For the past few months, as the earnings scenario has deteriorated and stock prices have plunged, it is been more difficult to come up with short-term recommendations. Growth is hard to come by and unlikely to be immediately rewarded by rising share prices.
The Q2, 2011-12 results are around the corner. Expectations are low. Consensus says there will be moderate or low earnings growth. Margins will be squeezed by high inflation. Under the circumstances, there could be an upside if there isn’t a downside! That is, due to low expectations, there is room for positive earnings surprises.
More pragmatically, investors will have to remain patient. This is a bear market, and given an uncertain global economy, things could get worse with share prices trending further down. The collective FII attitude is the biggest driver of short-term sentiment and the buy-sell patterns of FIIs are driven much more by global factors rather than by the domestic Indian situation.
Right now, it’s Catch 22 when it comes to FII attitude. If the global economic situation gets worse, the FIIs will run for shelter to hard currency bond markets. If the global situation improves, they will seek quick gains in beaten-down developed world equities. Either way, India is unlikely to be a favoured investment destination for a while.
In the circumstances, Indian investors should probably continue to avoid small caps and mid caps. During bear markets, smaller scrip can turn illiquid. The historical record shows that smaller counters lose more ground than large caps.
In the large cap space, one of the safer ways to proceed is by using dividend yields as a possible filter. Right now, the Nifty is trading at a weighted average dividend yield of 1.5 per cent. That is already well above the five-year average yield of 1.24 per cent. There are quite a few Nifty stocks trading at higher yields than that average.
An old Wall Street strategy is to buy the five highest dividend-yielding stocks in the Dow with the intention of holding until at least the next dividend is paid. If we applied that method and bought the five highest yielding Nifty stocks, the portfolio would be Hero Motor (5.3 per cent), Tata Steel (2.7 per cent), PNB (2.3 per cent), Tata Motors (2.3 per cent) and NTPC (2.2 per cent). Assuming equal weights, that is an average dividend yield of 2.9 per cent.
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This portfolio consists of three highly cyclical stocks, a PSU utility that is not doing very well and a PSU bank that is struggling to cope with higher interest rates. If you believe the business cycle is close to a bottom, you’re getting a fair chance of an upside in these stocks. Meantime, the yield provides a tax-free cushion.
The author is an equity and technical analyst