More than 66% of the stocks in the BSE500 index have lost money in 2019. The BSE Sensex has tanked over 1,900 points since the Budget. Slowing economic growth, fading expectations of aggressive rate cuts by the US Federal Reserve, rising tensions in West Asia, and lack of adequate stimulus to revive consumption in the recent Budget has been fuelling the market volatility.
With investment values eroding, one of the strategy for direct equity investors is to consider stocks that have strong earnings potential. This potential is measured by looking at the net profit margin, which is calculated by dividing the net profit by the sales revenue. Higher the net profit margin, the better is the financial health of a company as it implies larger profits relative to revenue.
Rising net profit margins over a period of time demonstrate the ability of a company to control its operating and overhead costs, which can help navigate periods of unexpected losses. However, these margins differ across industries due to their varying cost structures. For example, companies in the foods and beverages industry tend to have high revenues but low margins because a lot of money is spent on advertising, marketing and sales. Therefore, the analysis of companies based on net profit margins should be made in the context of the sectors in which they operate.
We identified companies whose net profit margins have been higher than the average industry margins consistently over the past five quarters—March 2018 to March 2019. Further, only companies whose margins more than doubled between March 2018 and March 2019 were considered. The 27 companies that passed our filters have delivered one-year average point-to-point return of 14.1% between 18 July 2018 and 18 July 2019. Comparatively, BSE500 and BSE Sensex delivered 1.8% and 6.9% returns during the same period.
Out of these 27, we selected stocks covered by at least five Bloomberg analysts and whose one-year forward price appreciation potential is more than 10%. The shortlisted companies were then evaluated in terms of their expected adjusted earnings per share (EPS) growth in the first quarter of 2019-20 as estimated by Bloomberg analysts. Let us look at four of these stocks whose recent research reports are available:
This infrastructure company is engaged in civil construction projects across segments. It has reported robust numbers for the fourth quarter of 2018-19, registering 41.5% and 69.8% year-on-year (y-o-y) growth in its revenue and net profit, respectively. Analysts believe that NCC’s well-diversified order book provides clear revenue visibility. Also, the reduction in the company’s gross debt will help keep its balance sheet healthy. The stock is trading at an attractive valuation and the company has suggested that its debt will be cut further in 2019-20. According to Bloomberg analysts’ estimates, the company is expected to report a 60% jump in its adjusted EPS in the first quarter of 2019-20.
- Jammu & Kashmir Bank
This private sector bank functions as a universal bank—commercial and investment bank—in Jammu and Kashmir and as a specialised bank—focused on financing select sectors—in the rest of the country. Analysts believe that rising margins, improved asset quality and normalisation of credit costs will improve the bank’s operational performance and boost its profitability. There is also an opportunity for the bank to expand its retail base without diluting margins. Its asset quality is likely to remain stable and the return ratios should gradually improve. According to Bloomberg analysts’ estimates, the lender is expected to report 28% y-o-y growth in adjusted EPS in the first quarter of 2019-20.
Growing faster than their peers
Net profit margins of these companies have consistently grown faster than those of their respective sectors.
Current price as on 22 July 2019. Source: ACE Equity and Bloomberg.
This global pharma company manufactures branded and generic medicines. Besides India, it is present in South Africa, the US, and some emerging economies. Analysts are bullish on it because of its robust US business, which is likely to drive its profitability. Cipla’s domestic business is growing at a steady pace helped by strong double digit growth across chronic therapy segments. The ramp-up in its existing products and new product launches will also support the company’s growth.
- Brigade Enterprises
This realty developer caters to residential, office, retail, hospitality, and education sectors. Analysts are bullish on the stock due to its robust track record, strong portfolio of operational rental assets, steady residential sales and diversified revenue profile across real estate, lease assets and hospitality. New launches and sharp recovery in pre-sales in the fourth quarter of 2018-19 will help the company gain market share.