Unique Stocks For Unique Returns

Do unique stocks that are the only ones listed from the industry deliver exceptional returns over the long term? Yogesh Supekar and Karan Bhojwani find that there is something unique about the returns given by such unique stocks. Read on...

When it comes to equity markets, portfolio management and wealth creation go hand-in-hand. Sound portfolio management is the real mantra for creating wealth in equity market consistently. While portfolio management is a sophisticated process, it can be simplified into two core concepts; first, how are assets allocated among different asset classes, and second, how individual securities are selected. In this cover story, we will touch upon the second part of portfolio management, i.e., how one can generate market beating returns by adopting a unique way of selecting stocks .

Indeed, how individual securities are selected matters ultimately to the overall portfolio performance. Security selection dictates how individual portfolio returns match to what the market offers. HNI investors and asset manager deploy various techniques to exploit inefficiencies in the markets in order to maximise the returns. At any given point of time, millions of investors are attempting to beat markets and adopt myriad techniques to do so.

We thought it will be interesting to test if an investor who adopts a unique portfolio strategy of concentration that involves including only those stocks in portfolio that do not have any listed peers would beat the markets.

Superficially, the idea of investing in those stocks that are the only listed entities sounds interesting, but does it really deliver superior returns? We think so.

For simplicity we will name the portfolio of those stocks that do not have listed peers and enjoy listing advantage as 'Unique Portfolio'.

The market beating returns of the unique portfolio is seen if one holds on to the bunch of stocks for the long term. The short-term performance is not disappointing either.

However, the study does not include the riskiness aspect and has a return bias. The volatility could be high for such stocks and lack of liquidity in few of the scrips in the list of constituents of the Unique Portfolio could be the possible constraints.

Only those stocks were considered which are sole listed entities involved in unique businesses and have virtually no competitor operating in the same business or industry. Even if the competitor is listed, the constituent of Unique Portfolio enjoys a monopolistic market share or operates in a duopoly as CDSL does.

If we consider the returns generated by such a set of stocks over several periods, we can see that this set of stocks with unique business model and no listed peers have outperformed on an absolute basis.

The returns are especially impressive over three-year period and five-year period. The long term returns on annualised basis not only beat the benchmark returns of Sensex and Nifty, but also challenge the returns of the broader market benchmark indices, i.e. Mid-cap index and Small-cap index.

Here is how the unique stocks have performed over the years. While some stocks have put up performance extraordinaire, few other stocks have bucked the trend. The beta value helps us understand the volatility of the selected stocks and it does show that unique stocks are 'high beta stocks.' The earnings multiples also suggest astronomical valuations for these stocks.

 

 

REASONS TO HOLD ON TO UNIQUE STOCKS/PORTFOLIO:-
 There could be several reasons for outperformance of such stocks that are the only ones listed in their respective industry. To start with, such listed stocks representing their respective industry with no listed peers have a definite advantage of being recognised as industry leader. Getting listed as the only player attracts investors' attention and may help raise funds from markets at a competitive rate when compared to its unlisted peers. There are certain soft advantages that the listed companies enjoy that may help the company further consolidate its market share. Such listed players thus may have a tendency to dominate and keep their profitability intact.

These sort of unique companies that are listed representing the industry also have unique business model leading to consistency in profitability. Of course, not all companies in the category can boast of sustainable business model, however chances of companies with profitable business model in the category is bright owing to factors such as monopolistic market share and unique products offering.

Point in case is Global Vectra Helicorp Ltd (GVHL). GVHL is a unique business to own. The company provides reliable helicopter services and is the only listed entity to run such operations.

PNB Gilts, Alphageo and CDSL are some of the finest examples of unique businesses that have no listed peers.

Hence, there is always a chance that these stocks will always be in demand owing to lack of supply of equity from its competitors.

In case an investor thinks that the equity investor base in India is going to rise considerably over the years in India, CDSL immediately come to mind as a good option to invest in as the company will benefit in the long run as the equity culture grows India.

Same goes for PNB Gilts. PNB Gilts Limited is India's only listed primary dealer of government securities. In case an investor has to bet on improving fortunes of bond markets in India there is no other name investor can look beyond PNB Gilts. If you are bullish on bond market in India and think that interest rates are going to soften which benefits the bond prices — PNB Gilts is the stock you want to own.

CONCLUSION
While there is no doubt that the portfolio approach is the most essential aspect of participating in equity markets, stock selection and weightages assigned is key to portfolio returns. While there could be several ways of picking stocks that may provide an edge to investors, including stocks in the screening list which are the only listed players is highly recommended.

