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Sunday, January 21, 2007

Deadpresidents Most Popular Pages - January 2007

TOP POST - Look for MORE Reports below this post.

(Updated Jan 21)

Results Calendar

Motilal Oswal Reports

EMKAY Reports

Anand Rathi

India Strategy Reports

IDBI Capital Reports

Citigroup Reports

KR Choksey Reports

Indiainfoline Reports & News

Edelweiss Capital

Anand Rathi

Morgan Stanley Reports


CLSA Reports

(Updated Jan 13)


What Charts Foretell

Citigroup Reports

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KR Choksey Reports

Indiainfoline Reports & News

Edelweiss Capital

Anand Rathi

Morgan Stanley Reports



(Updated Jan 7)

Motilal Oswal Reports

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IDBI Capital Reports

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Indiainfoline Reports & News

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Sharekhan Investor's Eye

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Investment Quiz

1. Hughes Software Systems was a well-known name that was also listed on the stock exchanges. The outfit has undergone a name change recently. What's it called?

2. Golfer Jeev Milkha Singh, much in the news in recent times for his tour wins, has also been signed on as a brand ambassador by a leading global financial services institution. Name it.

3. It is one of the largest regional airlines in the world and is a 100 per cent subsidiary of Air Canada. How do we know it?

4. With postgraduate degrees in science and management from the Berkeley, this highflying executive's assignment prior to his current one was as Chief Executive of Accel-KKR Telecom. Name him.

5. Which Indian bank has ATMs that are known by the brand name Moneyplant?

6. Ramesh Vangal, who steered the fortunes of leading names such as Pepsi and Seagram in India, has interests in the domestic alcoholic beverages business through which outfit?

7. Subir Raha, the flamboyant former top honcho at ONGC, has now floated a consulting outfit after hanging up his boots. What's it called?

8. What's the common thread that runs through the following four stocks - MTNL, HPCL, Zee and Tata Power?

9. Who was voted as Time magazine's Person of the Year for 2006?

10. With what programme would you associate the baseline, "Some questions can change your life"?


1. Aricent

2. Barclays Bank

3. Jazz

4. Arun Sarin, Chief Executive of Vodafone

5. Karnataka Bank

6. Mason & Summers

7. TrIdea

8. The last four stocks to move out of the BSE Sensex

9. You

10. The third edition of Kaun Banega Crorepati

Investment Nuggets

Charlie Munger, Warren Buffet's right-hand man in Berkshire Hathaway is as adept as Buffet at investing, and shares his simple non-nonsense approach to stocks. His views on investing and on the stock markets tend to be just as forthright as Buffets' own. Here are a few samplers:

"In many corporations, there is an obsession with meeting quarterly earnings targets. To do so, they'd fudge a little, sell stock at a capital gain, sell a building or two... Then, if that was not enough, they would engage in channel stuffing — if you were selling through a middleman, you could unload your product at the end of the quarter and make the current quarter look better but, of course, the next quarter would be worse. For many major pharmaceutical, consumer products and software companies, at the end of quarter, this was very common. That is pretty well over. A few public hangings will really change behaviour."

"If you are going to be an investor, you are going to make some investments where you do not have all the experience you need. But if you keep trying to get a little better over time, you will start to make investments that are virtually certain to have a good outcome. The keys are discipline, hard work, and practice. It is like playing golf — you have to work on it."

"Over many decades, our usual practice is that if (the stock of) something we like goes down, we buy more and more. Sometimes something happens, you realise you are wrong, and you get out. But if you develop correct confidence in your judgment, buy more and take advantage of stock prices."

"Some people seem to think there is no trouble just because it has not happened yet. If you jump out the window at the 42nd floor and you are still doing fine as you pass the 27th floor, that does not mean you do not have a serious problem. I would want to address the problem right now. They'd better face it."

