Method in the madness: Who led the market rally?

If you were buying stocks on New Year's Eve, going in for the cheapest ones would have handed you a bonanza. It was the really beaten-down stocks, trading at single digit price-earnings (P/E) multiples that saw the highest gains in this rally.

An analysis of stock price returns since January this year shows that investors selectively picked low P/E stocks from the BSE 500 basket, making them the top performers in the uptrend.

(Price-earnings ratio is a measure of how expensive or cheap a company's stock is relative to its earnings.)

BSE 500 stocks with a P/E of less than 10 (as on December 30, 2011) averaged a stellar 40 per cent return till date (as on February 17, 2012), compared with the index returns of 22.5 per cent. The lower the P/E, the better the returns, suggests the data.

Stocks with cheaper P/E multiple of less than five times delivered even higher returns of 46 per cent, on an average.

For instance, low PE stocks such as HDIL, IFCI, and Prakash Industries have more than doubled in the year-to-date rally. We have used trailing earnings of companies for four quarters to arrive at the price-earnings multiples.

Interestingly, the majority of stocks with 50 per cent plus returns in this rally belonged to the low P/E club.

Of the 100 stocks in the BSE 500 basket that surged by over 50 per cent in this period, seven out of every 10 had a price earning multiple of less than 10 (as on December 30).

What's more, low PE stocks within each sector too have delivered better than their peers.

While Tata Motors zoomed ahead of Maruti Suzuki (54 per cent versus 43), Madras Cements delivered twice the returns of ACC. HCL Technologies beat TCS by a comfortable margin (27 per cent versus 6 per cent) and Wockhardt's 72 per cent returns outpaced Dr Reddy's 4 per cent.

High P/E stocks (valued over 20 times their per share earnings) were laggards and belonged to sectors such as consumer goods and pharmaceuticals.

From hate to love

Stocks and sectors that were among the most shunned last year were the ones that put in the highest gains: GTL, IVRCL Infrastructure, Jai Corp and JSW Holdings are good examples.

That one in two of the 150 stocks that more than dropped to half in value in 2011 has gained by over 50 per cent in the rally puts this in perspective. Notably, of the 150 stocks only eight stocks have underperformed the BSE 500 in the rally.

Power stocks that were dropped like hot potatoes last year have also been among the top performers.

While expectations of lower interest rates and promise of fuel availability from Coal India buttressed the stock prices, the gains have been phenomenal. For instance, stocks such as Lanco Infratech, Indiabulls Power and JSW Energy have more than doubled this year.

Even the corollary to this was true, with stocks that had done well last year not seeing much action this time around.

For instance, Power Grid Corporation, which did decently well last year (gained 2 per cent when peers delivered negative returns), did not fare as well in the current rally. The stock gained by about 12 per cent, while peers returned much higher, averaging at 55 per cent.

The corollary applied to sectors too, with FMCG and pharma stocks not participating as much in the rally after having ruled the returns chart last year.

Unconcerned by uncertainties

Investors also seemed to have shed their inhibitions about stock fundamentals, buying cheap stocks without paying much heed to the uncertainties surrounding their business.

Realty player Unitech, for instance, surged by about 62 per cent even as it has struggled to expand its profits for over eight quarters in a row, while pharmaceutical company Aurobindo Pharma, which has had a forgettable 2011, marred by regulatory violations and losses, gained by about 40 per cent.

Construction and infrastructure stocks delivered attractive gains in spite of not having seen any commensurate revival in fundamentals. Stocks such as Nagarjuna Construction, Hindustan Construction, BGR Energy, RIIL, GVK Power and GMR Infrastructure, for instance, have gained considerably in the rally (55-90 per cent).

Small in favour

While large-cap stocks (market cap more than Rs 7,500 crore) provided the much-needed refuge in the volatile markets of 2011 — falling lower than their mid and small-cap peers — it was the small-cap stocks that led the rally.

Stocks such as 3i Infotech, Everest Kanto, Jet Airways, Rolta India, Karnataka Bank, Suzlon Energy, and Shree Renuka Sugars were among the small-caps that posted significant gains (more than 58 per cent).

Small-cap stocks (with market cap of less than Rs 3,500 crore) registered gains of about 36 per cent, higher than that put in by large and mid-cap stocks.