent.

"In such a scenario, investors should opt for the 'bottom-up' approach and look for stocks which are available at a fair valuation. They may consider broader markets to start with as these are picking up pace due to attractive valuations," says Mishra.

Tobacco and FMCG major ITC, for example, is currently trading at 16 times its trailing 12-month earnings, about 50 per cent discount to its five-year average price to earnings (P/E) multiple of 29x. Such a low valuation was last seen in the aftermath of the 2008 global financial crisis in the March 2009 quarter. There has been a sharp fall in ITC's top line and earnings growth in the last two years due to shrinking of its tobacco business but the company has shifted its focus to the fast-growing FMCG division that should yield dividend in the coming quarters. The FMCG division now accounts for a quarter of ITC's revenues; its PBIT rose 31 per cent in FY20. This is likely to support ITC's valuation going forward.

Similarly, Power Grid Corporation is trading at around 30 per cent discount to its five-year average P/E multiple. There has been a slowdown in top line growth in the last few quarters but it has one of the best return on equity (RoE) in the power sector. While the sector's RoE is 10-11 per cent, the figure for Power Grid is 15 per cent, making it an ideal value stock for long-term investors.

Bajaj Auto, too, is trading at a 30 per cent discount to its historical average P/E multiple. The company is not only a bet on two- and three-wheeler markets in India, it also leads the two-wheeler market in Africa and Latin America. Other large-cap stocks available at a discount to their long-term valuation ratios include JSW Steel and GAIL.

The beaten-down stocks like ITC, GAIL, Power Grid and ONGC have strong fundamentals. Mishra of Religare says one can invest in these companies. "These stocks are fundamentally sound and are trading at low valuations due to business mix and Covid-led disruption. However, going forward, as the situation stabilises and demand picks up, we may see these stocks gain traction. Investors may start accumulating these at current levels and adding more on dips with a time horizon of two-three years," he says.

In the midcap space, value investors should look at Petronet LNG, Bajaj Holdings and Amara Raja Batteries. While Petronet is the country's top LNG producer, Bajaj Holding is the main holding company for the Bajaj Group with large stakes in Bajaj Auto, Bajaj Finserv and Bajaj Finance. The company also has equity investment in non-Bajaj companies. Besides, it invests in debt instruments and operates like a diversified close-ended mutual fund, making it a good long-term investment for value investors.

Amara Raja Batteries is the country's second-largest automotive battery maker and has gained market share from incumbents in the last few years. The company's margins and earnings growth took a hit due to price war in the industry and slowdown in auto sales. However, things are looking up due to decline in international commodity prices and improved growth outlook for the automotive industry in the coming quarters.

In the small-cap space, Sterling Tools, LG Balakrishnan & Bros, Fiem Inds and Cera Sanitary Ware remain value buys at current valuations. While the first three are auto parts makers, Cera is the country's most profitable sanitaryware manufacturer.

In fact, many of these stocks have already started rising as investors look for ideas beyond the large-cap universe. JSW Steel, for example, is up 7 per cent in 10 days since August 14 while PowerGrid and Gail are up 5 per cent each. In the small-cap space, Sterling Tools and LG Balakrishnan are up 10 per cent each. Bajaj Holdings is up 5 per cent.

This is in contrast to the trend that persisted for almost two-and-a-half-years when markets were being driven by large caps. The Sensex and the Nifty did well but other parts of the market struggled. Small and mid-cap stocks peaked in January 2018 and then entered a long phase of underperformance. Between January 2018 and March 2020, the broader market indices were down more than 40 per cent relative to the BSE Sensex. "Growth slowed down due to a number of factors, including the GST law, the real estate regulation Act, the bankruptcy code and the new inflation framework, all of which may have dragged down growth in the near term, even if they are positive for long-term growth," according to global brokerage Morgan Stanley.

Mishra says broader markets provide valuation comfort at these levels given their sharp underperformance since 2018. "The earnings growth trajectory has also improved as the economy is opening up and growth is showing signs of improving. However, one should stick to quality names in this space and avoid penny stocks," he says.

Eye on the Future

G. Chokkalingam, Founder and Managing Director of Equinomics Research & Advisory Services, says most investors today are fixated with quick returns in a volatile market. "Most new investors don't look at valuation multiples and that's why value investing seems to be losing favour. But it is well-known that some of the best wealth generating scrips of today were value stocks some years back," he says.

For instance, Bombay Burmah is trading around Rs 1,500. It was nearly Rs 80 in January 2012 and has grown almost 19 times in the last eight years. Bombay Burmah, originally a tea trading entity, is the holding company for Britannia Industries, the flagship of Mumbai-based Nusli Wadia Group. Investors usually don't track shares of Bombay Burmah actively because it includes financials of Britannia only when it presents its audited consolidated numbers at the end of the financial year.

Similarly, the JB Chemicals stock, with face value of Rs 10, was trading at Rs 68 in 2010. It split to Rs 2 per share and is now at Rs 700, giving 54 times returns, says Chokkalingam.

However, experts throw a word a caution. "The millennials, people out of job or small entrepreneurs who are trading in the market don't have the patience to wait in the current tight liquidity scenario. So, the risk is very high right now. Penny stocks or those with bubble valuations can fall like a pack of cards anytime," says Chokkalingam.

Moreover, value investing has another crucial component - the vision to correlate a company's performance with broader socio-economic, policy and future scenario. MRF scrip is a case in point. It was trading at Rs 6,000 in 2011-12. It closed at Rs 59,720 on August 21. An investor who realised in 2011 that India's fast-growing auto market is alongside creating a consistent demand for tyre replacement too, would have seen her money grow 10 times in eight years. "The visionary aspect of value investing looks at the future, as happened in case of MRF," says Chokkalingam.

Shah agrees that future growth opportunities should be considered in value investing too. "Currently, valuations in some pockets are extremely low and earnings growth is slowly picking up due to pent-up demand. The crisis has pushed recovery in corporate earnings by at least a few months. Recovery may take longer than expected. So, value investments should be made looking at the PEG ratio (which compares P/E ratio to growth of the company) and future growth opportunities in small pockets. Not all companies in broader markets are attractive," she says.

So, what are the boxes which need to be checked before investing in companies even with low valuations? Primarily, companies with high debt or high promoter pledge should be avoided even though they are available at low valuations, says Shah. "Also, companies which start showing a significant decline in sales or margins should be observed more closely. High investment in capex, without any material return, is again a red flag. A number of such parameters must be considered before investing in strong yet undervalued stocks," says Shah.

Just as value investment requires caution, even an exit should be well thought out. "In a crisis, investors should not run to exit the stock just because the price is falling. It would be prudent to check if the fundamental debt and cash story is intact, and if all seems well, the investor should continue holding the stock irrespective of certain corrections," says Shah.

(The writer is Co-founder and Editor of 30stades.com)