"Personally, I think Berkshire will be a lot bigger and stronger than it is. Whether the stock will be a good investment from today's price is another question. The one thing we've always guaranteed is that the future will be a lot worse than the past."

Technocraft Industries: Avoid

Investors can refrain from subscribing to the initial public offering (IPO) of Technocraft Industries (India). The offer is being made in the price band of Rs 95-105 to finance expansion of capacities in its three divisions: Drum closures, pipes/scaffolding and yarn business.

At the stated price band, the price-earnings multiple works out to 7-8 times the 2005-06 consolidated per share earnings on the existing equity base.

While the PE multiple appears reasonable given its growth prospects, as a diversified play, the company may command a PE lower than peers in each of these businesses.

The positives linked to this offer are Technocraft's strong export presence in the drum closures division, good growth prospects for its pipes division and scope for improving margins through branding efforts in the yarn division.

The drum closures segment accounted for 27 per cent of revenues and 40 per cent of profit before interest and tax (PBIT).

The pipes (including scaffolding) division contributed 42 per cent of revenues and 26 per cent of PBIT and the yarn division chipped in with 26 per cent and 28 per cent of revenues respectively.

On the flip side, however, the scale and size of operations is likely to work to its detriment in the pipes and yarn division.

In addition, the volatility in raw material prices may be a cause for concern.

The competition is also likely to be fairly stiff in the domestic and export markets. In its drum closures division, the company plans to focus on the Chinese market for exports.

However, given the high duty structure and the fragmented steel capacities in China, penetrating this market may pose a considerable growth challenge.

The consolidated financial performance in 2005-06 too was hardly encouraging, with a 3 per cent drop in revenues and 2 per cent decline in post-tax earnings over 2004-05. The post-tax earnings have also stagnated in a narrow band in the last three years.

Offer details: The company is raising Rs 79-87 crore to part-finance its drum closure division (raising its bungs and flanges capacity by 36 per cent to 1,360 lakh pieces and clamps by 15 per cent to 230 lakh pieces), scaffolding division and set up a new yarn mill which will increase the spinning capacity to 61,104 spindles. It is also installing a 15 MW power plant to reduce its overall power costs.

The book running lead managers are Anand Rathi Securities and Centrum Capital. The offer opened on January 18 and closes on January 23.

Redington (India): Invest at cut-off

Investors can consider subscribing to the initial public offering (IPO) of Redington (India) being made in the price band of Rs 95 to Rs 113 per share.

This IPO, however, will be appropriate only for investors with a high risk appetite, aiming to broad-base their IT portfolio and with a medium-term investment horizon.

In the announced price band, the price-earnings multiple works out to 9-11 times the consolidated annualised first-half per share earnings on an expanded equity base. While we recommend investment at cut-off, our comfort and potential for capital appreciation will be greater if the final offer price is fixed at the lower end of the price band.

The company, which is an established distributor of IT products and peripherals in India, West Asia and Africa, recently expanded its portfolio to include mobile handsets and accessories in Nigeria and parts of India.

It also offers supply chain management solutions and support services. In India, its distribution reach is extensive, with 35 sales offices and 53 warehouses servicing relationships with over 30 vendors; many of these tie-ups are for more than 10 years.

Over the past three and half years, the company has grown its channel network from 6,359 to 10,474 partners across different regions.

With long-standing vendor relationships and superior logistic capabilities, Redington can scale-up revenues sharply in a buoyant demand environment for IT products. It recently also forayed into distribution of digital presses, consumer durables and gaming consoles.

Despite this, the company will remain a predominantly ``high-volume, low-margin'' player in the IT distribution space. Using its experience in the West Asia and African markets, it may be able to make a dent into other low-penetrated IT markets such as Central Europe and CIS in the medium term. As one of the few key national distributors (Ingram Micro being the one ahead of Redington in revenue terms), it has created sufficient entry barriers in this line of business.

