Beaten Down Stocks : Will They Outperform?

The Sensex has recovered almost 46 per cent from its March lows while the BSE Small-Cap index has recovered an impressive 56 per cent and the BSE Mid-Cap index has recovered by 48 per cent. In spite of such splendid recovery both in frontline stocks and the broader markets, there are many stocks that have not yet recovered and are still trading substantially down on YTD basis. Anthony Fernandes explains how best to deal with such beaten down stocks

Investing in stock markets has never been as interesting as it is now. The recovery in stock prices is a global phenomenon with the technology giants dominating the market trends. On Indian bourses, unlike in the US markets, it is the category of pharmaceutical sector stocks that is showing the best momentum in stock price gains. Basically, the defensives have been doing well and financials have underperformed big time in 2020. The Sensex made its all-time highs in January 2020. Since then the markets have corrected almost 40 per cent and recovered 46 per cent from March lows by August 2020.

While the Sensex shed almost 16,000 from its highs in January to March and recovered a little more than 12,000 points by August, there are at least 98 stocks that have gained more than 100 per cent since their respective closing in mid-January 2020. While most stocks have recovered, as many as 104 stocks are still down by more than 50 per cent from the mid-January level when the markets achieved all-time highs. Just to get an idea of how broad the recovery has been, we find that as many as 875 stocks are trading higher today than their respective prices as of mid-January. A question faced by most investors is with reference to the beaten down stocks.

Those stocks that have recovered and are showing momentum are relatively easy to deal with but it is slightly trickier to deal with stocks that are beaten down and have not recovered as much as desired. Says Shivjeet Patil, an active investor, “I am perplexed right now as I see that there is opportunity in buying beaten down stocks but it is the momentum category stocks that are outperforming. Whenever I decide to focus on stocks that have not recovered, I see the stocks that did well in June have done better in July and better still in August. But now I really want to focus on those stocks that have not recovered much even when the Sensex and broader markets have recovered so well. After all, valuation matters in the long term.” 

Beaten Down Stocks

Beaten down stocks can be defined as those stocks that have fallen by more than 50 per cent from the January levels. They are always easy to recognise but difficult to invest in because they lack the momentum and most traders don’t fancy them. They could be lacklustre in recent times and you will find that no chartist promotes them. Usually it is advised that beaten down stocks get beaten down for a reason and hence until the reason or problem is not known these stocks should not be touched. That said, beaten down stocks are also those stocks that have the potential to provide abnormal returns and can beat the key benchmark indices handsomely.

The current risk mode in markets since March 2020 when a record number of retail investors were seen participating – partly owing to the lockdown which forced a huge population to stay inside their respective homes – has pushed investors’ attention in the direction of several beaten down stocks. Vodafone Idea, CG Power, Suzlon Energy, R Systems and Reliance Communications are just some of the popular beaten down stocks that did very well in 2020 and have seen higher retail participation in recent months. Vodafone Idea, especially, has been a favourite of retail investors, lately. 

If one studies carefully each beaten down stock, the story is unique and so is the journey of its recovery. It is important that investors acknowledge the core problems faced by the company and ascertain the solution which may trigger recovery in beaten down stocks. For Vodafone Idea it could be the favourable ruling by the court on the adjusted gross revenue (AGR) issue or Google investing in the beleaguered telecom company; for CG Power it could be a solution in the form of a reputed group investing as much as `750 crore. It is of paramount importance that the investor has an insight into the probable solution to the business problem. Only then should one venture into beaten down stocks and hold them in the portfolio based on fresh developments.

With market valuations and momentum stocks fetching a huge premium and making it a risky proposition for investors to place huge bets, beaten down stocks in the current market situation may provide a better risk-reward opportunity for investors. Following is the list of beaten down stocks or stocks that are down by more than 50 per cent from the January levels, which are also the constituents of the BSE 500 index. It is clear that most of the beaten down stocks belong to the finance and banking sector followed by retail and hospitality. These sectors have been the most impacted by the virus-induced lockdowns.

❝You won’t improve the results by pulling out the flowers and watering the weeds❞

Peter Lynch, American investor 

Conclusion

Professional investors are bewildered to see the resurgence in Indian equities despite the economic impact from the stillspreading corona virus. At this juncture the valuations are stretched for most of the large-caps while valuations remain relatively attractive in sectors such as automotive, metals and energy. Select companies in the finance and banking sector are also getting attractive due to their non-participation in the current market rally. It is always useful for investors to understand that different category of stocks have different risk and reward characteristics.

Beaten down stocks will exhibit different risk-reward relationship when compared to those stocks that are trending right now. The risk-reward equation could be far more favourable in beaten down stocks than in trending stocks at this juncture. It is a foregone conclusion that market corrections are great opportunities to buy stocks. The fact that market corrections – Dalal Street’s definition of stock prices going down a lot – can push outstanding companies to bargain prices makes beaten down stocks extremely noteworthy. The thing with the beaten down stocks that one needs to understand is that just because a company is doing poorly does not mean it is going to do worse. 

Each beaten down company, which merits further fundamental analysis after qualifying initial screening for liquidity and market capitalisation, should be checked for its worsening business scenario. If the business scenario is not worsening and in fact is expected to improve leading to recovery on ground, the recovery in stock prices can be impressive. Not to forget that the investment horizon while taking exposure in beaten down stocks has to be long term ranging from three years to five years.

At the same time, investors have to take care that merely buying a company with mediocre prospects just because the stock is cheap is a losing technique in stock markets. Companies don’t grow without reason. Understand the growth drivers or the lack of them in beaten down stocks and you may start getting great insights into the company’s profitability which helps build conviction in stock picks. Looking at the current market situation and keeping an open mind for new ideas in beaten down stocks may reward risk-takers higher in the long run than blindly chasing momentum!