Even if the empirical data suggest superior returns for those players with unique business models and consistent performers that have no listed peers, these stocks may not be available cheap. Investors need to perform thorough analysis before investing in these so-called unique monopolistic stocks.

As there is no industry benchmark, finding the true value of these stocks may be difficult. Having said that, looking at the potential upside on identifying such stocks early, it is worth identifying unique stocks that are the only ones listed on the bourses representing the industry.

Rajat Jain
Chief Investment Officer
Principal PNB Asset Management Company

 

How do you identify a good business model and how do you know if the business model can work?
Some of the most basic things you would look for in a business model would be the size of the market opportunity that the company is trying to address, the sources of competitive advantage in the industry, the relative power of the different entities in the value chain, the regulatory scenario, the entity's pricing power, the competitive landscape, the likely return on capital that the business can make and the free cash flows it can generate. Further, speaking to the management of the company, one gets an idea of the execution challenges and what it would take for them to deliver. Of course, one only knows in hindsight if a business model has delivered or not, but one can at least check the boxes that makes a company more likely to succeed than otherwise.

For a fund manager how do you rate a stock that is the only listed player in its industry and has no listed peers?
In such a case, while a company may not have immediate peers in its sector, one can look at the return ratios the company makes and the sustainability and the growth potential of those returns. Also, the things referred to above, would help as a guide in evaluating a company. Besides, if there are global listed companies in the space, then they would also help as a benchmark for the listed company.

Does it makes sense to invest in such stocks which have no listed peers?
If the stock passes the tests listed, there should be no issues in investing in these companies. If we look back, say, over the past 15-20 years, there were no power companies listed, few if any logistics companies, no telecom companies (except the PSUs, which themselves got listed in the early ‘90s), no oil marketing companies and many such. Some of these companies have made handsome returns for investors. This diversity of companies is one of the strengths of the Indian market, which is unlike other EMs in this regard which tend to be dominated by financials, real estate, hardware technology or commodity producers.

What is your outlook on equity markets for H2 FY17?
The growth momentum in the economy is likely to pick up, basis continuing growth in urban consumption and improving growth outlook for rural consumption. The government's focus on infrastructure, namely, roads, railways, housing and irrigation should also support economic growth. Execution on the ground should improve as we head into 2019 elections. There could be near-term disruption due to the roll out of GST, but it is difficult to estimate. Overall, the GST seems to have gotten off to a relatively smooth start. In the near term, corporate profitability should increase in FY18 led by earnings from banks, metals, autos etc. Besides, we expect earnings growth to be better in partly also because the base figure had been impacted somewhat by demonetisation and its impact. We think that fund flows should remain steady, both from domestic and offshore sources, barring any unforeseen events. Risks potentially could come from the geopolitical side. Another risk is the complacency in the global capital markets which, if shaken, could impact capital flows.

Vijay Kedia
Ace Investor

 

There are some listed stocks that have no peers in the industry. As a strategy, does it make sense to look at these stocks uniquely?
The future of the stocks which you are referring to are very bright because now they have not even touched the life of even 2- 4% Indian population, so there should be consistent growth year on year. That's why these shares command high premium as compared to others, hence they are listed expensive, held expensive and sold expensive. Having said that, I find the current valuations of these shares absurd.

How much weightage will you give to business models while analysing such type of stocks with no listed peers?
They have unique business model which is new in the Indian context. But it is not new to the world. It is not a unique model like Tesla, Google or Amazon. All these business models, going forward, are prone to competition. In a bull market like this, people tend to ignore the facts and create an illusion. We should distinguish between value and pride.

In your view, do the listed stocks enjoy any advantage over their unlisted peers just because these are listed on bourses? Does listing help the company grow at faster rate? The biggest advantage for companies getting listed is that they find their own 'value' which one can use to leverage for future growth. After listing, their accountability increases and they are subject to stringent compliance and scrutiny. Accountability breeds response-ability.

What are the risks associated with investing in monopolistic stocks?
The major risk involved in buying such stocks is that they are traded at 'abnormal' prices. Also, one should not forget that all stocks are subject to slowdown because of market sentiment and economic environment. Do not commit when you are very excited.

Jimeet Modi
CEO, SAMCO securities

What aspects should be looked into while investing in shares of companies that are the only listed entities representing the industry?
There are several aspects which should be looked into while investing in such shares, such as the size of the industry, scalability, extent of competition, growth prospects of the industry and the market share that the company is currently enjoying vis-a-vis its unlisted competition. The main factor, nonetheless, is the growth that the company is likely to achieve and how efficiently it can do so will be the basis for investors' wealth creation.

