Beating The Markets With Beaten Down Stocks!

“Markets are always volatile” says Gaurav Sharma, who is a long term investor investing in Indian equities. Gaurav has identified a unique investing strategy that allows him to beat markets regularly. His strategy involves identifying beaten down stocks during market correction and then constructing a diversified portfolio around these heavily corrected stocks.



Says Gaurav, “What I do is simple- I just identify opportunities in the market correction – How many stocks have corrected by more than 50 per cent, either from their all-time highs if the highs are made in the same year, or from their 52-week highs. At times, I also consider the YTD returns and identify stocks that are down by more than 50 per cent in the given period. Once I have the list ready, I analyse the prospects of these stocks and construct a well-diversified portfolio of stocks that are beaten down by more than 50 per cent.” Indeed, it is only logical to buy shares when the prices are lower, but is buying the beaten down stocks a good idea? Does it always pay off?

Many investors who are stuck with stocks such as DLF, JP Associates, Suzlon, Reliance Communications and the like will definitely not agree with the strategy of buying beaten down stocks. The weaker stocks that have corrected heavily have a tendency to inch lower and the so-called long-term investors buy these beaten down stocks only to see them lose their value further. Therefore, buying beaten stocks blindly can be disastrous. If we look at the data pertaining to BSE 500 index constituents in the table below, we find some interesting insights into the price behaviour of beaten down stocks. To understand the price behaviour of beaten down stocks, we observed the data for the BSE 500 index constituents during three different market corrections when the Sensex had corrected by more than 20 per cent. We find that the number of stocks that corrected by more than 50 per cent during the period from February 2015 to February 2016 was 30. The average returns for these 30 stocks that corrected by more than 50 per cent stood at a negative 58 per cent. One year down the line from February 2016, the same set of 30 stocks delivered nearly 79.50 per cent returns.



Similarly, if we consider the data for those BSE 500 index constituents that were down by more than 50 per cent during the market correction period of December 2010-Decemebr 2011, we find that there were 86 such companies. The average return of these 86 companies was negative 59.63 per cent during the market correction phase. If any investor would have purchased these 86 stocks in December 2011, the average returns considering an equal weighted portfolio would have been 56 per cent. Over the three years, the average returns would have been 271 per cent, and in five years, the average returns would have been 492 per cent if one had invested in all these 86 stocks in equal proportion.

The market correction in 2008 was one of the most devastating for the investors where we saw the key benchmark index Sensex crash by more than 50 per cent. During the 2008-09 market correction, there were at least 263 stocks within the BSE 500 constituents that corrected by more than 50 per cent. The carnage in the market ensured that the average returns of these 263 stocks remained a negative 69.18 per cent by the time market correction ended. Assuming the beaten down stocks were purchased in January 2009, the average returns one year down the line would have been a whopping 183 per cent. The 3-year returns would have been 167 per cent and five-year returns would have been an impressive 492.65 per cent.

The only learning that we can derive from these findings is that every market fall presents investors with mouth-watering opportunities. If long term investors consider investing in markets when the key benchmark index is down by more than 20 per cent and create a well-diversified portfolio of only those stocks that are beaten down by more than 50 per cent, there is an opportunity to beat the markets. Here the trick lies in constructing a portfolio during the turbulent times consisting of beaten down stocks and holding on to them till the market situation improves. Of course, the trick also lies in scanning the beaten down stocks properly and applying basic portfolio management rules carefully.

The most common complaint investors make during the market correction is that they know the prices are cheaper for a whole lot of stocks and they would want to buy when these stocks are cheaper, however they do not have enough money to buy the stocks at the cheaper rate. Usually, the investors are already invested and majority of their stocks are down anywhere between 20 to 50 per cent or even more. Investors get caught on the wrong foot usually during market corrections.

Ajay Rane, who prefers to invest in growth stocks, says, “I purchased Ashok Leyland in the first week of May this year and within two months, the stock has corrected by more than 35 per cent. It was trading close to `100 and I was confident it is a good buy near `100, but I could not buy more shares as I was fully invested in my portfolio”.

Taking into consideration such practical aspects of the market, it is always prudent to be in cash in order to maximise profits during turbulent times.

Barring the practical aspects of being short of cash when the stock prices are low, it makes tremendous sense to scan deeply all those stocks that have fallen by more than 50 per cent owing to market correction.

