The Indian stock market has underperformed most other global indices in 2008. Among the bigger emerging markets, China and Russia have done worse than India. However, the steep fall in these markets must be seen in a broader perspective. China’s Shanghai Composite Index has fallen about 64% this year compared with Nifty’s 52% because both.. these indices had more than doubled in the previous two years. So indices that rose very rapidly after 2005 also fell sharply in 2008 as the global meltdown got everyone in a major bear hug. That seems quite logical.

For a more objective analysis, it may be worth looking at Indian companies in a 10-year time frame. If one looks at the stock market performance of several Indian companies from 1998 to 2008, some interesting results get thrown up. Both 1998 and 2008 had bear markets in India, so the two periods are quite comparable for judging stock performance over a decade. Significantly, even at today’s listed market price, there are 15 companies (mostly mid-cap) who have given a compounded annual return of 50% or more between 1998 and 2008.

As per a study by Ridham Desai of Morgan Stanley Research, if you had bought the shares of Pantaloon Retail, Marathon Next Gen, K S Oil, United Phosphorus, Kotak Mahindra Bank, Unitech, Aban Offshore, Mercator Lines, Matrix Labs, JSW Steel, Nagarjuna Constructions, Era Infra Engineering, Jai Corp, NESCO and Lupin, the compounded annual returns on these stocks from 1998 to 2008 is 50% plus. Even after its share price has fallen over 80% in this bear market, Unitech is still giving a compounded annual return of 58% over the decade ending 2008!

These are also companies which have given the best compounded returns over the past decade from among the entire universe of Indian stocks. Of course, one advantage that mid-cap companies have is that of a low base from where if they do consistently well, both the topline and bottom line tend to grow very steeply and the stock markets tend to discount their future earnings much more than they do for large-cap companies with already high turnovers.

However, stocks of companies with large market capitalisation have also given extremely good returns during this period. Among the top market capitalised companies today, L&T, HDFC Bank, Infosys Tech, ICICI Bank, HDFC, Reliance Industries (RIL), BHEL and State Bank have provided 20% plus compounded annual returns from 1998 to 2008.

Going forward, how should one look at the Indian companies that have given the best returns in the past decade? Ridham Desai’s conclusion is that mid-cap companies are the best bet going by the much higher returns they have given as compared to the large-cap stocks. He has argued that today’s large-caps may not be tomorrow’s winners. Here one would disagree because there are some problems with the mid-cap companies which have given stunning annual returns of over 50% in the past decade. For one, these companies, mostly in the retail, infrastructure and construction space, had done very well on the back of massive equity and debt support from global finance, especially in the last five years. In fact, cheap equity and debt from abroad had made many of these mid-cap companies complacent.

As a result, many of them are highly leveraged today and therefore in deep trouble. Their cash flows were predicated less on income from operations and more on their stock valuation which attracted PE funds to them. They will take at least two-to-three years to sort out their finances and consolidate their gains.

Besides, there is a huge survivor bias in the list of top mid-cap performers cited by Ridham Desai. For every mid-cap company that performed well over a decade, there must be a hundred that fell by the wayside. This is not captured by the data on the top mid-cap performers. Also, corporate governance remains an issue with many mid-cap companies. This is a qualitative factor which data cannot capture.

On the other hand, the large-cap companies are more reliable in terms of their ability to survive and grow in a period of turmoil. They have the necessary critical mass to survive and ride through a storm. The domestic banking system too has a strong bias toward funding large cap companies. You just have to see how in these troubled times, when there is an overall lack of trust, large-cap companies are the first to earn the trust of public sector banks with special bridge loans and guarantees.

Today, banks are staying away from highly leveraged mid-caps. Witness the manner in which Unitech is being forced to sell its telecom licence and other real estate properties to deleverage its balance sheet.

However, it is quite possible that once global finance comes out of its shell and starts pursuing good assets in the emerging markets, the mid-caps will also get a share of their funds. But the story of mid-cap stocks giving 50% annual returns consistently over many years is over.

source: Economictimes

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