What are the winning formula of frontline stocks!

Broad market participation, intense market strength, greater marketability and high quality business. These are not bullet points of a power point presentation showing strengths of a business, but the winning formula of frontline stocks on Dalal Street. Often referred to as ‘market movers’, they decide if bulls would roar or bears would hug stock markets on any given day. Here’s an insight into why these stocks rule over others and the reasons behind their stable performance. Market movers
A lot of investors confuse the identity of frontline stocks with companies that form part of National Stock Exchange (NSE) benchmark index, Nifty, and Bombay Stock Exchange (NSE) benchmark index, Sensex. Analysts point out that though most of the Nifty and Sensex stocks meet these parameters, not all qualify as frontline stocks.
Explains Amitabh Chakraborty, president (equity), Religare Securities: “There are some stocks in the BSE 100 index and MSCI index too which are considered to be frontline stocks. They, however, are usually placed in the A group, which has good volume, distributed ownership and strong profitability. They may also enjoy leadership position in the industry and most of the F&O stocks meet this criterion.”
He cites the example of stocks such as Reliance Industries, RPL, RNRL, SBI, Tata Steel, Tata Motors, IFCI and Ispat Industries which enjoy trading volumes even on bad days, hence ensuring instant liquidity to investors who wish to pull out.
According to analysts, frontline stocks can be best identified with characteristics of low to moderate risk, high-quality business and high fancy among investors. Normally, their leadership position in the industry not only helps them thrive in a deteriorating market but also outperform the benchmark in booming markets. “Generally they are the market movers. They have the capability to quickly rebound from massive, market-wide sell-offs,” says D K Aggarwal, director of SMC Global Securities.
Delightful mix
As a thumb rule, feel analysts, frontline stocks can comprise 50% of the total portfolio of a retail investor. If you are looking for liquidity, analysts recommend an allocation of as high 60-70%, since exit is easy on a bad day. “Eventually, they provide stability and liquidity to your portfolio,” argues Ashok Kumar Jain, chairman and managing director, Arihant Capital Markets.
As far as returns are concerned, in a structural bull market, analysts say, you can expect these stocks to deliver around 20-30% compounded annual average return. Though over a short-term, returns can be negative, if the market becomes volatile. These stocks are also favoured by stock analysts. And not without a reason. For instance, over the last three years, stocks (as on January 1, 2008) of companies such as RIL, SBI, L&T, BHEL and Bharti Airtel have all delivered average annualised returns of 50% to 110%.
On the investment horizon, Jain believes that you should stay invested for a minimum of two-three years to reap good dividends. “They are relatively stable stocks due to institutional holding, as most institutions are long-term players and do not take their investment decisions based on short term volatility,” he reasons. According to him, a good mix of frontline and mid-cap stocks in a portfolio can deliver the required alpha and generate decent returns over medium to long-term period.
Aggarwal, however, feels there can’t be a general rule for the time you should remain invested in a frontliner. “They are the high-quality, low-risk stocks with high alpha. You need to have a broader view and a long-term perspective of one-three years once you decide to invest in frontliners. No doubt, these stock fall in a bearish market, but the downside is capped to a limit of their fair value. However, in times of a bullish market, frontliners are the stocks which recover quickly and sometimes even more than the market,” he says. He agrees that past performance is no guarantee of future results, but bases his argument on the fact that a 25% plus return on yearly basis can’t be ignored. “There’s something reassuring about these stocks that they go up year after year,” he says.
Zip ahead
Frontline stocks deliver good returns even when the market is choppy. Experts say this is due to high interest shown by foreign institutional investors and fund houses. “These are stocks which have most of the institutional interest and always trade at a premium against their mid and small-cap peers due to continuous buying interest,” says Jain. Aggarwal too agrees. “It’s a play of high alphas and low betas which helps them pass through rough weathers. Also, they are traded a lot and watched by many people,” he says.
On why the price of these stocks is relatively stable, Aggarwal says that if a stock is cheap, speculators in the market tend to buy it. And if a stock is costly, another set of speculators tend to sell it. Therefore, the efforts of professional speculators make prices ‘fair’, and the normal investor benefits from their efforts at zero cost. “Also, long-term investors feel safe to buy a liquid stock,” he insists.
Perhaps, that’s one of the reasons why a driver who grabs a pole position eventually sets the track on fire and wins the race most of the times!