High inflows during economic weakness distorting prices of select stocks: Ambit

Stocks of companies with high earnings visibility during the period marked by weak economy and robust equity inflows have done exceedingly well in the past four years, but the tide often turns for these firms once the economy is back on track, says a report published by brokerage firm Ambit Capital.

According to the brokerage, this phenomenon is in fact cyclical, with firms with high visibility benefiting when the safety trade is in vogue and underperforming when the economy recovers.

In keeping with its view, the brokerage has put ‘sell’ rating on 14 companies such as Infosys, Hindustan Unilever, Wipro, NTPC, Asian Paints, Dr Reddy’s Laboratories, HeroMoto Corp, Dabur India and Britannia Industries etc. among others. These stocks witnessed sharply rally in the last few years as investors sought shelter in these companies on high earnings expectations, leading to a massive rerating and distortion in the prices of these stocks, said the report.

As a result, these firms trade at relatively high valuation premiums versus their historical trends, leaving little room for further upside.

On the flip side, the brokerage has referred to investors in seven firms on which it has assigned a ‘buy’ rating with high dispersion and low stability in past earnings. This means, stocks of companies such as Tata Motors, Tech Mahindra, Ashok Leyland, Tata Power, TVS Motor Company, Ipca Laboratories and Bata India are likely to show uptrend when the economy picks up momentum.

According to the brokerage, the Sensex has barely managed to deliver 9 percent earnings growth over the last four years (FY11-15), but cumulative FII inflows over the same period have been closer to $90 billion. Surprisingly, inflows into equity mutual funds have also accelerated even in the wake of intensifying downgrades of Sensex earnings estimates.

On the sectoral front, the brokerage has particularly highlighted the consumer staples space, which has benefited from the flight to stocks with earnings visibility. It does not expect stocks from this sector to see any meaningful rally over the next 12-24 months as most of these stocks were rerated to trade at valuations of mid-to-high 30s on two-year forward earnings.

“To be sure, we believe that both economic growth and Sensex earnings growth are likely to disappoint on current consensus expectations and hence a difficult market environment is likely to persist over the next few months,” Ambit Capital said.