On the flip side, however, the company remains exposed to the risks of low gross margins, which may get magnified with limited visibility of demand. If competition fuelled by consolidation (of the Ingram Micro-Tech Pacific genre) intensifies, the scope for improvement in margins will be limited.

Since Redington also depends to a large extent on a limited set of vendors for generating its revenues, any deterioration in relationship with any vendor can affect business volumes and, in turn, the financial performance.

The company also generated negative operating cash flows of Rs 134 crore and Rs 154 crore in 2004-05 and 2005-06 on account of higher receivables and inventory. Finally, Redington remains exposed to the risk of technological obsolescence on inventory carried on hand at any point in time.

Demand push

Going by demand projections from IDC India — the IT research outfit — the demand for IT products (comprising systems such as PCs /notebooks, peripherals, components, networking products and packaged software) is likely to be robust.

The IDC projections are that the domestic IT products market is likely to grow at a compounded growth rate of 17.5 per cent between 2005 and 2010, with systems, peripherals and networking products expected to grow at 15-20 per cent.

With a compounded annual growth in revenues of 49 per cent (at Rs 6,790 crore for 2005-06) and post-tax earnings by 63 per cent (at Rs 71.9 crore), Redington has displayed its ability to manage a five-fold growth in revenues, with a sharp step-up in post-tax earnings in the past two years.

Domestic revenues accounted for 54 per cent of the total in 2005-06 and international incomes the rest.

However, by virtue of being a high-volume business with intense competition, its operating and net profit margin have been locked between 1.8-2 per cent and 1.1-1.3 per cent respectively over the past four years.

The competition is likely to intensify further in the coming years as Ingram Micro, which was weighed down by its integration with Tech Pacific so far, is likely to get more aggressive. And the impact of this competition will be watched closely for its impact on operating margins.

Offer details: Redington is making this offer to set up four automatic redistribution centres in India, and 68 service and repair centres, as also to make investments in its wholly-owned subsidiaries.

This IPO is expected to raise Rs 149.5 crore. Enam Financial is the book running lead manager. The offer opens on January 22 and closes on January 25.

IPOs: Look before you bid

With the Initial Public Offerings from Global Broadcast News and Akruti Nirman boasting huge over-subscription numbers (42 times and 79 times, respectively), one may be tempted to conclude that the primary market is recovering from its slump. But such a conclusion may be premature. The break-down of subscription numbers reveals that high-net-worth individuals and institutional bidders have been the key drivers of response this time around, rather than retail investors. However, the bids appear to be influenced, to some extent, by short-term considerations. For one, runaway response has been reserved only for companies piggybacking on fancied themes in the market, such as media or real estate or mobile aggregation, where listed stocks of a similar genre have delivered impressive gains. Second, response to IPOs also appears to have been influenced by the listing performance of the companies in the immediate past; a few good listings in a particular sector seem to contribute to a pile-up of bids for the ones that open later. With several offerings originating from companies with a novel business model or in a nascent business, it is easy to get carried away by the prospects of spectacular growth. The difficulty of assigning a valuation to such "idea" stocks has also encouraged ambitious pricing. Under the circumstances, retail investors may be better off sticking with a cautious and selective approach to investing in IPOs.

House of Pearl Fashions: Avoid

Investors need not subscribe to the initial public offer of House of Pearl Fashions (HOPF). At the upper end of the price band, the offer values the company at about 20 times its annualised consolidated FY-07 per share earnings on an expanded equity base.

There are no exact comparables in the Indian space as the business model is unique vis-à-vis traditional textile players — a significant proportion of revenues is derived from distribution and sourcing of apparel.

Garment export major Gokaldas Exports can, however, serve as some kind of a reference point from a valuation perspective. The latter trades at a 25 per cent discount to HOPF.

We believe that the valuation is stiff considering the risks involved. Our recommendation reflects the scaling up challenges of HOPF's sourcing business, execution risks of its proposed foray into retail, and the long gestation period of its expansion project.

