It is with mixed feelings that we write this first annual review of our Prime Stocks performance. When we flagged off stock recommendations as a new addition to our platform on January 14 2021, it was after a lot of internal debate on whether it was the right time to do this.
In early 2021, the economy was in the doldrums after the first wave of Covid and the earnings outlook for India Inc was uncertain. Yet, stock markets appeared detached from ground realities with the Nifty PE at 40 times and signs of a super-heated market were visible everywhere. First-time investors were joining the equity cult in droves, fleeting stock ideas were turning into multi-baggers and the prevailing narrative was that no price was too high for ‘quality’ stocks.
However, as believers in the long-term potential of equities, we felt that we owed it to our subscribers to unearth good companies in all kinds of market conditions, without waiting for the ‘best’ time that may never arrive.
In a bull market, a rising tide lifts all boats – even leaky ones. Therefore, while selecting stocks we decided to err on the side of caution by:
- Stringently filtering the listed universe for companies that met a high bar on fundamentals – good revenue and profit growth in the last 3/5 years, low leverage, high and stable operating profit margins, Return on Equity and Return on Capital Employed.
- Finding stocks from the filtered universe that had not been bid up to a huge valuation premium, either over the stock’s own historical multiple or the market
- Sticking to recommendations from sectors we knew and understood and avoiding those we hadn’t tracked closely
- Focusing on businesses with the ability to compound earnings over the next 3 or 5 years, without worrying too much about whether the stock price would run up quickly
- Looking for stocks with ability to contain downside or pay healthy dividends that would protect investor value in the event of a market crash
Given this defensive approach, we tried to set realistic expectations from our Prime Stocks’ performance through this January 2021 post that clearly highlights our philosophy with stocks.
The above process resulted in our making 17 buy recommendations through 2021. This is outside of the many avoid IPOs that we gave as we were seldom comfortable with the offer price of these IPOs, whether they delivered on listing or otherwise.
On December 25, as we take stock of how these recommendations have fared relative to their relevant benchmarks such as the Nifty 50 and Nifty 500, we know that we’ve delivered very mixed results to our investors.
Viewed in terms of stock price performance, these were recommendations that delivered positive returns to our subscribers. The stocks that did perform delivered returns beyond our expectations for single-year gains.
Of the above, IRCTC, which trebled in short order, ran up so far beyond our comfort zone on valuations that we downgraded the stock to a Hold on July 26, to prevent folks from buying into a speculative frenzy. In hindsight, the call proved well-timed.
We recommended the IndiGrid Invit more as a dividend/passive income holding, than as a ‘stock’ with growth prospects. While it is early days to evaluate if its distributions match our expectations, the unit price has unexpectedly gained more than the market. On the above stocks that have delivered on earnings and exceeded our expectations on price gains, we will continue to track performance.
But we will not be in a hurry to ask investors to ‘book profits’ based on price gains alone, as long as the underlying company is delivering earnings growth and is performing in line with our investment thesis. We would like to avoid the newbie investor mistake of hurting portfolio returns by cutting the flowers and watering the weeds.
The following stocks on which we put out buy recommendations are sorely disappointed. They not only lost money for investors who entered them at our buy price, but also trailed the index in the period since our call.
We don’t see this underperformance as cause for alarm. But being equity investors ourselves (we own personal stakes in most of our recommended stocks), we do understand the pain that our subscribers go through when stocks they own sit tamely on the sidelines or go into a decline, when other stocks in the market are doubling or trebling with seemingly little effort.
As fundamental stock pickers who’ve seen a few market cycles, we know that it is unrealistic to expect prices of our portfolio companies to move in line with the index over short time frames such as a year.
Stocks that outperform or underperform markets over short terms often do so due to the market’s sectoral fancies and any diversified portfolio cannot expect to have all its stocks beating the market at any given point in time. Given this philosophy we would not be unduly worried if the companies we’ve picked have delivered on the earnings growth we projected for them, but have not been recognized by the market. We firmly believe in the credo that stock prices are slaves to earnings. Therefore, prices and PE multiples will ultimately catch up for companies from our reco list that do deliver expected earnings expansion.
But we are worried about companies that saw substantial downside in a rising market, failing to meet our defensive objectives. We will also be rethinking our stance on companies that failed to deliver to our expectations on the earnings front, or where our investment thesis seemed to be faltering.
As investors, we know that the biggest mistake that we can make is to not admit to bad stock picks and to convert them into ‘long-term’ holdings. Over time, hanging on to duds and booking profits in outperformers is a sure recipe to failing in equity investing. This is why we undertook an honest re-assessment of our lagging stock recommendations at year-end, to tell you if our investment thesis remains intact. You will find our stock-wise commentary on our laggards here (stocks that have crossed at least a 3-month period since our recommendation).
A few stocks from our recommendation list are yet to complete three months from our buy date and it would be futile to take stock of them at this juncture. Honeywell Automation, Syngene and Equitas Small Finance Bank fall in this list. We will however not neglect to track their earnings performance, to see if our thesis is playing out.