It may happen that the individual stock has corrected in isolation due to some issues specific to the company. These stocks usually are tricky to own and investors often get stuck in such stocks as they fail to understand the exact nature of the problem affecting the company and it is often impossible to quantify the damage in an environment where the stock price is falling.

What we are saying here is that investing in beaten down stocks and constructing a portfolio of these stocks when the overall has market corrected is a different strategy from the one involving identifying an individual scrip that has fallen by more than 50 per cent in isolation. If an individual stock is falling heavily owing to company-specific reasons, it is a sign of weakness in the counter and hence investors ought to be careful while investing in such stocks. Investors mostly tend to average such weak stocks without analysing the prospects of the company that has fallen sharply.

Therefore, constructing a portfolio of beaten down stocks will provide immunity to the portfolio from a particular stock’s heavy underperformance and the risk-reward trade-off can be favourable for the investor.

Promoter holdings During turbulent times, our focus is often on stock prices and we tend to calculate how low they have gone from their respective highs. One of the activities that investors ought not to forget, especially during turbulent times, is to keep a tab on what promoters are doing with their stakes in the company. It is useful to know if promoters are increasing their stakes in the company.

It is signal that promoters think that their stocks are trading cheaply and also reflects the confidence of the promoters in the future prospects of the company.

Here is a list of 30 stocks where the promoter holdings have increased in this quarter as compared to the previous quarter.






Alok Singh
CIO, BOI AXA Investment Managers

"The recovery in stock price depends on the reason for the correction"

What is your outlook on equity markets for coming quarters ( 1-yr to 3-yr)?
Currently, the market is grappling with many issues and this is quite visible from the heightened volatility in the market. The current results season is progressing well and the recent price correction has removed lot of excess from the market. This, along with moderation in global issues, should result in the normalisation of the current volatility to a great extent in the coming months. However, the general election of 2019 should remain the most keenly watched event. Having said that, we believe that the Indian consumption story should remain intact. Hopefully, the capex cycle too will start sometime next year. Now, if the global environment remains stable, then the Indian economy will continue to grow around 11-12% on nominal terms. This means that the stock market should also deliver decent returns.

How should investors participate in the markets given that the markets are expected to remain volatile till the national elections results next year?
The markets are always volatile, but sometimes the volatility is on the higher side. Therefore, for a long term investor, it is always good to invest in a staggered manner. One can do it either through SIP or through normal staggering over a period of time. This is a good way to take care of large event risk such as national elections.

Is it correct to say that those stocks which get beaten down by more than 60 per cent hardly recover? Your take on this.
Well, it’s not always true. The recovery depends on the reason for the correction. If the reason for the fall is repairable, then one can expect a recovery once things settle down, otherwise the recovery may be difficult.

For example, Divi’s Lab had seen a very steep correction in the past because of the US FDA issues and the stock bounced back once the issues got resolved. There are many such cases.

What are the key risks to equity markets that, in your view, markets have not factored in yet?
We think the current market correction has discounted a lot of things. Having said that, the issues around the trade war, crude oil and Indian election outcome remain the key issues to watch out for. During the year, the market will continue to focus on these things.

Do you expect the MF inflow into equities to dry down or you think it will increase in the coming year?
The current market volatility may temporarily disrupt the MF flows, but we think that MF flows should continue to increase in the coming years

Conclusion
A good stock is a good stock that one must invest in. But just because a stock has fallen by more than 50 per cent does not warrant an investment. However, as an active investor looking to beat the markets on a consistent basis, one can consider investing or building a well-diversified portfolio around these beaten down stocks that are down by more than 50 per cent, when the markets have corrected by more than 20 per cent. Predicting market bottom, to say the least, is a futile exercise and an impossible task. The historical data suggest that the key benchmark indices have bounced back sharply whenever the markets have corrected by more than 20 per cent. There is a strong case to prepare a shopping list whenever the markets are down by 20 to 25 per cent from their recent tops and chances of beating the markets improve drastically once a portfolio is built around those stocks that are scanned for quality and are analysed for their prospective performance, when these stocks are down by more than 50 per cent within a one-year period or from their all-time highs. While constructing such a portfolio that includes stocks that are beaten down in value, one must remember that not all stocks that are beaten down will eventually manage to surpass their highs. Therefore, a careful selection of beaten down stocks is the key to such an investment strategy.