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In the near term at least, the Indian market is likely to remain choppy as foreign investors have turned risk-averse, due to the looming US rate rise that will possibly reduce the flow of cheap money.
The state of the stock market represents that of a falling knife.
Since August, the market has been unable to sustain rallies and the declines have been steep.
While many will argue that catching a falling knife causes bleeding, history is also proof that if the right stocks are bought, the gains could be handsome when the trend reverses.
Weak earnings growth, a deficient monsoon and delays in passing key Bills by Parliament remain worries but the recent fall in the Indian market is largely due to global uncertainties, especially the slowdown in China and on fears of the US Federal Reserve raising its policy rate.
Stocks of mid-cap companies, especially the ones that surged merely on hope, have taken a beating.
Large-caps, too, have fallen.
In the near term at least, the Indian market is likely to remain choppy as foreign investors have turned risk-averse, due to the looming US rate rise that will possibly reduce the flow of cheap money.
A Chinese slowdown will also hurt various sections, especially commodity producers. Most experts believe investors could look at cherry-picking large-cap companies with good earning prospects and track records.
Large-caps in a sweeter spot Manish Sonthalia, senior vice-president and head of equity portfolio management services at Motilal Oswal Asset Management, says, "Whether you buy today or at 500 points below current levels, the India story does not change. Markets are correcting because some India-based ETFs are selling."
You can buy either mid-caps or large-caps but the risk is lower in the case of large-caps.
At the same time, foreign intitutional investors prefer the large-cap names.
The risk-reward will only get better with the market correction."
The cheaper valuation vis-à-vis mid-caps also provides some comfort (see chart).
The price-equity multiple of the Nifty fell below the PE of the CNX Mid-cap in July and the gap has widened.
Whenever sentiment revives, it would be the well-run larger companies with good earning prospects that will rise faster.
Stocks up on mere expectations will take a longer time to gain, and since investors have already burnt their fingers in such counters, others will want to wait for more proof of earnings before taking a call.
Large-caps in a sweeter spot Ajay Bodke, chief executive officer and chief portfolio manager (PMS), Prabhudas Lilladher, also believes large-caps are attractive.
"The market is looking quite attractive from a medium-term perspective. Most of the froth looks to have dissipated.
There are global headwinds determining the course of all markets and India is no exception.
With valuations attractive, the correction is an opportunity for investors.
Large-caps are looking quite attractive from a medium-term perspective, as a rate cut (by the Reserve Bank of India) is imminent," says Bodke.
He adds, with Nifty earnings (12 months ending August 2016) at Rs 484, the index is trading at 15.8 times, in line with its average of the last 10-years' one-year forward earnings.
Large cap companies also have their set of woes.
For instance, metal stocks have taken a beating as metal prices have fallen off the cliff. There are also companies from other sectors with high debt finding it difficult to service these in an environment of benign demand.
So, how does one pick stocks?
"The best way is to position oneself with companies where there are numbers to back and not only hope," says Sonthalia.
He believes companies across information technology, pharma and private banking look attractive and says investors should avoid cement, private sector capex plays, real estate and commodities.
To pick investment-worthy large-caps, we crunched data of the BSE 500 companies. Companies with a market cap over Rs 15,000 crore or Rs 150 billion and those whose earnings are estimated to grow at a compounded annual rate of at least 15 per cent during FY15-17 were considered.
Within these, companies generating a return on equity (RoNW or ROE) of a minimum 14 per cent (in FY15) were looked at.
While fundamentals are important, price is equally crucial.
That's where valuations came into play. Companies with a one-year forward PE (FY17 earnings) of less than 20 times found their way into the list. Bodke says, "When there is panic, you get an opportunity to get your hands on some of the good stocks."
He likes Axis Bank, YES Bank, L&T, Maruti and Motherson Sumi, among others. If markets revive, companies with good fundamentals should do well.
See table for list of companies that met the criteria laid out. Notably, many of the companies (excluding financials) are either almost debt-free or have manageable debt.
Many (including financials) are also among the top players in their sector.
