Right Stock Selection in a Turbulent Market Environment

Right Stock Selection in a Turbulent Market Environment

7 Lakh crores vanishes from the market on a Manic Monday in India with over 500 Billion Euros wiped out in the European market, wonder what has happened to your investments in the stock market which you have made with your hard earned money. With Large cap and Mid cap stocks falling all around there is a blood bath in the world markets with blue chips falling in almost double digits, what stocks does an investor look at investing in and how does one select an appropriate strategy. The classic age old saying is buy low sell high but in practice is this really the low or would it go down further or this is the right time to buy. Even professional investors are unable determine the exact time when to enter a stock at its lowest levels or sell at the heights point hence in order to create wealth in the long term an appropriate long term strategy must be in place  in order to withstand the short term shocks and stress that the markets would pose.

As discussed in the earlier post one of the most important things that one should look at in any stock is the corporate governance standards in the company along with the fundamental strength in the company. In order to make an appropriate choice out of the universe of stocks a few thumb rule techniques could be applied in order to arrive at the appropriate stocks. One of the time tested methods that can be applied and has worked over a period of time not only in the Indian markets but also internationally is the two pillar approach of selection of stocks: Dividend Yield and Return on Equity (ROE)

In order to build long term wealth and have a regular stream of income the strategy to pick high quality companies with a dividend yield of 2% or more and having a ROE of 20% or more could be one of the best possible strategies. Anecdotal evidence shows that Rs 1 crore invested in such a portfolio of stocks which are selected with a dividend yield of 2% or more would end up in a corpus of Rs 4 crores with an initial income stream of Rs 2 Lacs per year growing up to Rs 8 Lacs  at the end of 10 years.

Starting from a universe of all the listed companies listed on Bombay Stock Exchange (BSE) and short listing companies that are selected would be relatively large businesses having market capitalization between Rs 700 crores and above. Post which the criteria of ROE of 20% would be applied and finally the last criteria of dividend yield of 2% or more. The analysis period was January 2003 to June 2015 of such selected stocks shows that a return of 34% compounded annual growth rate (CAGR) over the period when the NIFTY returned 19% CAGR over the same period. This means that the investment of Rs 1 crore would have become Rs 26 Crores in 2015.

The dividend yield at the time of investment in a portfolio having selection using the above criteria was 4.8% and by 2015 the dividend yield was 3.8%. The rupee payouts would have been much higher at Rs. 480,000 in 2003 compared with the conservative estimate of Rs. 2 Lacs and would have been almost Rs. 1 crore in 2015 compared to the conservative estimate of Rs. 8 Lacs that we have taken above.

The portfolio value would fluctuate depending on the time period like in 2008-09 it would have fallen substantially as the markets overall did and the value would have risen in 2014 as the overall market did. The NIFTY has dropped around 55% in one year that being its worst drop, in the same year a portfolio of stocks selected with above criteria would have dropped around 34% much lesser than the overall market.

Applying this portfolio of stocks  to a different time period say beginning of 2005 and you had held these passively till 2015 Rs. 1 crore would result in Rs. 6.3 crores with a 19% CAGR compared to a 14% CAGR of the NIFTY. The dividend received in the period would be over and above this.

If such a portfolio was selected in January 2008 at the peak of the markets the last life time high, the selection would result in picking 15 companies which pass thru these two criteria Rs. 1 crore invested would result in Rs. 3.4 crores over the period of 2008 to 2015 resulting in a CAGR of 18% compared to a NIFT return of CAGR of 5%.

This clearly illustrates that long term wealth generation in the market can be attained by selecting large cap stocks having established track record and a substantial size. The above section criteria would help you select companies in sectors like FMCG, IT, manufacturing, Oil and Gas and Public sector enterprises there by restricting your choice to very large companies and proving the myth wrong that long term investment would give you a multi bagger return only choosing small and mid-cap companies.

In order to survive a very challenging macro-economic world environment it is essential to choose the right companies to make long term investments in so that the returns over a period of 5 to 10 year period would be far superior than the overall market and such a section would result it wealth creation and help in capital protection in very challenging times.  It is of prime importance to evaluate other fundamental factors in selecting a stock but this could be used as one of the techniques used that has stood the test of time and may resulting in similar performance in the future as well.

_ Farzan Ghadially