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Concepts & Tutorials

Big dips: How to choose stocks in a downturn

The Nifty’s fallen 15% since its highs, and even then I had said that it was not undervalued. I seem to put my foot in my mouth when I comment but I still maintain that we are not overvalued.

Currently, the Nifty has a P/E of 18. This may not sound significant but from what I see, nothing much has changed in the earnings growth area! Meaning, I still expect to see growth of over 25% in the top few companies (which comprise the Nifty) and this means that there is still value in these companies.

Tata has acquired Corus at a 12 billion dollar value, and Suzlon and Hindalco are also paying big money for their acquisitions. This will hit their books in the short term, but provides excellent long term value for all these companies, mainly because the integration will give them lower costs and higher margins.

Reliance and IPCL will merge and the benefit will entirely go to Reliance. Think about it – IPCL has a P/E of less than 6, and Reliance is at about 18. IPCL has past 4Q earnings of Rs. 50 (approx) per share, which adds to Rs. 1300 cr. of profit over the last four quarters. The combined entity, if you add up the last four quarter profits, will have 11,857 cr. of profits, giving an EPS of Rs. 82 per share. At the current price of Rs. 1285, RIL shareholders will have a company of P/E 15 or so – which, at the rate it’s been growing, is remarkably cheap. I am personally buying RIL shares on a regular basis nowadays.

Now, what am I saying? Should you just go and buy any company because the Nifty seems undervalued? Well, no. Like in the RIL-IPCL case above, make your decisions based on future potential.

A lot of companies will seem like bargains to you now. Bajaj Auto at 2500! It was up to 3000 a couple months back! But that is no reason to buy, because 3000 could have been simply too high an expectation. In the face of rising interest rates, people will have lower leverage to buy vehicles, so the growth may be tempered. Plus, with the world cup around the corner, Hero Honda, a prime advertiser, is likely to put a lot of heat on Bajaj. So perhaps Bajaj is not the best bet today.

Another example: SBI is at 955, and just three months ago it was above 1200. That’s a 20% drop and may look like a darn good deal! Unfortunately, interest rate hikes and slowing growth in retail lending will take its toll, and perhaps SBI will not grow at 20% or more in the next few months.

But there are others which sound just too good to be true. BHEL for instance, has an existing order book of 30,000 cr. Plus, the government wants more ultra mega power projects, which BHEL has a lot of expertise in. And the growth seems less dependent on interest rates or competition pressure, so the earnings visibility is fantastic. Add to this the fact that they’ve announced a 1:1 bonus (likely to be decided by May) and that their price is now at Rs. 2,000 (a P/E of 24). At the current price this seems like a great buy!

Disclosure: I own all the stocks above. And none of these will give you benefits overnight or within three months. Think of this as investments that will pay your medical bills when you are old.

If you find a vendor selling apples cheap, will you buy the half rotten ones that were ripe a few days back? Or will you choose only the good ones? It doesn’t matter if they are cheap, you still want good apples.

This market has a lot of value, but you must search for value that is absolutely plain and obvious to you. Don’t buy based on other people’s tips, or what you remember of the stock price during the boom.

And if you find a good stock, please let me know too. Perhaps we can share and earn a lot more together!

  • Giridhara Srinivasan says:

    >Hi Deepak,
    Thanks for your opinion. I’m also thinking to purchse RIL shares. Some friends suggests me to purchase IPCL, because as per IPCL board meeting, it declared dividents and we can get 1 RIL share equivalent for 5 IPCL shares. But my opinion is, before 7th of this month, if we purchased the IPCL shares it will be worthy. Now a days 5 shares of IPCL is morethan 1 RIL share 🙂

    Regards
    Giri

  • hari says:

    >Hi DEEPAK,

    I would like to get your views on the pharma sector. I think Ranbaxy is a superb pick for the long term.Since you have mentioned that the company should be independent of intrest rate and other stuff,I think the Pharma sector is evergreen(I feel it will see sustained growth). If I am wrong please correct. I thank you a lot personally for suggesting a few stocks.This is a great blog. You have done a great work. I will try to mail you a few more picks that I feel will be good.My email id is hariharan666@yahoo.com. please do mail me.

