 "Higher ratings correlate with higher stock returns")
A sum of Rs 1 lakh invested in a portfolio of AAA-rated stocks in March 2006 is now worth Rs 3.9 lakh. A similar investment in the Sensex is now worth Rs 2.2 lakh.
The analysis is based on the past 10 year's month-end market capitalisation data for 46 non-government companies whose long-term debt is AAA-rated. Long-term debt comprises term-loan bonds and debentures, and pass-through certificates in the case of mortgage lenders.
Most of these companies, part of the AAA-index as calculated by Business Standard, have enjoyed this rating for 10 years. These include top corporate groups and business leaders - Reliance Industries, Tata Consulting Services, L&T, ITC, Housing Development Finance Corporation, Maruti, Tata Motors, Bajaj Auto, Hindustan Unilever, MRF, Hero MotoCorp, Sun Pharmaceutical, Cipla, UltraTech Cement, ACC, Nestle and Exide, among others. And, have out-performed the broader market in the period.
A majority of AAA-rated companies belong to cash-rich and low capital-intensive sectors such as consumer goods, information technology (IT) services and pharmaceuticals. There are only a handful of non-government companies in the capital-intensive sectors such as metals, infrastructure and commodities whose debt enjoys AAA-rating. The exclusive club includes Hindustan Zinc, L&T, Cairn India and Reliance Industries, beside cement makers.
AAA-rating is, however, no guarantee for a success on the bourses. Nine of these underperformed the broader market in the past decade. Reliance Capital is the biggest laggard and gave a negative return of 2.2 per cent in the period. Followed by GE Shipping Company (-0.6 per cent compounded annual growth rate or CAGR), Cairn India (0.9 per cent) and ACC (4.7 per cent). Other laggards are Wipro, Siemens, ABB, Tata Investment and Cipla.
Outperformers, however, more than compensated for the poor show by laggards and helped the AAA-rated portfolio beat the benchmark index by a wide margin. This list is led by pharma major Lupin, whose market capitalisation has grown at a CAGR of 35.3 per cent in the past decade. Followed by Dewan Housing Finance (32.3 per cent), Asian Paints (30.1 per cent) and Kotak Mahindra Bank (29.8 per cent).
Analysts are not surprised. "Top credit rating typically goes to companies with quality management, good corporate governance and strong operational and financial performance. These are mostly likely to make the most of any market opportunity and grow faster," says G Chokkalingam, head, Equinomics Research & Advisory.
The combination of a stronger balance sheet and lower cost of borrowing makes their growth model more sustainable than peers with lower ratings, he adds. AAA-rated firms can borrow capital at the most favourable terms, lending support to profits.
Others, however, caution against getting carried away by the historical performance. "Strong finances are not the only reason for AAA-rated firms to shine on the bourses. Top companies in defensive sectors such as FMCG, pharma and IT also gained from a valuation expansion, as equity investors ran for safe havens due to a global economic volatility," says Dhananjay Sinha, head, institutional equity, at Emkay Global.
"As the market got flooded with cheap liquidity after the 2008 Lehman crisis, many of these firms turned into quasi-safe havens, resulting in their valuation expansion. The situation might reverse if liquidity conditions tighten or economic growth revives," he adds.
