What price investing in Nifty stocks?

Anup Menon

THAT ONLY a few listed stocks have provided returns commensurate with the associated risk is clear from an analysis of the stocks comprising the S&P CNX Nifty.

Only 15 stocks posted returns higher than the benchmark 10 per cent, considering the risks associated with them.

Some of the star performers are Infosys Technologies, Hindustan Lever, Satyam Computers, Zee Telefilms, NIIT and Britannia, while the under-performers include Tata Chemicals, Tata Steel, ABB, Colgate Palmolive and HPCL. This trend holds good for returns in absolute and risk-adjusted terms.

The return-risk pattern shows some interesting results. Risk, as measured by the average deviation from mean returns (standard deviation), has been increasing across the board, over a seven-year time-frame. However, the trend in returns has been mixed, with only select stocks managing to sustain increasing returns. The average volatility in the 50 stocks from 1995 to 2000 first half increased from 1.69 per cent to 3.84 per cent

Statistical analysis indicates that stocks such as Cipla and Infosys Technologies have a better chance of generating higher returns than others, assuming that the current price trends continue. The analysis also suggests that the market seems indifferent to the size of the companies. For instance, while the large-cap stocks, such as Tata Steel and HPCL, posted negative returns over the seven-year time-frame, the small-cap ABB and Bank of India posted significantly negative returns.

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The data used for the analysis represents the closing prices of all the stocks that form part of the Nifty. The daily returns were generated based on the price data, after adjustment for bonus and stock splits. The returns were divided into monthly, quarterly, half-yearly and yearly components to study differences based on time estimates. The period of the analysis was January 1994 to August 2000.

The returns were computed by summing up the daily returns for the given period. For instance, the monthly return of Infosys for July is arrived at by adding the daily returns of Infosys for the given time period. The standard deviation, a widely accepted proxy for risk, is used to measure the stock's riskiness. For instance, the standard deviation of 6 per cent for Cipla in 1994 indicates that the average returns may have varied between 114 per cent and 130 per cent.

The trends in the monthly returns present some interesting aspects. For instance, 33 stocks registered positive monthly returns for over 50 per cent of the time period analysed. An investor buying into these stocks and holding it for a month could expect positive returns. This is possible because, over the last six years, most Nifty stocks have traded in positive territory.

A look at specific stocks indicates that of the FMCG scrips, Britannia and Nestle lead the positive returns list. Both companies generated positive returns for 54 months out of the maximum possible 80 months. The worst performers are some of the Old Economy stocks, such as the Tata group, SBI and IPCL.

Is it a good idea to buy stocks in January or December? A study of the monthly averages offers some indications. Based on the average returns for December, around 43 stocks were in the positive returns territory. The worst-performing months were October and November, with less than 10 stocks showing positive returns.

There is a popular perception that the market declines in December, attributed to the fact that FII investments are negative in December, as they tend to face redemption pressure from their unit subscribers. Available evidence suggests that this may not be true in all cases. Over the last three years, the FIIs sold slightly ahead of time -- in October or November, rather than in December. This may account for the high degree of negative returns in that period.

The risk trends have gone up over time. Stocks that are actively traded, such as Satyam Computer Services, have a much higher volatility level than, say, Nestle (India). In 1999, Satyam's yearly volatility was 4.19 per cent compared to Nestle's 2.36 per cent. Hence, the key to picking the right stock is the ability to make the right trade-off between risk and return (see accompanying story).

On a year-to-year basis, volatility is increasing. But does it vary from time to time? The data on quarterly returns suggests that the risks related to the underlying stocks have been moving up in the last six quarters. However, the returns have not really moved up. For instance, returns on ABB over the last six quarters declined to a negative 15.64 per cent compared to a positive return of 0.33 per cent before 1999. In the same time-frame, the risk measure moved up from 15.52 per cent to 20.60 per cent.

The increased volatility in the last six quarters should be seen in the light of several factors. First, the BSE's BOLT system went nationwide and helped increase market participation. The mandatory disclosure of quarterly results may have also had an impact on the volatility.

Also, between early 1999 and mid-2000, some major events -- such as the Kargil war and the greater participation by FIIs in the Indian market -- increased the risk profile of most of these stocks.

Hence, it may be concluded that the overall level of market participation improved over this time-frame. This augurs well for the stock market, as increased participation leads to higher liquidity which, in turn, improves market efficiency.

An analysis of the distribution of `daily returns' of the 50 NSE index stocks indicates that some stocks may have a greater chance of generating higher returns. Cipla, Infosys and HDFC Bank fall in this category. Conspicuous absentees from this list include ACC, Ranbaxy Laboratories and NIIT.

Another question is whether the trends vary with the company size. This may be difficult to determine. For instance, the monthly volatility of large-cap stocks, such as Infosys Technologies and Hindustan Lever, is 2.53 per cent and 1.76 per cent respectively. In the same time-frame, small-cap stocks such as Asian Paints and ABB show volatility of 1.84 per cent and 2.28 per cent respectively.

Until now, the movement of individual stocks has been discussed. It would also be worth looking at what happened to the Nifty over the same time-frame. The average monthly returns for the Nifty are 0.27 per cent. And the risk level of the index is 1.50 per cent. A comparison shows that 25 stocks outperformed the index.

The above observations are based on broad market trends. However, in practical investing, the key would lie in the investor's ability to take into account the return after adjusting for the risk.