    Regards
    hari

  • Deepak Shenoy says:

    >Hari: Thanks for the kind words. I like Ranbaxy as well – in fact a very significant part of my portfolio is in Ranbaxy and DRL now. It’s a time when they are not recognised as much and they will be great in the future, I feel – but they will perhaps take a few years to fructify.

  • Vikram says:

    >HI Deepak
    What do you think of ICICI BANK?
    Inspite of rising interest rates and the like, ICICI’s continues to register good earnings growth and profit margins as compared to SBI.
    Also, since they’re gonna demerge their insurance and asset management businesses, that should unlock a lot of value.It looks quite cheap at these prices. But they have already mentioned a slowdown in Home loan and retail loan demand. Thats a cause for concern but I still think that inflation is at manageable limits and should cause no major impact on the banking sector.
    Vikram

  • Deepak Shenoy says:

    >Vikram: I personally don’t like the story of ICICI bank for its high valuation. Currently it’s valued at 23 times earnings, which is nearly double that of SBI (13 times earnings). SBI is bigger and has far more coverage, plus is getting into the retail space in a very big way – and the competition will hurt ICICI.

    Plus of course loan defaults will start in the next year, and pressures on retail lending will show.

    The AMC is not very valuable, honestly – frankly, SBI and Reliance are leaders in the pack and have beaten ICICI comprehensively here. The insurance business is ok only because they are new and claims haven’t started coming in big time. I have personally faced claims issues with ICICI (medical insurance) and I believe their insurance business will collapse if they continue in this fashion.

    Personally I have only had bad experiences with the bank: They tried to corner funds when we did money transfers through them, they performed dismally on the only mutual fund I ever bought from them (tech), they have refused to help me close my broking account despite three years of reminders and are still charging me fees.

    See these comments and this page for more such experiences.

    When you find such things it is usually a very bad signal. I wouldn’t buy this stock at all, because of my experience, but you need to make a choice based on yours.

  • Girish says:

    >Hi Deepak,

    A informative blog to read for a new investor like me. Your analysis based on P/E ratio gives a good start to me. I would like to know your opinion on Idea Cellular, I personally feel they have a good growth potential in near future, since they are targetting tier 2 cities where major players have less penetration. So is it a good buy at the current levels ?

    Thanks,
    G

  • Deepak Shenoy says:

    >girish: Thanks! I think Idea is relatively new in the market and they have no earnings, so it may be betterto wait for them to show some growth before you buy.

    I like the company but I can’t imagine that growth will to to a point where the current valuation makes sense. but I may be wrong so I will wait for a couple quarters to check the growth…

  • Alien says:

    >Hi..

    I have been looking at kalpatru power and infotech enterprises. the latter has run up quite a bit in the recent past… I am wondering if it will consolidate a bit and continue the uptrend?

  • Sivaprakasam says:

    >What do u think abt Reliance Capital?

    In Dec2006, I bought it at 570 and sold@690 in Feb07.Its 52-week high was 729.
    Again,I bought it at 577 on 06Mar07 and sold at 660 on 22Mar07

    I wish to suggest you that you can analyse selective stocks in all sectors and
    mention why particlular or particular sector stocks suddenly goes down/up.For example,
    after govt. pressure, cements stocks are down.

    Can u pls tell me why is SUN TV this much high?

  • Anonymous says:

    >Again, SBI is doing pretty well. Its at 1600+…Banking shares are generally doing good. What say??

  • Anonymous says:

    >Hi Deepak,

    I would like to congratulate you for taking this initiative to set up a blog dealing with these subjects. I am pretty new to investing and all, and stumbled upon your blog as I was looking for info. Thanks. Will dip in again and perhaps leave a few drops in your ocean later. Cheers!

    Cyn.