Turn the risk-return maths to your favour

Tags: Stock Market
Turn the risk-return  maths to your favour
Whether one is a trader or an investor, everyone has the same objective in the equity market — maximise the rewards with the lowest possible risk. The equation of risk and reward may look simple: higher the risks, higher the rewards. But in real life, it is not as simple; simply because often the perception of risk is highest when it should be the lowest and vice-versa.

For example, everyone rushes in to buy stocks when the market has already moved up sharply. This can be seen from the high trading volume that a particular stock attracts when it is near its high, and the low volume it witnesses when it is near its low. The complexity in the risk-reward equation arises largely because most investors do not appreciate the fact that risk is a matter of perception while return on investment is a hard number; one has to keep perceptions aside in order to earn good returns.

The understanding of risk perception and managing it the right way become important in an extremely polarised market, like the one we are seeing these days. Today we have a situation where some stocks from the FMCG and pharma sectors are quoting at extremely high price earnings multiples, whereas others from the infrastructure and real estate segments are getting extre-mely low valuations. This is the exact opposite of what was happening in 2007. Now the fact is, if the 2007 situation did not last long, the situation of 2012, too, will have to come to an end.

Going by the above assumption of a market situation not being constant for too long, the risk is very low when it comes to buying the beaten-down stocks in the realty and infrastructure segments compared with that in buying a stock from the FMCG sector, which has outperformed the market for the past five years and is quoting at extremely high multiples now.

We are of the view that the time has come for investors to once again look at the beaten-down sectors and take exposure to companies that have good fundamentals and relatively clean managements and balance sheets. The reward for investing in beaten-down stocks from the real estate and infrastructure sectors will be much higher compared with what one would earn by sticking to highly defensive stocks.

Stocks from sectors like real estate and infrastructure have gone through a phase of consolidation and it is only a matter of time before they start showing improved performance and draw the attention of institutional investors again. We would suggest investors to look at companies where the debt is low; but do check carefully the debt at the subsidiary level besides the load on the books of the parent company. The moment there is a recovery in commercial realty, bottomlines of realty companies with zero or extremely low debt are going to see a big jump and that will lead to the re-rating of some of these stocks.

When we say re-rating, we do not anticipate real estate stocks to touch the heights they had touched in 2008, but a number of them surely have the potential of giving more-than-decent returns in the very short term.

Besides debt level, investors should also look at changes in shareholding patterns of the companies. Stocks where current FII holdings are not very high simply because they were listed after the 2008 meltdown, or the ones that have seen a steady rise in FII holdings along with a rise in prices are the ones that have high pros­pects. Firms that claim to have huge land banks and have been hit by FCCB issues are better avo­ided, as they are unlikely to see any improveme­nt in valuations anytime soon. Similarly, infrastructure companies that have high debt levels or FCCB issues should better be avoided. zz

(The writer is director of independent brokerage Elan Equity Services and consulting editor of Financial Chronicle)

rajivnagpal@mydigitalfc.com

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