Investors throw caution to the winds

Stock Up On Mid-Caps With Weak Fundamentals To Boost Value Of Their Portfolios

THE dramatic rise in stock prices over the past one month has resulted in investors throwing caution to the winds. According to brokers, many investors — domestic institutions and foreign portfolio investors — are buying into midcap companies with dubious or weak fundamentals in a bid to add higher beta value to their stock portfolios.
    The BSE Midcap and BSE Smallcap indices have appreciated 17% and 19% respectively over the past one month, while the 30-share benchmark — Sensex — has gained just over 17% during the same period. A few stocks doubled in this rally on the back of value buying, but many others in the pack rallied purely on speculation and market momentum.
    "Investors have forgotten the fear of investing into weak companies," said Gopal Agarwal, equities head, Mirae Asset Global Investments. "At the peak of the credit crisis, investors were apprehensive whether these companies (in mid-cap space) will be able to raise working capital at easy interest rates. But with the global credit spreads shrinking from 750 bps to 85 bps over the past few months, there is a positive feeling that smaller companies will be able to raise money. This is spurring speculative buying in these stocks," Mr Agarwal added.
    According to brokers, when the markets are sober and there is high risk aversion, companies with strong fundamentals and sound balance sheet do well. When an investment frenzy takes over, companies with strong EPS growth but weak operating cashflows and poor balance sheets outperform their larger peers.
    "Many stocks that we would not touch in more sober times have risen in excess of 50% over the past few weeks," said Noble Group's Indian equities head Saurabh Mukherjea.
    "If we segregate BSE-500 companies into four groups on the basis of company fundamentals and strength of balance sheets, the segment that encapsulates 'below average fundamental companies' and companies with weak balance sheets will outperform their larger peers in times of less risk aversion and buoyant markets," he added.
    Companies with weak fundamentals tend to have low cashflows and weak balance sheets. They typically have lower price-to-earnings ratios. There are quite a few companies belonging to the infrastrcuture, real estate, cement, BFSI and metal sectors that are riding high plainly on the momentum wave; some of them are trading 30-50% higher that their large-cap peers. "Investors can buy good mid-caps with a long-term horizon. Companies with weak fundamentals should be avoided as it can be very risky in times of a rapid market fall," said Prashant Sharma, head of investments, Max New York Life Insurance.
    shailesh.menon@timesgroup.com 

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