The methodology adopted here is pretty straightforward. We assumed that an investor parked a sum of Rs 1 lakh in the top 10 stocks on April 1, 1992 (when we began our BT 500 surveys). The weight allocated to the stocks is based on their market capitalisation (the basis of the BT 500 survey). He keeps this portfolio for a year and revises it based only on the next survey. In other words, he sells the companies that have fallen off the Top 10 list and buys the new companies that entered the list. He then churns his portfolio according to this formula every year up to our current listing.

What is the value of his investment now (i.e. on October 1, 2004)? After adjusting for bonuses and splits, the portfolio would have grown to a moderate figure of Rs 1,57,919 only. In addition, he would also have received Rs 18,976 as dividends during these twelve-and-a-half years. But that's not bad. An investment of Rs 1 lakh in the BSE 30 Sensex would have grown to only Rs 1,32,451 during the period under review. Prima facie, it looks a good strategy; so why has it generated such modest returns? First, the exercise started at one of the most volatile periods in the history of the Indian stockmarket (just after 1992 securities scam). The entire market, including our top 10, went into a tailspin after that. That is why the portfolio value reached a low of Rs 46,060 by April 23 next year. The corresponding Sensex figure was Rs 49,024.

Secondly, though it is a good a passive strategy, it has its own limitations. The concentration on a few big stocks (TISCO had a weight of 22 per cent in 1992, Hindustan Lever a weight of 33 per cent in 1999 and Wipro 34 per cent in 2001) is one among them. In addition, at various times, depending on the market mood, the portfolio gets biased towards particular sectors. For example, commodity stocks were the flavour of the market in 1992, FMCG stocks in 1999 and it stocks in 2000; naturally several of them got into the top 10. This concentrated strategy generates handsome returns in bull markets, but works against the investor when the mood turns bearish (see How The Top 10 Fared). And over a long-term period, the pluses and the minuses cancel each other out, leaving the investor with only moderate returns.

Take Our pick

We mined data from a thousand companies and chose the five which offer the greatest upside potential.

By Narendra Nathan

The strategy of blindly investing in the top 10 companies works, but generates only moderate returns. What should you do to generate better and more stable returns? First, you have to select the best company and not the biggest company. Secondly, as your return will be a function of the market price, concentrate on companies that have potential to perform in the stockmarket. More importantly, for stable returns you have to invest across sectors (we have already seen that blindly following the Top 10 strategy results in concentration on a few sectors at extreme periods). So we have decided to pick one stock each from sectors like IT, pharma, FMCG, auto and banking.

Information Technology:

When we asked market experts to pick the best it company, they were almost unanimous in selecting Infosys Technologies. What is so special about Infosys? It consistently beats market expectations and also its own guidance. And the latest quarter (ended September 30) was no exception. It was able to report a revenue and net profit growth of 51 and 49 per cent, respectively. And more importantly, it has raised its guidance for the full year (ending March 2005). This higher guidance is due to the return of pricing power: New clients are giving higher rates. It is renegotiating rates with existing clients as well. "The fact that Infosys has added 5,000 new employees this quarter shows its confidence in future growth," says Amitabh Chakraborty, Vice President and Head of Research (Private Client Group), Kotak Securities. But the share price has already soared. So, is there still scope for appreciation? "Yes," says Chakraborty. "It is quoting at only 20 times our EPS estimate of Rs 87 for the next year ending March 2006. "The share price should go up to Rs 2,100 by March 2005," he feels.

