Word of caution for picking stocks that have run ahead of reality

Here’s a word of caution as you go about picking stocks in a market that some say has run ahead of reality. While it’s generally said that holding stocks for a long time would give good returns, there is a flip side to the common refrain in the world of investments. In the last 10 years, Indian equity market has witnessed three bull runs, including the recent one. But, there is a long list of BSE500 companies that have not generated meaningful returns in this period.

Companies such as Future Retail, Tata Steel, Ranbaxy, Hindalco, Reliance Infrastructure, Videocon Industries, Jubilant LifeSciences, JP Associates, IDBI Bank and HCL Infosystems have given returns ranging from –34% to 25% in the last 10 years (see chart). This means even the best performing stock of the lot rose just 2% annually. This is despite their sales growing multi-fold. Take Hindalco, for instance. Its sales surged from Rs 8,223 crore in FY04 to Rs 87,228 crore in FY14; but, the stock has gained only 25% in the period. Similar is the story with most other companies.

The common thread — and also a key takeaway for investors — is that most of these companies (excluding banks) had, and continue to have, high debt, which, more than anything else, contributed to their dismal performance, with the cost of debt eating into profits and cash flows.