HOPF is a holding company and operates completely through its subsidiaries. In India, it operates through its 60 per cent subsidiary Pearl Global. It holds 12 subsidiaries directly and indirectly that operate in the US, the UK, Hong Kong, Indonesia, and Bangladesh, besides India.

Its international operations were only recently integrated into the company after a restructuring. On an annualised basis, the newly consolidated entity would boast a revenue of close to Rs 900 crore (financials are available only for the first half).

HOPF has 10 manufacturing facilities — seven in India, two in Bangladesh and one in Indonesia. But manufacturing contributes only about 30 per cent of its revenues, with the rest comes from third-party outsourcing. HOPF sources apparel from 150 third-party vendors from China, Bangladesh and India. It counts names such as JC Penny and ASDA Wal-Mart among its customers.

Objects of the offer

HOPF will raise about Rs 290 crore at the upper end of the price band. About Rs 60 crore of the offer proceeds will partly fund a Rs 100 crore capex plan that would double its annual garment capacity to about 40 million pieces.

About Rs 50 crore of the proceeds will also go towards payment to promoters as consideration for the transfer of assets (at book value) from group companies as part of the restructuring initiative. An equal amount will go towards pre-payment of loans.

HOPF is also planning to foray into the retail business in India as well as in the UK. It plans to invest Rs 73 crore in setting up a chain of stores in India; Rs 55 crore will come from the proceeds of this offer.

It has also earmarked Rs 40 crore of the proceeds for the acquisition of a brand in the UK or US for its operations outside India. A small portion of the proceeds will fund setting up of a design centre in Gurgaon and an integrated technology system. The impact of these initiatives is, however, unlikely to be realised in the near term. The new manufacturing capacities are likely to come on stream in a staggered manner, beginning September 2008 and stretching to March 2010. The full benefits of the expansion are likely to be realised only in FY-11.

The current production facilities operate at about 65 per cent capacity (as of June 2006), which offers some headroom for further ramp up in volumes; but it may not make a very significant overall contribution. For the near term, the company would have to count on its other businesses to drive revenue growth.

Sourcing challenges

HOPF sourced apparel worth over Rs 300 crore in the first half of FY-07. Its strengths in this business lie in its relationship with over a hundred small- and medium-size vendors in China, Bangladesh and India.

It is also looking at Vietnam, which is emerging as a hot sourcing destination.

The company sees its sourcing business as a way of scaling up revenues with limited investment, lending it a higher return on capital versus traditional garment players such as Gokaldas Exports. However, the focus on sourcing does lead to lower profit margins.

Margins in the sourcing business were at about 9.5 per cent in H1-07, while that of manufacturing was higher at 11.5 per cent. Therefore, HOPF's earnings prospects hinge to a great extent on a significant ramp up in business volume, unlike in the case of a pure garment manufacturer.

We see scaling up from these levels as a challenge for the distribution and sourcing operations. While there are no comparables in India, there are several sourcing outfits at the international level.

HOPF does not appear to have any marked competitive advantage over these outfits. Trading giants such as Li & Fung operate at a scale that is likely to help it deliver products at far lower prices. They also acquire brands across product categories to increase their bargaining power with retailers.

For a significant improvement in earnings from current levels, HOPF will have to continually forge relationships with more vendors across different countries.

To sum up, though the business model is quite different from pure manufacturers, the company's success in scaling up its sourcing base over the next few years will hold the key to its stock commanding a premium valuation.

Other risks

HOPF's proposed foray into retail may not yield the desired results. The company plans to open a chain of 10 pilot stores in a year's time. Given the planned investment amount, we do not expect this operation to contribute significantly to revenues in the near term. The timeline for its proposed acquisition of an overseas brand is fluid; integration of any such acquired brand will be an additional risk.

Offer details: About 60 lakh shares are on offer, of which about 12 lakh shares are on offer for sale by the promoters.

