Investors should shun stocks with poor fundamentals, say analysts

The equity market has turned volatile in recent days after a near-unidirectional rally that lasted about a year. The resolve of a large number of retail investors, who have chosen to participate in equities directly — demat accounts have risen by 12.37 million from March 2020 to February 2021 — will be tested in the coming days.

An inevitable consolidation  

The primary reason for the current bout of volatility is that markets can’t keep running up forever. “The markets had moved up very rapidly,” says Aashish P Sommaiyaa, CEO of White Oak Capital Management. Some degree of consolidation is inevitable after such a run-up.

Rising bond yields in the US and Indian markets are affecting equities. “Corporates’ cost of capital will rise. Also, higher interest rates in the US could cause foreign portfolio investor flows to slow or even reverse,” says Ankur Kapur, managing partner, Plutus Capital, a Sebi-registered investment advisory firm.

Besides, soaring Covid cases have led to fears of localised lockdowns, which could hamper economic activity.

“With the markets turning expensive, many investors have decided to book profits,” says Vivek Bajaj, co-founder of StockEdge.  

Monitor corporate earnings  

Markets could remain volatile for some time. “Corporate results have surprised positively over the past two quarters. Much will depend on whether this improvement sustains over the next two quarters,” says Sommaiyaa. If bond yields rise sharply, they could create cost pressures for corporates. How rapidly the vaccination progresses and the second wave is contained will also determine sentiment.

Stick to quality 

Retail investors need to realise they have enjoyed a hefty dose of beginner’s luck. “Investors should not mistake luck for skill. The timing of their entry into the markets after the lockdown began was very good. They bought at inordinately cheap levels and stocks moved up thereafter. But they will need real skill now,” says Sommaiyaa. He suggests investors should invest part of their portfolio directly to garner experience, but should combine it with investments in mutual funds.  

Those who decide to invest directly should stick to quality names. “Go with companies that have given return on capital employed (RoCE) of at least 15 per cent consistently for 10 years or more. Revenue growth should have beaten inflation each year over this period, and the company should have zero debt,” says Kapur. 

He says investors may pay a high valuation for consistent compounders, but should counter it with a long investment horizon. Investing in quality names will also give investors the confidence to hold on to them if the correction deepens.  

Investors with a long horizon should just ride out any interim volatility. “Invest in names whose business models won’t get disrupted over the next five years, and stagger your purchases,” says S G Raja Sekharan, lecturer on wealth management at Bengaluru’s Christ University.

Instead of worrying about the direction of the overall market, focus on the prospects of the stocks you have picked, and on business performance rather than stock price movement. Sommaiyaa suggests sticking to sectors you understand. Bajaj warns against over-leveraged bets that can magnify losses. He also favours cutting your losses in poor picks. Finally, he says, long-term investors should not look at stock prices every day. “Fundamentals-driven investors need to tune out the noise so they can invest methodically,” says Bajaj.