What are the risks while investing in such stocks?
Such companies face the risks of reduction in scarcity premium due to more companies coming out with IPOs as can be seen from the past examples. During the bull market phase from 2004 - 08 there were very few real estate companies listed on the exchanges, DLF, Sobha, Oberoi Realty etc were not listed and, therefore, few companies like Unitech and BF Utilities Ltd got super high valuation multiples. Similar was the case with the IT boom of 2000, resulting in shrinking valuation of entire top IT companies. It is often difficult to judge the performance of the company as figures of its unlisted peers are not available for comparison.

Karthikraj Lakshmanan
Sr. Fund Manager — Equities
 BNP Paribas Mutual Fund

 

What aspects should be looked into while investing in shares that are the only listed entities representing the industry? When a company is the only one listed in an industry, the industry data and peer comparison on various performance metrics becomes that much more difficult. However, from a fundamental analysis perspective, the process would remain the same. We would follow the Business-Management- Valuation (BMV) focus on the business, the management ability and the valuations.

What are the risks while investing in such stocks?
When the company is the only one listed in the space, it would be that much more difficult to get the total industry data and measure the performance of the listed entity vis-a-vis peers, right from growth, profitability, strategy, market share and so on. In such cases, one may have to dig out ROC filings of the unlisted entities, do channel checks and pull out data from industry consultants to get complete information in order to evaluate the company.

Tejas Khoday
Co-Founder, FYERS

 

As a strategy, in your view , does it make sense to look at listed stocks with none of its peers listed?
Of course. In the absence of peers, investors will have to look at the stock uniquely because they don't have a benchmark to be compared with. Some important metrics to analyse such companies are market share, business model, sustainability and potential growth rate because of industry expansion.

Determining fair valuation is tricky for these companies. If they have monopolistic or oligopolistic positions, they tend to enjoy higher price to earnings multiples. Usually, companies in rapidly growing but nascent industries are not listed. The first company that gets listed among them ‘'usually'' has a size advantage over their peers.

How much weightage will you give to business models while analysing such type of stocks with no listed peers?
A very high weightage. Survival is key and the fact that the company has grown large enough to get publicly listed validates that the business model has been sustainable so far. Investors will have to forecast the future potential of its business model considering how things might evolve. The business model and competitive advantage determines how the company can grow in the future. For instance, CDSL has a very predictable business model. Since it operates in a duopoly market structure, there is almost no scope for disruption. If the industry grows, it is easy to forecast future earnings.

Rekha Chauhan
Sr. Research Analyst, Advisorymandi.com

"If a stock is the only listed representative of an industry, then it is easy to choose and include it in portfolio. The single stock enjoys all the positive outcomes related to any policy or regulation pertaining to that industry. However, there are always two sides of a coin. If a stock is the sole listed scrip representing the industry, then the risk associated with it are higher than the others and it will directly affect the portfolio or the value of your investments."

Ramnath Venkateswara
Fund Manager — Equity, LIC MF

"Major advantages of listed companies vis-à-vis unlisted competitors are: 1) easier access to raise external capital (if demanded by business requirements) and 2) better corporate visibility amongst various stakeholders. Apart from these, there are no major business advantages for the listed companies."

Here are two picks that fit the bill in current market environment and can be looked at from investment perspective. Both recommendations are unique businesses with unique propositions.

SYNGENE INTERNATIONAL

BSE Code: 539268
FV: 10
CMP: 500
Market Cap (F.F.): Rs.1,100.99 Crore

Syngene International Limited, Asia's largest contract research and manufacturing company, is a subsidiary of Biocon Limited and provides contract research and manufacturing facilities for early stage drug discovery and development to pharmaceutical and biotechnology businesses.

The company also provides discovery chemistry and biology services, toxicology, pharmaceutical development, process development and manufacturing of intermediates, active pharmaceutical ingredients, and bio-therapeutics.

The company operates in pharmaceutical, biopharmaceutical and biotechnology segment and also offers analytical studies in concerned fields.

The company specialises in and serves pharmaceutical and biotech industry, agrochemicals industry, nutrition related developments, animal health industry, as well as speciality and performance chemicals industry.

On the financial front, the company posted decrease of 12.1 per cent in revenue from Rs 331.5 crore in the fourth quarter of FY16 to Rs 291.3 crore in Q4FY17, due to a fire breakout in its facility in December 2016.

The company had reported a rising trend in the revenues in the first three quarters of the financial year 2017. The net profit of the company also witnessed a drop of 0.76 per cent to Rs 78.4 crore in the fourth quarter of FY17 on a year-on-year basis.