Changes to our approach
Apart from preparing a report card on how the stocks we recommended fared, we also prepared one on the market opportunities on which we missed out. For this, we sliced and diced the performance of the Nifty 500 stocks. We learnt quite a few lessons from this exercise, which we will be sure to apply from the coming year.
- Despite pricey market valuations at the beginning of the year, we took a conscious call not to seek safety in large-caps and to remain market-cap agnostic in our choices. This worked out. As the table below shows, stocks in the mid-cap basket outperform large-caps by a good margin and small-caps didn’t fare much worse. In the year ahead, though we expect a market correction, we will continue to pick stocks from across the market cap spectrum, as we believe that the quality of a company’s business has nothing to do with its market capitalization.
- 2021 was a year of hectic sector rotation in the market. We missed out on a good number of opportunities because of sticking to sectors that were familiar to us. A break-down of the sector-wise returns in the Nifty 500 revealed the following divergence.
The above data will tell you that we remained prudent by staying off pharma, FMCG, banking, paint and insurance stocks that were flavours of the season when we kicked off our recos, but turned laggards later in the year. We also caught outperformers in railways, specialty chemicals and software.
But we didn’t help investors by sticking to secular earnings plays and staying away from core-economy sectors such as power generation, textiles, chemicals and non-ferrous metals which threw up some blockbusters. In the year ahead, we will remedy this by adding core economy sectors to our coverage as we think the economy will pick up speed. We think the Omicron threat won’t be long-lasting and if it is, won’t lead to business disruptions like the first two waves. We will also strive to evaluate opportunities from sectors outside our comfort zone based on individual merit.
- Our conservative approach on refusing to pay high valuations for ‘quality’ stocks also led to missed opportunities. Taking stock of the year’s multi-baggers we don’t regret missing a Tata Tele Maharashtra (up 2047% in one year) or a Poonawala Fincorp (earlier Magma Fincorp, up 383%), which are loss-making and wouldn’t have made it past our quality filters. But we do regret dilly-dallying on IEX (up 222%), CDSL (up 175%) or Linde India (up 138%). These stocks did meet our quality filters and figured on our stock watchlist way back in December 2020, but their pricey valuations even then (trailing PE ratios of 35 times for IEX, 40 times for CDSL and nearly 70 times for Linde) deterred us from putting out buys. While we regret such misses, we are not tempted to chase high PE stocks in the year ahead.
We believe that the market’s indifference to multiples and its willingness to pay nose-bleed valuations for quality businesses in the last couple of years has been driven largely by the gusher of FPI and domestic flows into Indian stocks and record low interest rates. With inflation rising and developed world central banks reversing both easy money and low-rate policies, we think the year ahead could very well see a ruthless de-rating of global equity multiples, Indian markets and quality stocks with modest growth. Our investment approach will thus accord a higher weight to valuations than it did last year.
- Finally, while it is nice to put out homilies such as ‘time in the equity market is more important than timing’, we are pragmatic stock investors and don’t really believe in them when it comes to direct stock investing. We know fully well that, to make a reasonable return from any stock, the timing of our entry (and sometimes exit) makes all the difference. A high-quality business bought at the wrong price will not deliver long-term results. A business with poor past financials may turn around if bought at bargain valuations. We will therefore be making our best attempt to time our equity calls to corrective phases in this market (which we believe will be plentiful this year).
We urge our subscribers not to lose patience if we refrain from calls for extended periods or bunch them up at one go. From our side, given that downside protection remains a key objective with all our stock calls, we hope to take help from experienced chartists to time our fundamental buys better.
In order to have a clear objective and set your own return expectations clear in our stock calls, we recently classified our recommendations into the following categories:
- Earnings Compounders
- Tactical buys
- Dividend earners
- Early movers
We have provided the explanation of what each of them mean when you go to their individual tab in our Stock recommendation page. When you choose your stock calls, depending on your objective and your risk profile, this classification may help pick the stock most appropriate for your needs.
Disclosures and Disclaimers
The following Disclosures are being made in compliance with the SEBI Research Analyst Regulations 2014 (hereinafter referred to as the Regulations).
1. PrimeInvestor Financial Research Pvt Ltd is a SEBI-Registered Research Analyst having SEBI registration number INH200008653. PrimeInvestor Financial Research Pvt Ltd, the research entity, is engaged in providing research services and information on personal financial products. This Research Report (called Report) is prepared and distributed by PrimeInvestor Financial Research Pvt Ltd with brand name PrimeInvestor.
2. PrimeInvestor Financial Research Pvt Ltd, its partners, employees, directors or agents, do not have any material adverse disciplinary history as on the date of publication of this report.
3. PrimeInvestor Financial Research Pvt Ltd has not received any compensation from the subject companies in the past twelve months. PrimeInvestor Financial Research Pvt Ltd has not been engaged in market making activity for the subject companies.
4. In the last 12-month period ending on the last day of the month immediately preceding the date of publication of this research report, PrimeInvestor Financial Research Pvt Ltd has not received compensation or other benefits from the subject companies of this research report or any other third-party in connection with this report.