Most wanted stocks

Patience pays, especially when it comes to stocks. Any investor will vouch for this. If you give stock investments enough time to grow, they will churn out bountiful returns. But patience alone isn't enough. You also need solid research and analysis to pick the right stocks.

However, most retail investors skip these crucial steps of the investing process and leapfrog into the final stage, basing their purchases on tips from friends, colleagues and brokers. As a result they often buy high and sell low, the opposite of what investment gurus advise.

Doing your own research is the best way out. But this is easier said than done. There are 5,287 firms listed on Indian bourses. Sifting through brokerage reports on these stocks is not the best way to spend a weekend. Thankfully, there is a smarter way. Find out what the best minds on Dalal Street are buying and follow in their footsteps.

The 404 equity mutual funds in India have invested roughly Rs 1.97 lakh crore in stocks. Each mutual fund has an army of equity analysts, which puts firms under the financial equivalent of an MRI scanner. Every strength is inspected and every weakness is studied in detail. Opportunities are explored, threats are scrutinised.

Only when a firm is found fit is the investment team given the go ahead. In the past one year, the Sensex has risen 25.65 per cent, while the average diversified equity fund has climbed 38.42 per cent. Clearly, fund managers know what they are doing. For you and me, it means that we can rarely go wrong when we buy stocks in which these financial whiz kids invest.

Following in the footsteps of smart money, however, is not as simple as it seems. Yes, mutual funds are choosy, but the universe they invest in is vast. The latest data on mutual fund holdings shows that they hold shares of 705 firms. It's a heady mix of largecaps, mid- caps and small- caps. What do you buy? This is where our cover story will come in handy.

Money Today teamed up with Value Research to conduct a study of mutual fund portfolios and identify the stocks most wanted by fund managers.

A simple aggregation of the portfolios of all mutual funds yielded predictable results. Reliance Industries was at the top, followed by Infosys, SBI and ICICI Bank. The problem was the distorted picture that such a listing gave. Bharti Airtel is the eleventh most widely held stock by funds. However, the funds were busy trying to get rid of the Bharti shares in the past year rather than add more.

The number of Bharti shares held by funds has come down from 20.56 crore (adjusted for split in July 2009) in May 2009 to 9.86 crore in May 2010. While these blue-chips were widely held, some were not really the most wanted.

PLAYING IT SAFE

With equity assets worth Rs 1.97 lakh crore under their management, fund managers would want to play safe. They have parked around 37 per cent of the funds in index-based blue-chip stocks. This ensures that the NAVs do not drop below acceptable levels.

"No fund manager will be criticised for buying an Infosys or an ICICI Bank," says Value Research chief executive officer (CEO) Dhirendra Kumar. Even in the worst case scenario of a market meltdown, the returns will closely track the broader market indices.

The top 10 stocks held by mutual funds (by value) figure in both the Sensex and the Nifty. Investments in these 10 stocks add up to 21 per cent of the total equity assets of the industry. Even here, fund managers have been very choosy.

In the past five years, the Nifty has delivered an annualised return of 19 per cent, while the top 10 stocks registered an average growth of 25 per cent. In the past three years, the Nifty grew by seven per cent per year, while the fund managers’ top 10 picks grew by 14 per cent.

If you seek stable growth, pick stocks from this list. Finding the next Infosys is the ultimate dream of any stock investor, the holy grail of investing. But these top 10 stocks are already richly valued, commanding an average price multiple of over 24 times their 2009-10 earnings per share (EPS). This is at a premium to the BSE-500 Index, which is trading at 20 times. For better returns, investors need to look beyond the top 10 list.

To do this, we tweaked the study to look at stocks in which mutual funds had consistently raised their exposure in the past one year (May 2009 to May 2010). From the total 705 stocks, we were left with a more manageable 34 scrips, comprising 12 large-caps, 15 mid-caps and seven small-cap stocks.

LARGE-CAP STOCKS

The 12 large-cap stocks, in which fund managers have increased their exposure in the past one year, account for almost seven per cent of the total equity assets of the mutual fund industry. As on May 31, 2010, funds had allocated a gargantuan Rs 14,456 crore to these stocks.

It is interesting to note that fund managers are betting on firms that have just come out of the earnings slowdown. Seven of the 12 firms saw a strain on their finances during the past couple of years due to the economic slowdown, acquisition costs, operational difficulties or government regulations.

As these firms went through a painful business reorganisation, their stocks lagged the broader market. However, with the economy back on track, these companies started witnessing robust sales. This made the fund managers lap up more of these stocks. A case in point is Ashok Leyland.