Pharmaceuticals:

Anew international patent regime will kick in on January 1, 2005. To benefit from that, Indian pharmaceutical companies will have to focus on establishing their presence in key global markets by building a strong and sustainable R&D pipeline. Among the few Indian companies well placed to do this is Dr. Reddy's Laboratories (DRL). What makes the stock a good pick now is its low price; its price has crashed from Rs 1,250 in February 2004 to Rs 750 now following the recent failure of its patent challenge case against Pfizer in the US. But one failure cannot signal the end of the road for a company that is into hardcore basic pharmaceutical research. "Dr. Reddy's Labs has the ability and wherewithal to withstand failures like this," says Ambareesh Baliga, Vice President at Karvy Stock Broking. Investors have to keep in mind that DRL took a conscious decision to focus on product development as long ago as the late 80s when reverse engineering was the order of the day. And its May 2004 acquisition of US-based Trigenesis Therapeutics Inc, which is into new drug delivery system research in dermatology, will give it access to more products and proprietary technology platforms. Acquisitions like these will help DRL realise its dream of a becoming "discovery-led global pharmaceutical company".

FMCG:

Are the FMCG companies down in the dumps? No. Though FMCG top gun Hindustan Lever is passing through a trough (see Page 108), most others are reporting decent growth. That explains why the second-most valuable company in this category, ITC, is a good investment pick. Belying pre-budget fears of a rate hike, the Union Budget for 2004-05 left the excise levy on ITC's core tobacco business untouched. Consequently, its cigarettes continue to sell exceptionally well. And it is a good pick even for ethical investors who avoid ITC because it is a tobacco company. Though primarily known as a cigarette company, other businesses like hotels & tourism, paper, agricultural exports and packaged foods are showing good growth and now account for about 25 per cent of revenues. But the price of the scrip has zoomed recently from Rs 850 in June to Rs 1,100 now. "As ITC is expected to comfortably clock a 16 per cent growth rate, the current valuation is well justified," says Harrish Zaveri, Assistant Vice President (Equity Research) at Edelweiss Capital.

Automobiles:

A choppy monsoon is bad for automobile companies that depend on rural demand. That is why the prices of these stocks have fallen from their peaks. And things look quite bleak for companies that cater directly to agriculture (think tractor manufacturers). That is why some smart analysts are placing their bets on tractor and utilities vehicles major Mahindra & Mahindra (M&M), which has seen its stock price fall from Rs 525 in July to Rs 430 now. First, overall agricultural production is expected to remain flat despite the below-average monsoon. "The production loss of 10 per cent in the Kharif season should be compensated by higher output in the Rabi season," explains Rashi Talwar Bhatia, auto analyst at Motilal Oswal Securities. That means tractor and utility vehicle sales should be very strong in the coming quarters. M&M is positioning itself to take advantage of this expected spurt in demand by tying up with nationalised banks like Dena Bank and Central Bank, among others, for financing tractors. Secondly, M&M is also jumping into the export bandwagon in a big way. Exports (vehicles as well as spare parts) are expected to contribute 15 per cent of its sales by 2005-06, up from around 4 per cent in 2003-04. This is expected to add significantly to both the top and bottomlines. So, use the current fall to your advantage.

Banking:

The investing fraternity is divided on whether to go for banking stocks right now. This is because an increase in the interest rate structure is a double-edged weapon. The opportunities thrown up by the pick-up in corporate credit (the main reason for this expected increase) are enormous. Simultaneously, though, it will result in a huge fall in gilt prices, thereby eroding their investment holdings. What is the way out? Go for HDFC Bank, which has small treasury profits and, therefore, is largely insulated against gilt price movements. But what makes HDFC Bank really unique is its demonstrated ability to grow faster than others without taking too many risks. It does this by launching innovative products. For example, it will soon launch a doorstep service to deliver foreign exchange to individual customers in Delhi and Mumbai. The bank also has the ability to identify and squeeze profits out of niche markets. "HDFC Bank has already cornered a major share of the stock broking business in India," says Nimish Shah, Director and CEO of Parag Parikh Financial Advisory Services. Besides, HDFC Bank's corporate portfolio is expected to grow at a much higher rate this year compared to 15 per cent last year because of the expected spurt in corporate spending. This will result in higher profits and, hopefully, in higher stock prices.