COMMENT: Using history, geography and politics to pick stock winners for FY18

Madhuchanda DeyMoneycontrol Research

The Nifty is ending the fiscal year 2016-17 (FY17) on a high note – with return of close to 18.5%, a sharp turnaround compared to -9% in the previous fiscal.

While the Nifty return has been varied over the years, the divergence in return between the top gainer and loser within the Nifty does suggest that the alpha managers have the last laugh.

No wonder Indian markets remain a paradise for stock pickers, not only in the small and mid-cap space, but also in large cap.

Our research into the top ten gainers and losers does throw up some interesting insights. The winners list is an eclectic mix of companies from various sectors, which makes our market attractive and an interesting investment destination as it is not dependent on a few sectors or companies to propel earnings growth.

Similar diversity is visible in the list of losers as well.

Winners in a particular year rarely repeat their stellar stock price performance the following year – perhaps investor optimism at times runs ahead of fundamentals. Similarly not all losers see themselves at the bottom of the chart year after year. Investor pessimism, guided by stock price performance, at times fails to recognise a possible turnaround. We did some empirical analysis on this list and arrived at a conclusion that winners or losers rarely follow any empirical pattern, and hence fundamental merit of the stock remains the one and only differentiator.

As this analysis suggests winners rarely retain the crown and losers seldom remain underdogs forever. This should provide a useful backdrop as we embark on crystal ball gazing in the large cap space for FY18.

FY17 was a reasonably decent year for the markets that survived the odds of Brexit, Trump’s surprise election victory and demonetisation. While the surprise surge in commodity prices led by output rationalisation in China and the ‘hope rally’ post Trump’s victory didn’t help India, it did support the stock price performance of commodity producers. The best for the markets was, however, kept for the last – the landslide assembly election victory of the ruling Bharatiya Janta Party that provided visibility of political stability for seven years.

As we look at FY18, we see imponderables galore, which is true with equity markets every year. That is what perhaps makes this asset class so exciting. First and foremost, on the earnings front, earnings expectation has to translate into reality in FY18.  It is worth nothing that in the past three years (FY14 to FY17), we haven’t witnessed earnings growth for the Nifty while markets have risen  by close to 37%, thanks to the support of FIIs (foreign institutional investors) and the recent faith of domestic investors

The current valuations at 18.3x FY18P earnings and 15.5x FY19P earnings looks optically reasonable but rides on earnings growth forecasts of 17% and 18% respectively. Investors, should therefore, keep a hawk eye on earnings. Political stability and acceleration of reform including roll out of GST are sentimentally positive and would keep the interest of DII as well as FII alive.

However, while we broadly know that GST is positive for the organised sector, the teething troubles in the initial phase and the impact of the same on earnings is yet to be ascertained. While the monsoon’s impact on markets has waned over the years, a significantly sub-par monsoon coming close on the heels of demonetisation-led disruption will be more challenging. Finally, on the global front, in addition to the impact of Brexit and French election, markets will be constantly distracted by Trump and his policies.

In this volatile backdrop, we present a portfolio of a dozen large-cap stocks to ride on in FY18 and beyond.