Earnings visibility seen key to riding market wave

Analysts urge focus on stocks with growth visibility instead of defensive strengths

With the Sensex scaling new highs, market experts are favouring strategies to focus on companies which offer robust earnings visibility.

Since valuations are no longer cheap and growth expectations are on the higher side, stocks may be increasingly vulnerable to earnings disappointments.

Smaller companies, which are relying on huge expansions, may also be subject to execution risk. As a measure of caution, a shift in focus to stocks with high level of growth visibility, apart from those which display strong defensive strengths should be preferred, according to analysts.

Though corporate performance and economic growth will ensure that stock market do well overall.

"Several companies may be vulnerable to execution risk. So one has to be careful while picking stocks. Companies with proven management may be better bets in these times," says Rashesh Shah, CEO and managing director, Edeweiss Securities.

In the recent rally, several medium and small companies have run up substantially making their valuations unusually rich. The high valuations, however, indicate that growth expectations are running high which means these companies may be more susceptible to disappointments. Already mid-cap valuations are on par with large-caps.

For the record, the Sensex is now trading at a price-earnings ratio of 15.88 times, while the S&P CNX Mid-cap is trading at upwards of 18. "Since growth expectations are running high, one needs to take note of the execution risks that companies face today" says Rashesh Shah.

A recent report by CLSA recommended stocks with visible growth apart from stocks which were likely to improve their profit margins. "With mixed signals from the domestic as well as global economy, for 2H 2005, our model portfolio focuses on visible growth, but also seeks to capture opportunities in stocks with potential margin upside and in bombed-out cyclicals," said CLSA in its recent report.

The firm maintained software, energy, industrials and telecom as its key over-weights citing that the secular growth in mobile telephony, credit-led consumption and organised retailing apart from the "cyclical push" in IT services and engineering and capital goods.

It also included government-owned power utility firm NTPC and domestic pharma companies Sun Pharma and Cipla in its model portfolio, enhancing the defensiveness of the portfolio.

Motilal Oswal expects textiles, metals, telecom and fertiliser will see the strongest growth in net profit. Arvind Mills, United Phosporous, ONGC, Eicher Motors, Hindalco and Hexaware are expected to be the top 10 on the basis it its net profit growth projections. Dr Reddy's, BPCL, HPCL and IOC are likely to be among the worst.