However in comparison with the third quarter of FY17, the net profit increased by 5.38 per cent. The EBITDA of the company witnessed a rise of 3.33 per cent to Rs 124.3 crore in Q4FY17 on a yearly basis.

On an annual basis, the company reported an increase in its revenue by 14 per cent to Rs 1272 crore as compared to the revenue in the previous fiscal. The EBITDA of the company rose by 24 per cent to Rs 478 crore in FY17 on a yearly basis.

KEY HIGHLIGHTS
Strong financials
Earning growth visibility
Expansion strategy in place

The profit after tax also witnessed an increase of 19 per cent to Rs 287 crore in FY17, compared to the PAT of Rs 241 crore in FY16. The Q4FY17 results were extensively affected by the fire break-out in the company's manufacturing facility.

However, the company is expected to revive from its dampened performance in Q4FY17 soon with a rapid growth momentum.

The company is expecting to strategically expand its presence in the Indian markets. Syngene International partnered with the US-based HerbalLife research and to set up India's fifth and HerbalLife's first nutrition development centre in India.

The company also established a CGMP manufacturing at its Bengaluru formulation facility to produce a wide range of solid oral dosage forms including tablets, pellets, capsules, granules, powders and NDDS (Novel Drug Delivery Systems).

Furthermore, the company has also signed a deal with a Canadian biotechnology company for the development and manufacture of five novel antibodies. The company has also completed over six USFDA audits of its clinical development facility in the last three years.

PNB GILTS
BSE Code: 532366
FV: 10
CMP: 52.10
Market Cap (F.F.): Rs.243.84 Crore

PNB Gilts Ltd, one of the most preferred name when it comes to Indian debt market, was one of the first entities to be granted the primary dealership licence by the Reserve Bank of India.The company is a subsidiary Punjab National Bank.

PNB Gilts is a dominant player in the government bond markets in India, marking its presence with significantly high market share in the overall trading turnover.

As a primary dealer, the company's primary activities entail supporting government borrowing program via underwriting of government securities issuance and trading in a gamut of fixed income instruments such as government securities, treasury bills, state development loans, corporate bonds, interest rate swaps and various money market instruments such as certificates of deposits (CDs), commercial papers (CPs) etc.

The company has been a pioneer in retailing of government securities, contributing to a deep and broad-based market. PNB Gilts Ltd has a wide base of clientele, ranging from Provident Fund Trust, regional rural banks, co-operative banks, corporates, individuals, among others, and has an independent marketing and sales team to cater to the specific requirements of clients.

On the financial front, PNB Gilts Ltd reported a decrease in revenue by 23.09 per cent to Rs 60.61 crore in the fourth quarter of FY17 as compared to the corresponding period of the previous fiscal.

However, the net profit of the company rose 69.18 per cent to Rs 11.78 crore in Q4FY17 from a net profit of Rs 3.63 crore in the fourth quarter of FY16. The PBDT of the company massively increased by 256.19 per cent to Rs 19.84 crore in the fourth quarter of FY17 from Rs 5.57 crore for the same period in the previous fiscal.

On an annual basis, the company reported increase in its revenue by 46 per cent to Rs 499.93 crore for FY17 on year-onyear basis. The company posted a substantial increase of 384.55 per cent in the net profit to Rs 167.17 crore in FY17 as compared to Rs 34.50 crore in FY16. The company's PBDT also rose 393.91 per cent to Rs 256.54 crore in FY17, as against Rs 51.94 crore in FY16.

KEY HIGHLIGHTS
Growing fixed income market in India
Only listed primary dealer in India
To benefit from benign inflation (interest rates) in India

As the Indian economy expands and the fixed income issuances increase in India, PNB Gilts stands to be one of the biggest beneficiaries. The increased activity in primary markets and secondary fixed income markets in India augurs well for the company.

The company is well-capitalised and is trading at attractive valuations at almost close to its book value. As the retail inflation eases, the hopes of interest rates softening this fiscal is reviving among market participants.

On the risk management front, the company adopts counterparty exposure limits and instrument-wise exposure limits to manage the credit risks in the business.

Being the only listed primary dealer in India uniquely places PNB Gilts to benefit from the activity in fixed income markets in India. Looking ahead, the benign outlook for inflation, possibility of good monsoon, slow pace of industrial production growth and the over-indebtedness of the corporate sector all suggest that there is room for easing.

Owing to the benign outlook on interest rates, government bonds market will definitely get a boost as RBI's stance and the monetary policy expectations influence every strategy formulated for trading in bond markets.