ICICI Securities believes that unless the risk-on environment returns driven by private capex cycle revival, the current paradigm of factor performance will continue.
The market has been rangebound since December especially after the strong rally in November, which indicated that market may have discounted sharp fall in oil price, rupee appreciation from historic lows, and hope of rate cut and early resolution to trade tensions between US & China.
If we check the data from last month, Nifty50 has been broadly in a range of 10,400-10,900 levels. Apart from general elections 2019, which could keep market volatile in first half of 2019, the rangebound trade suggested that the market could be waiting for strong earnings recovery, which could be possible in second half of 2019, experts said.
In addition, the consumption boost which we have been seeing for last couple of years is largely due to government (public) capex and not private capex.
Analysts largely have been expecting the private capex to pick up but it has not been happening on ground, so unless that happens one has to be very stock specific where sustainable earnings growth and, return on equity are high, and where the government spending is reflecting, experts said.
"We believe that unless the risk-on environment returns driven by private capex cycle revival, the current paradigm of factor performance will continue and low risk, asset light business models with strong sustainable earnings growth will be in vogue," ICICI Securities said.
It expects outperformance from factors like high operating asset turnover (OPATO), mid-low beta, low financial leverage, sustainable high earnings growth, high RoOA (return on operating assets), high RoE (return on equity), and select capital intensive stocks (low OPATO) which are positively impacted by government spending.
Here are these factors explained by ICICI Securities to pick 9 stock ideas:
Factor performance changed post FY10
Empirical analysis of the BSE 200 universe based on factor quintile performance since FY05 indicates that Indian stocks entered a different environment in terms of factor performance since FY10.
During the previous bull-run (FY05 to FY08) factors which outperformed significantly were low asset turn (OPATO), high financial leverage, high beta, low P/B (price-to-book value), low RoOA, low RoE and low market capitalisation. However since 2010 there has been a paradigm shift and factors which changed course since then are high OPATO, low beta, high P/B, high RoOA, low financial leverage, and high RoE.
However, during short spurts of bullishness (such as FY10, FY15 and FY17) factor performance reversed to FY05-08 patterns.
As against the above factors which changed course, high earnings growth remained the outperforming factor across time irrespective of the market environment.
Cheapest stocks on P/B have been a 'value trap' post FY10
Cheapest stocks (quarter fifth) in terms of P/B (typically stocks with high capital intensity and financial leverage) were amongst the best performing portfolios from FY05-FY10. However post FY10, the lowest P/B quintile stocks have been 'value traps' thereby resulting in the worst performing portfolio amongst the BSE 200 universe.
Primary reason for the huge underperformance of the lowest P/B quintile portfolio has been the deteriorating ROE from around 17 percent in 2008 to 6 percent in 2018, significantly below cost of equity as profitability deteriorated. On the other hand high P/B (first quarter) stocks have outperformed.
Expensive stocks on forward P/E have outperformed since FY10
Outperformance of high forward P/E stocks is explained by market awarding high valuations to growth stocks. However, on a trailing P/E basis the results are not conclusive as prolonged earnings recession and volatile earnings has distorted the observations.
Low risk – high returns
Contrary to conventional logic, stocks with low risk as measured by lowest beta have outperformed significantly (quarter fifth - 15.6x) since FY05 except for periods of strong bullish environment such as of FY07-FY08.
Mid-size stocks outperform over the long term
Although FY19 has been the year of mega cap outperformance, over the long-term, mid-size stocks have outperformed the most. Midcap stocks that are leaders in sectors with attractive growth prospects will outperform significantly.
FY19 so far – Expensive, low risk and large cap stocks outperform
Amongst factors which have outperformed strongly in FY19 so far are: (a) high trailing P/E & P/B, (b) large market capitalisation, and (c) low beta while underperformance is observed at the other extreme.
On valuations, the research house prefers high P/B and moderately high P/E (price-to-earnings) stocks. On market capitalisation, it prefers a mix of large-caps and industry leading mid-cap stocks.