Let's say you were bored in the first lockdown in May last year and you decided to try your hand at throwing darts.
To make it more exciting, you chose the names of India's largest steel stocks as the targets for the darts.
And you resolve to invest some money in the stock that your dart throwing points to.
How much gains do you think this exercise could have fetched you within a year of investing?
Well, a neat 300%!
This is not a joke.
Stocks of the top 5 steel companies in the country have had average gains of around 300% in the past year.
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Even a PSU like SAIL gained 356% after languishing for a decade.
After languishing for years, the reason these stocks are finding so much favour among investors are not difficult to fathom...
India's revival and the post Covid recovery of corporate India is heavily dependent on new demand.
The government has tried to stoke such demand with PLI (production linked incentive) schemes.
To say this has worked would be an understatement.
MNCs like Apple, Samsung, Dell and Foxconn are all lining up to set up capacities in India.
India's cab service provider Ola is all geared up to become the largest electric 2-wheeler maker in the world.
Indian companies are bagging contract manufacturing deals from global behemoths.
All of this has taken the projected demand for steel several notches higher than anticipated.
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So, the demand outlook for steel is looking rosier than ever before. Add to that the chances of higher pricing and sale of premium products.
What also attracted early investors to steel stocks was that these companies were trading at a fraction of their replacement value.
Of course, the expectation here is that the companies will make hay when sun shines.
Most steel companies have weak balance sheets with loads of debt, poor cash flows, and wafer-thin profit margins. Investors believe the post Covid recovery will reverse all of that.
So, are the 300% gains justified?
Should investors who do not own steel stocks regret missing the bus?
Well, predicting the recovery of a commodity cycle when in the middle of a once-in-a -century pandemic, is easier said than done.
Such gains look easy only in hindsight.
However, investors disciplined about buying below book value stocks could have done a phenomenal job last May.
Such deep value buys can be a double-edged sword for high exposure investments. So they aren't for me.
I prefer to recommend businesses that have clear visibility, both in balance sheet and cash flows.
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Moreover, deciding the exit from commodity stocks like steel is even trickier.
It did not take any special skill to identify a 300% gaining steel stock last year. Even the dart throwing could have got same results.
But timing entry and exit from commodity stocks has a very poor success rate.
I certainly do not regret giving these 300% gainers a miss.
In fact, I would suggest investors to re-evaluate whether the debt heavy steel stocks will put their houses in order with the temporary profits.
If not, this a sector I would not want to touch with a barge pole until volumes, profits, cash flows and debt levels show a real improvement.
How about you?
Did you get a chance to ride the surge in the steel cycle? Do you expect it to last?
And would you like to ride these big winners?
Stay tuned for more on the megatrends driving India's revival.
Warm regards,
Tanushree Banerjee
Editor, StockSelect
Equitymaster Agora Research Private Limited (Research Analyst)