The stake of the Seth family (the promoters) post offer will be about 65 per cent. The lead manager is JM Morgan Stanley. The offer closes on January 23.

Cinemax India: Invest at cut-off

An investment can be considered in the initial public offer of Cinemax India. The company operates a chain of multiplexes, and has a presence mainly in Mumbai. Cinemax is now looking at aggressively expanding its national footprint, as are other multiplex chains. The rapid addition of screens is likely to ramp up revenues, provided the quality of film releases remains good. The valuation of the offer appears to be in line with that of peers such as PVR and Inox Leisure on a one-year forward basis. However, execution risks are high.

Exposures can be considered from a one-year perspective. We believe investors can hold a clutch of multiplex operators in the near term, since all of them are on an expansion spree and there are few parameters that differentiate one from the other. Over a longer period, concerns such as oversupply in some cities, the phasing out of entertainment tax exemptions and inability to create a sustainable competitive advantage could dampen prospects; that would require investors to be more selective.

Widening presence

Cinemax India is the latest multiplex operator to join the expansion bandwagon. Promoted by Kanakia Group, a real-estate developer, the chain with about 33 screens in 10 properties is smaller relative to other listed players. However, it has a fairly strong presence in Mumbai with 30 screens in nine locations.

With the money raised from the offer, the company intends to add 108 screens by 2008-09, taking the total to 141 screens.

Cinemax reported consolidated revenues of Rs 75 crore in 2005-06. About 65 per cent of its revenue is derived from box-office collections. The company has undertaken a mall development project in Thane and Nagpur, which also contributed to the revenue stream. However, it has decided now to focus only on multiplexes.

Its decision to move outside Mumbai is a positive, as the city continues to attract more players with fresh expansion plans. Cinemax has had the advantage of owning properties in the city, thus saving on steep rental costs. However, its new properties will be taken on lease to save on capital outlay. As the company is expanding in several Tier-II cities, rentals are likely to be more moderate.

Cinemax has opened a gaming centre, Giggles, at its mall in Thane and intends to open seven more such centres in various multiplexes. We have not factored the revenues from this business in our recommendation. Given the dearth of such entertainment options, it is likely to draw crowds.


In terms of scale, Cinemax would be behind PVR and Adlabs even after expansion.

Scale ensures that the multiplex operator enjoy greater bargaining power with distributors/producers. Cinemax is focused on being a pure-play exhibitor even as peers foray into distribution to secure some control on content. Content screened is likely to be the deciding factor in driving occupancy rates in the long-term when supply catches up with demand.

Concerns remain on its ability to draw crowds in smaller towns and cities; it might have to lower entry prices to ensure occupancy levels. There also does not appear to be great scope on the margin front, as rentals would take a greater share of expenses going forward. Entertainment tax is likely to be a major component of expenses, as only about 40 per cent of its properties are likely to enjoy an exemption going by the information in the offer document.

Revenue growth from screen additions is likely to drive earnings growth. Execution, however, is a big risk. Multiplexes across the board have witnessed delays due to failure by the developers to handover properties in time and delays in getting approvals.

The impact of poor execution compounded with a string of failures in the box office would have an adverse impact on revenues and earnings and is the major risk to our recommendation.

Offer details: On offer are 89 lakh shares, including an offer-for-sale by the promoters of 19 lakh shares. The offer will raise Rs 108 crore on the upper end of the price band of Rs 135-155. The offer closes on January 24. The lead managers are Enam, JM Morgan Stanley and Edelweiss Capital.

Revisiting the IPO scene

Buoyed by the bull phase and an unrelenting appreciation in stock prices in the preceding two years, the IPO (initial public offering) market has been quite active in 2005-06, with several big names raising funds through this route. Not only did this list include some high-profile companies such as Jet Airways, Shopper's Stop, Suzlon Energy and Reliance Petroleum, it also featured stock market debuts by some unconventional companies in new businesses such as multiplexes, aviation and broadcasting, hitherto unrepresented on the stock market. Business Line made recommendations on 100 of these IPOs between January 2005 and June 2006. We revisit some of these companies for a report on where investors in these IPOs now stand and evaluate whether these new entrants still merit investment.

