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Quality Stocks Outperform As Steep Corrections bring value back

Author: Kumar Shankar Roy/Wednesday, March 18, 2020/Categories: Exclusive

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Quality Stocks Outperform As Steep Corrections bring value back

Indian markets have shed a lot of flab tracking negative global cues amid economic uncertainty due to the Coronavirus impact. During such volatile times, smart investors always stick to quality stocks. Quality stocks offer not just safe refuge, but also a cushion for growth. In simple words, such companies are well insulated from global and domestic shocks. Since the Covid-19 concerns are still elevated and lingering, expect the uncertainty to continue in the near term. Historical studies show that quality stocks are likely to outperform in these situations. Read on.

Quality outperforms in major market corrections. Historical analysis done by Elara Securities (2008 -2019) of steep market corrections (in excess of 10%) reveals that in each of the 15 instances (including the current one till March 11), quality portfolio has outperformed the market significantly. For instance, between January to October 2008, the Nifty fell by 60 per cent, but quality stocks fell by 43.2 per cent. In Oct–Nov 2009, Nifty fell by 11.2 per cent, but quality stocks gained by 9.1 per cent. In Jan–Feb 2010 period, Nifty tanked by 10.7 per cent, but quality stocks inched lower by just 0.6 per cent. Between April and May 2010, the Nifty dipped by 10.6 per cent, but quality stock portfolio gained six per cent. Such instances of out-performance can be seen in 2011, 2012, 2013, 2015, 2016, 2018 and 2019 also.

Coronavirus has triggered a global risk-off sentiment and has aggravated the global growth challenges and the incremental growth forecasts for all major economies are turning negative. Lately, the OECD has reduced its global growth expectation from 2.9 per cent to 2.4 per cent and may even lower it to 1.5 per cent if the virus persists which is more worrisome for the markets. In this backdrop, investors should consider adding quality, both large caps and midcaps, to their portfolios. 

What are quality companies/stocks?

Quality stocks have various attributes, First, they benefit from a diversified income stream from its multiple lines of business selling into many different industries. Second, the company has a wide moat defending its business and keeping competitors at bay. Three, the company has limited debt, which means relatively low and serviceable net debt. Four, the company has consistent profits, which give available cash allowing the firm to weather storms and take advantage of opportunities. Fifth, good management is an intangible that is tough to beat in any quality stock. They have an ability to see opportunities and capitalize on them. Additionally, quality stocks are insulated from global demand and supply shocks. Some quality stocks benefit from lower raw material prices (crude and commodities). They also have a good earnings visibility over the next couple of years, which helps in projecting earnings growth.

Is there one metric that can help understand quality?

Yes, some analysts have chosen to use the Piotroski F-Score for a quality stock screen. The Piotroski F-Score concentrates on profitability, capital structure, and operating efficiency in evaluating the quality of a company. The higher the score, the better it is.

Looking for a handy set of quality stocks?

Here are some ideas. Elara Securities' quality list has Hindustan Unilever, Asian Paints, Nestle India, Titan Company, Britannia Industries, Berger Paints, Colgate-Palmolive, Bata India, Relaxo Footwears and Dr Lal Pathlabs.

S&P BSE Quality Index constituents include Adani Enterprises, Bharti Infratel, Bosch, Castrol India, Coal India, Colgate-Palmolive India, Dabur India, Godrej Consumer Products, Hero MotoCorp, ICICI Prudential Life Insurance, Infosys, InterGlobe Aviation, Marico, Page Industries, etc.

An important disclaimer in the search for quality stocks is that investors should not over-pay for such stocks. Last two years have seen investors chasing ‘quality at any price’ theme thereby making risk-reward unattractive.

"Given calibrated auto healing of the economy and prevailing global risk-off sentiment, we see best risk-reward in quality GARP names (such as ICICI, Infosys, L&T, SBI Life) or select turnaround plays (like Axis Bank, SBI, Bharti, DLF) which are witnessing structural endogenous improvements. We also like select value plays (like ITC, Powergrid, Coal India) which have been de-rated, still have reasonable growth prospects and bereft of meaningful risk of business model disruption," says HDFC Securities Institutional Research..

SBI ETF Quality is an exchange traded mutual fund scheme. It tracks the the Nifty-200 Quality 30 TRI index. The fund's portfolio stocks are Hindustan Unilever, Nestle India, Infosys, Asian Paints, HCL Technologies, Tata Consultancy Services, Coal India, Maruti Suzuki India, ITC, Titan Company, etc.

(The writer is a journalist with 14 years of experience)


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