Investors on Dalal Street adopt various strategies to generate good returns. While some cherry-pick stocks on the basis of valuation ratios such as price-to-earnings or book value in an approach known as value investing, while others prefer going with companies with growth potential in what is called growth investing.
At any given point of time, the market provides opportunity for both types of strategies. However, due to the cyclical nature of the market, which keeps altering between bull and bear phases, the number of such opportunities would be more in one or the other.
For instance, as many as 72 stocks in the BSE500 index traded below their book values as of June 7, offering opportunity for value bets. The list included stocks like Deepak Fertilisers, Hindalco, Indiabulls Real Estate, Inox Wind, BHEL and JSPL.
Following the selloff seen in midcap and smallcap stocks since January 2018 and rising hopes of earnings recovery in the near term, analysts say an approach blending both approaches can deliver better returns going forward.
“Sectors such as FMCG, consumer durables, financials, specialty chemicals are expected to provide both growth and value opportunities,” says Narendra Solanki, Head of Fundamental Research at Anand Rathi Shares & Stock Brokers. He said investors can look at stocks like ITC, HUL, Deepak Nitrite and HDFC.
Growth stocks are companies that are expected to grow faster than peers in terms of revenue generation, cash flow or profitability. They tend to pay no or lower dividends, as their priorities are to grow business by reinvesting cash flows in new plants, labour or technology. Growth companies offer higher return potential and are, therefore, inherently riskier.
There are companies whose bottom lines grew over 25 per cent CAGR during the past five years and have delivered up to 3,000 per cent return to investors since June 2014.
For instance, shares of Tasty Bite Eatables rallied 3,160 per cent to Rs 8,150 on June 7, 2019 from Rs 250 on June 9, 2017. Among other instances, KEI Industries has grown 1,638 per cent, Minda Industries 1,605 per cent, Bajaj Finance 1,536 per cent and Shivalik Bimetal 1,354 per cent.
To pick growth stocks, market participants should look at past performance and future growth prospects of a business. Growth in top line, bottom line as well as EPS are key indicators that can help pick growth stocks.
Basant Maheshwari of Basant Maheshwari Wealth Advisers is positive on private financials and consumer sectors. “We focus on companies which are growing at 25 per cent CAGR and where prices are reflecting earnings growth,” he told ETMarkets.com.
In value investing, companies that are generally large, well established within their industry often throw up opportunity.
Such companies have already demonstrated good performance track records in terms of profit growth, but the stocks may be quoting at lower share prices due to cyclical factors, adverse short-term perception or other macro factors.
“Such stocks usually trade below valuations of their peers or at a discount to the broader market. Investors generally invest in such stocks in anticipation of returns after a cyclical or adverse event gets over. Value stocks tend to outperform early in an economic recovery cycle, but lag in a sustained bull market,” said Solanki.
Is it possible to get a mix of both in one stock or sector?
“Traditionally speaking, growth and value stocks are complementary to each other, but both have different definitions. While growth stocks are those that show high future growth potential, value stocks are those which are currently considered undervalued compared with their intrinsic value (i.e. book value),” said Amit Gupta, Co-Founder & CEO, Trading Bells, an online stock broking platform.
Gupta says it is possible to find undervalued growth stocks. “PEG ratio (price-earnings v/s EPS growth rate) is one indicator that can help incorporate growth expectations in the valuation metrics to find such stocks,” he said.
He said in the current market, Tech MahindraNSE -0.74 %, Aurobindo PharmaNSE -4.44 %and Avanti Feeds can be considered both growth and value stocks.
TechM is virtually debt-free with a healthy dividend payout, Aurobindo Pharma has a good RoE track record of 27 per cent for past 3 years and Avanti Feeds has delivered consistent profit growth of over 70 per cent for 5 years now.