Investors would be sitting pretty had they invested in our `invest' recommendations, which generated an average return of about 80 per cent. Celebrity Fashions and Jet Airways, however, have not performed as well as expected.

Heightened business risks due to events that played out after the IPO appear to have contributed to the poor performance of these stocks. The number of IPOs rated `Avoid' was 44. These stocks, on an average, generated an unimpressive 2 per cent return till date.

A significant number of IPOs rated `Invest' quote at about twice their offer price. Our `Avoid' list has also panned out well, with a few stocks quoting at a 40 per cent discount to the offer price. Here, we attempt to follow up our initial recommendations in some of these stocks, with an emphasis on scrips that have registered the most and least gains from their IPO price.

Bombay Rayon: Phase-out of the quota system in global trade along with the government-sponsored TUFS loans has driven capacity expansion in the textile industry.

Buoyed by a bull phase in the secondary market, a significant number of companies in this sector tapped the primary market. Bombay Rayon, which made its debut in December 2005, was among our top picks in the textiles space. Within the space of a year the stock trades at Rs 210 against Rs 70 (the invest price). The sharp deprecation has not altered our view that investors would be better off exiting this stock, as valuations appear stretched. It trades at a premium to similar-sized peers in the textile industry. The company is on an expansion binge, though revenue from these plans is likely to flow in only in the medium term given the order backlog in the textile machinery industry. An equity dilution, which appears to be on the cards, is a dampener.

SPL Industries: Buoyed by the response in the primary market to Gokaldas Exports and opportunities in the global markets, SPL Industries, in July 2005, offered 90 lakh shares at Rs 70 apiece. Despite the stock trading at a significant discount to its offer price, we continue to be bearish. At Rs 40, the stock trades at about nine times its trailing twelve-month earnings. Though valuations appear moderate, earnings prospects remain uncertain. While its export potential remains intact, SPL Industries faces competition from larger peers. SPL's margins, which are thin, have come under further pressure in recent quarters. Larger integrated players are our preferred picks in the textile sector.

Uttam Sugar: Rated `Avoid', this is a stock in which IPO investors have lost significant value. Offered at Rs 340 per share in March 2006, it now trades at about Rs 140. The sharp decline in the stock, however, has not materially altered our overall view on it.

Uttam Sugar, an integrated player in the sugar business, tapped the market to fund its greenfield expansion plans. The lifting of the export ban on sugar and commencement of production at its 4,500 tcd facility at Khaikheri augur well for revenue growth. However, the earnings growth for sugar companies may slow from the scorching pace of the past, given the weak trends in domestic and international sugar prices.

Intense competition for cane procurement in Western UP is an added risk. Under the circumstances, it may be better to restrict stock exposures in the sugar sector to one or two frontline players.

Sadbhav Engineering: An infrastructure player focussed on road projects, Sadbhav Engineering has registered a two-fold rise on its offer price. With the company riding on a comfortable order-book position in the road construction business, we continue to retain a positive view. Sadbhav, however, faces intense competition in the road segment from larger peers.

A ramp-up in its capital base, which is about Rs 130 crore, would be required for Sadbhav to leap into larger projects. However, with Gammon holding a sizeable minority stake in Sadbhav, order-flows from this larger peer are likely to fast-track revenue growth. Mining operations and irrigation projects are also among the company's focus areas. Diversi- fication is key for the company to break away from the low-margin highway business.

