Beaten down stocks have different risk-reward characteristics compared to trending stocks and have the potential to provide a good rate of return and beat benchmark indices. Of Late, Investing in the stock market has been most confusing for individual investors. In such a scenario what should investors do and is there still scope to participate in the market?
Reasons for the fall
Though the World Health Organisation (WHO) has sounded an alter about a new corona virus during the last week of December 2019, it had not affected Indian then. The magnitude of the pandemic was realized only when it hit our country and the number of cases and deaths started moving upward. Based on the WHO announcement, many countries suspended passenger traffic to stop the spread of corona virus. This threatened smooth functioning of businesses. India also prohibited entry of any international cruise ship, crew or passenger with travel history to corona virus hit countries to its major ports.
Meanwhile, Foreign Institutional Investors (FII) have continued selling Indian stocks, As per NSE data, FII have been net seller every day since February third week. In March alone, they withdrew a net Rs. 20,831 crore from domestic markets. The carnage in march is also partially attributable to oil related fund based selling as there was a sharp fall in crude oil prices.
Reasons for the recovery
Various announcements of the Reserve Bank of India on lending and supporting the economy sent positive vibes to the market. Sectors such as MSME, NBFC rural economy, banks etc. were the beneficiaries. The pharma sector regained attention of the investors after 3 years of under performance. Cement, metal and auto are favored sectors in the short to medium term. The smart recovery is also attributable to Foreign Portfolio Investors (FPI) as they like to invest in high beta stocks, especially in emerging markets such as India.
Can Investors consider beaten down stocks?
Despite such a wonderful recovery, there are many stocks that have not fully recovered. Let us call them beaten down stocks. For our discussion purpose, let use define beaten down stocks as those shares whose prices have fallen by more than 50% from the January level. It is easy to recognize these stocks but difficult to invest as momentum is lacking in such stocks. Essentially, beaten down stocks have a great potential to provide a good rate of return and could beat benchmark indices once investors recognize such stocks.
How to choose among beaten down stocks?
Before investing in a beaten stock, investors should study about each stock. Investors need to identify the major problems faced by those companies and identify the possible solution which might trigger recovery. For instance, if the courts have given a favorable verdict to a telecom company on computing its adjusted gross revenue or a reputed group is investing a significant amount of money in it can be interpreted as a good signal.
To conclude, beaten down stocks have different risk-reward characteristics compared to trending stocks. So, investors should carefully choose beaten down stocks for a higher risk-reward ratio than simply investing only in momentum stocks.
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