As the industrial activity picked up, fund managers rightly guessed the demand for commercial vehicles and bought more Ashok Leyland stock. Their holding in this firm has gone up from 205 lakh shares in May 2009 to 669 lakh shares now, a jump of 226 per cent in one year. The firm was struggling to sustain sales in 2008. At the height of the economic slowdown in 2007-08, its EPS dropped from Rs 3.50 to Ra 1.40, a fall of 59 per cent.

However, sharp economic recovery helped the company improve its operational performance. By 2009-10, the company was back on track, reporting a 122 per cent jump in EPS. In line with improving business activity the firm reported a 140 per cent surge in fourth quarter volumes, which led to a 21 per cent growth in sales from last year. Its EBITDA margin of 12.9 per cent is the best in six years.

With the commercial vehicle cycle clearly on an uptrend, analysts are pencilling a double digit growth in the firm's sales for the next two years. "We raise 2010- 11 EPS estimate by 45 per cent and 2011-12 by 55 per cent to reflect good CV demand outlook," says Anand Rathi. The research house expects the firm to report a 30 per cent rise in sales in 2010-11.

Glenmark Pharmaceuticals is another stock that has seen a rise in fund managers' interest. From 21.8 lakh shares in May 2009 to 1.08 crore shares in May 2010, fund managers have raised their stake by five times. The stock has been underperforming due to a series of setbacks on the research front. The firm was not able to sign substantial out-licensing deals for around two years.

Four years ago, Dr Reddy's had acquired Betapharm for Rs 2,250 crore. While this helped it access the German market, the subsequent regulatory and integration issues were a drag on its finances. Soon after the acquisition, the German market shifted to the tender-based model, making it difficult for the firm to sustain sales. The firm's revenues from the German market dropped 26 per cent from Rs 985 crore in 2008-09 to Rs 30 crore in 2009-10. Subsequently, integration issues and erosion in market value of Betapharm plunged the firm into losses.

Due to the re-valuation of Betapharm and low revenues, Dr Reddy's incurred a loss of Rs 917 crore in 2008-09. However, by early 2010, the acquisition issues smoothened out and the firm returned to profits in the January-March 2010, quarter. For 2009-10, it booked profits of Rs 351 crore.

Tata Motors is another stock that has caught the fancy of fund managers due to a turnaround in operations. Easing liquidity conditions and improving sales at JLR helped the firm turn profitable in the last quarter of the last fiscal.

The firm posted a profit of Rs 2,516 crore for 2009-10, against a loss of Rs 2,465 crore in 2008-09. The income went up 30 per cent to Rs 92,519 crore against Rs 70,370 crore in 2008-09. The high sales volumes turned the UK-based unit profitable during the quarter.

Financial services is the hottest sector for mutual funds, accounting for 18.36 per cent of the total equity assets. HDFC is the only blue-chip stock that was consistently bought by the fund managers over the past one year. This is due to its consistent growth in earnings and dividend payout history.

HDFC has surprised the investors by reporting a 23 per cent rise in the April-June net profits. The firm reported a robust growth in approvals as well as disbursements for individual loans, which is visible through the 17 per cent growth in the loan book. Other financial stocks include Allahabad Bank, LIC Housing Finance and Shriram Transport Finance.

There are two entertainment stocks as well. Zee TV has gone through restructuring and has bought six regional entertainment channels from Zee News. This helped the firm promote its channel more aggressively and improve the margins.

During 2009-10, the regional entertainment channels generated a revenue of Rs 404 crore and an EBITDA of Rs 126 crore. This translates to an EBITDA margin of 31.2 per cent, higher than that of standalone Zee TV. Analysts say the acquisition will enhance the earnings of the firm.

Another aspect that worked in favour of these two stocks is the improving ad revenue and growing viewership. Despite intense competition from sports programmes and other Hindi networks, Zee TV continues to dominate the Hindi entertainment space with a share of 20 per cent.

Sun TV, on the other hand, is being preferred for its dominant position in the lucrative south Indian market. Buoyed by a growing ad market and lower staff/content costs, Sun TV has posted a 40 per cent rise in 20090-10 revenues. This translated into an EBITDA and profit growth of 52 per cent and 41 per cent, respectively. The growing DTH penetration and its focus on overseas markets are expected to drive its pay TV revenues.

Finally, the recent deregulation of petrol and hike in gas prices has enhanced investor interest in ONGC. Mutual funds' holdings in the stock went up by 50 per cent to four crore shares in May 2010. Deregulation in prices is likey to reduce the overall underrecoveries and improve earnings visibility of the PSU.

According to Motilal Oswal, of the total gas volumes of 57 mmscmd, around 50 mmscmd is sold under the administered price mechanism. The price hike is expected to result in an additional revenue of Rs 7,100 crore for ONGC. With partial decontrol of petroleum prices and hike in gas prices, this percentage share in under-recoveries is expected to come down.