Sasken: The fundamentals of Sasken, a hybrid telecom products-cum-services play, rest on a strong footing. Our positive outlook on the stock stems from the strong demand for offshore R&D services — going by the R&D spend by telecom equipment majors, its blue-chip clientele — the broad range of service offerings and recent acquisition of Finland-based Botnia. The upside in the stock is likely to come from the ramp-up in product revenues, which is not fully factored into its current valuation. We reiterate an `invest' on the stock recommended in April at Rs 352 and suggest investors stay invested at current price levels.

3i Infotech: A strong third-quarter performance, with robust growth in revenues and swelling order-book, sustained acquisition spree of small sized companies and evenly-spread revenues from different geographies, continue to inspire confidence in the 3i Infotech stock.

The downside risks stem from slowdown in discretionary spends in the banking domain and heightened competition affecting growth prospects and putting pressure on margins. In the latest quarter, the company also revised its earlier policy of capitalising its software development costs by charging software product development costs as incurred through the profit and loss account. We have an outstanding `buy' recommendation on this stock made in August at Rs 169 and now recommend a `hold'.

Investing with different caps

Everybody's raising a toast to the new lifetime highs for the Sensex and the Nifty... but are you wondering why your portfolio has not matched the stellar returns on these indices. A closer look at the kind of companies that make up your portfolio may give you the answer.

Stocks of small and mid-sized companies have lagged behind well-known names by a big margin over the last one year. While the Nifty (which represents a basket of large-cap companies) has recorded a 44 per cent gain over the past year, the CNX Midcap index (which represents mid-cap companies) has managed only 28 per cent.

Large-, mid- and small-cap stocks perform differently through different market phases. This is why paying closer attention to the market cap profile of the stocks you buy could help you achieve much better investment results.

Market cap boundaries

Market capitalisation or "market cap" is a simple indicator of the value placed on a company by the market at today's prices. It is arrived at by multiplying the number of outstanding shares of the company with its current stock price. Stocks are classified into large, mid or small cap, based on their overall market cap. Bellwether indices such as the BSE Sensex and the CNX Nifty represent a basket of large-cap stocks. At present, the market cap of stocks in the Nifty basket range from Rs 5,000 crore to Rs 1,86,000 crore, with the average market cap at Rs 39,000 crore. Under present market conditions, stocks with a market cap of over Rs 5,000 crore are usually considered as large cap stocks, while those between Rs 1,500 and Rs 5,000 crore are considered as mid-cap stocks; those falling below the Rs 1,500 crore bracket would be classified as small caps.

However, the boundaries between large-cap, mid- and small-cap stocks are not carved in stone; they change in tune with market conditions. What was a small-cap stock a few years earlier may graduate to a large-cap status, as the company ramps up in size and gains greater recognition from the market?

How they differ on risk and reward

Just as the risk-reward equation for a steel stock is vastly different from that for a technology stock, large-cap stocks offer a return potential different from mid- or small-cap stocks. As large-cap stocks usually represent well-known companies with a sizeable scale of operations, they often carry the potential for steady growth in line with the economy.

Earnings of such companies will seldom grow in leaps and bounds, but may exhibit fewer surprises from quarter-to-quarter or year-to-year, as they are tracked by a veritable army of analysts!

Foreign institutional investors (FIIs) seeking to dip their toes into the Indian markets often make their first investments in large-cap stocks. If you are the conservative type, do not plan to actively manage your portfolio and would like to buy and hold for the long term, you should probably pick your investments from the basket of large-cap stocks.

On the other hand, if you like a big dose of excitement with your stock market investments and are hoping for multi-baggers, you must sift through multitudes of mid- and small-cap stocks to home-in on your choices. Mid- and small-cap stocks usually represent companies that are in nascent businesses or those that are lower in the pecking order, within a sector, in terms of revenues or market share.

Though they offer potential for higher returns because of their ability to register earnings growth at a faster pace, mid- and small-cap stocks often carry higher risks. Their earnings could suffer bigger blips because of vulnerability to a downturn in the business. Also, small and mid-cap stocks are often not traded as actively as large caps, dwindling volumes could magnify the decline in prices of such stocks in the event of a market meltdown. It is, therefore, important to put your choice through a liquidity filter (check for the stock's historical trading volumes over a couple of years) before investing in mid- or small-cap stocks.

Different boom-bust cycles

Because of their differing risk-reward characteristics, large-, mid- and small- cap stocks usually have distinct boom-bust cycles within a broader market trend. Large-caps are usually the first to lead any market recovery, while mid- and small-cap stocks tend to join in later.

If you are booking profits on your portfolio because you expect a big correction, your mid- and small-cap stocks should probably go first, as they would be most vulnerable to any meltdown in prices. Mid- and small-cap stocks will usually under-perform large caps during periods of high uncertainty.

Global events impacting FII flows or political upheavals often prompt a "flight to safety" which results in liquidity fleeing mid- and small-cap stocks into the tried-and-tested large-caps.

In the Indian context, mid-caps/small-cap stocks sharply outpaced large caps in the year to May 2006; but bore the brunt of the correction in May/June as investors reacted to the spike in global oil prices and the prospect of a US slowdown.

However, the experience of the past five years suggests that large-, mid- and small-cap stocks do not always follow the textbook scenario; therefore, making your decisions on the basis of individual stock valuations and your own appetite for risk, is quite important.

If you now have a grip on how large-, mid- and small-cap stocks behave, here are a few additional pointers on investing based on market cap:

Maintaining a balance between large-, mid- and small-cap stocks in your portfolio is as important as spreading your investments across different sectors and businesses. Making investments only in small and mid-cap stocks could make for high volatility while sticking only with the large-caps could deliver modest results.

Though shifting your allocations between large-, mid- and small-cap stocks based on market conditions promises the best results, practicing such a strategy can be quite difficult, requiring timing skills. A much easier approach would be to decide on your allocations to each group based on your appetite for risk and to adhere to this, irrespective of market conditions.

Investing the core portion of your portfolio in a flexi-cap fund (equity funds which have the flexibility to change allocations between market caps) with a good long-term record, would be a good way to make sure that you leave the call on allocations to an expert.

Bharat Bijlee: Buy

Strong financials and expanded capacities, combined with increased demand for transformers on the back of power reforms lend strength to the earnings prospects for Bharat Bijlee over the medium term.

At the current market price, the stock trades at 13 times its expected earnings for FY08. We reiterate a `buy' on the stock with a medium-term perspective. Returns may, however, be moderate in contrast to the manifold gains over the past couple of years.

Bharat Bijlee manufactures power and distribution transformers and a range of electric motors. After restructuring its business portfolio, which involved divesting its elevator field operations, the company has focussed on its transformer business. This resulted in an increase in the segment revenue from 34 per cent in FY2005 to about 50 per cent in FY2006. The company expanded its transformer manufacturing capacity from 4800 MVA to 8000 MVA in March 2006. This is already reflected in the 50 per cent jump in revenues for the nine months ended December 2006 against the same period last year. This expansion appears well timed and augurs well for the company's revenue growth given the current boom in offtake of power equipment. Until 2005, Bharat Bijlee lagged its peers in terms of operating profit margins (OPMs). It has since then improved its OPMs by moving to higher range transformers that typically yield better margins. Its OPMs for the third quarter of FY2007 at 20 per cent are superior to most similar sized companies in the industry. The motor division, which has clients such as NTPC and Reliance Industries, accounted for about 30 per cent of the revenues over the last two years. We expect the current capital spending by various industries to aid steady growth for this division. Bharat Bijlee has a comfortable cash position, despite operating in a working capital intensive industry with long gestation periods. Internal accruals and a solid investment book is likely to take care of further expansion plans, without the need for equity dilution. Any hike in price of raw materials such as copper can impact margins. The financial health of State Electricity Boards, who are major clients for the company, still remains a cause of concern. However, fund assistance through power reform programmes has mitigated the above risk to some extent.