Nifty chart: a midweek technical update (Jan 17, 2018)

During the first three days of trading this week, FIIs turned bulls once again. Their net buying in equities touched Rs 13.5 Billion. DIIs were net sellers of equity worth Rs 2.5 Billion, as per provisional figures.

WPI inflation was lower than anticipated at 3.6% in Dec '17 compared to 3.9% in Nov '17. Falling fruit and vegetable prices were main reasons for the lower number.

India's trade deficit was at its widest in 3 years in Dec '17, as a surge in gold and oil imports offset rising exports. Imports increased by 21.1% to $41.9 Billion. Exports increased 12.4% to $27 Billion. 

The daily bar chart pattern of Nifty had formed a 23 points upward 'GAP' on Jan 8. Some bullish and bearish technical possibilities were discussed in last week's post, with the scales tipping towards the bearish side.

Support from the 'GAP' was successfully tested twice last week - on Wed. Jan 10 and Fri. Jan 12. On Mon. Jan 15, the index opened with another upward 'gap' that was quickly filled during Tuesday's correction.

Bulls went on a rampage today. What changed the bearish outlook? News that the govt. will borrow an additional Rs 200 Billion this financial year (ending Mar '18) instead of Rs 500 Billion planned earlier may have acted as a catalyst.

FIIs and DIIs combined forces to buy equity shares today. However, the total number of advancing shares was matched by the total number of declining shares. That means bears are refusing to give up.

Nifty crossed the 10800 level intra-day for the first time ever, and is trading well above its three rising EMAs in a bull market. Daily technical indicators are in their overbought zones. MACD is showing upward momentum. Slow stochastic is showing negative divergence by touching lower tops as the index has moved higher.

Nifty's TTM P/E is at 27.18 - much higher than its long-term average. The breadth indicator NSE TRIN (not shown) is falling rapidly inside its overbought zone - and can limit index upside. 

Hind. Unilever declared excellent Q3 (Dec '17) results after trading hours today. That may boost bullish fervour tomorrow.

(Note: Thinking of adding quality mid-cap and small-cap stocks to your portfolio? Subscribe to my Monthly Investment Newsletter. Paid subscriptions are being offered to blog visitors, followers and subscribers for 4 more days only - till Jan 21, 2018. Contact me at mobugobu@yahoo.com for details.)

Technical updates – Colgate and HUL

Why do I like FMCG stocks? Predictability of earnings. Plus the fact that most companies are almost debt free, generate huge cash flows, pay regular dividends and grow steadily whether it is a bull or a bear cycle in the market.

But aren't they expensive? Sure they are. So are BMW cars and Harley Davidson motorcycles. Just as you can (and probably do) buy expensive vehicles using EMIs, you can buy expensive FMCG stocks using SIPs.

Colgate and HUL - two of the better known stocks in the FMCG sector - gave very little capital gains for nearly 18 of the previous 24 months. But they have 'caught fire' during the past 6 months - thanks to demonetisation and GST. 

The balance of power is shifting from the unorganised to the organised sector. The FMCG sector will be one of the biggest gainers of this shift. If you have avoided the sector because it is 'too expensive', it is time for a rethink.

Colgate

Colgate's stock has tested the patience of long-term investors. But long-term investors know the benefit of patience.

After moving sideways in a broad range of about 200 points - giving longer term trading opportunities, the stock has rallied sharply to close at a high of 1128 on Jul 3 '17.

Overbought technical indicators that showed negative divergences by failing to touch new highs with the stock have triggered some profit booking. The dip is providing an entry opportunity.

HUL

HUL's stock moved sideways within a 160 points range - testing the patience of long-term investors. But their patience has been well rewarded. 

The stock rose sharply to close at a high of 1124 on Jun 21 '17. But all four daily technical indicators touched lower tops. The combined negative divergences led to a correction down to its 20 day EMA, which has provided good support.

The stock can correct/consolidate a bit more. 

The best way to accumulate HUL is to spare 10K or 20K from your monthly savings and just go on buying for the next 5 years. (I can assure you that it is better than paying EMIs on a BMW or a Harley - both of which are depreciating assets.)

Is the FMCG sector a good place to hide?

Sensex and Nifty are consolidating near their lifetime highs - moving up one day and down the next. FIIs have stared selling. Market experts are voicing concerns about near-term fundamental and technical headwinds.

What should small investors do? Stay on the sidelines, or continue to invest regularly? Where to invest? Everything appears so expensive!

At times like these, the best place to hide is the FMCG sector. Why? Because companies from the sector have visible earnings, generate a ton of cash, have negligible debt, don't require frequent capital expenditure and pay decent dividends. 

The sector is likely to benefit from GST and pent-up demand following demonetisation. If you have a long-term investment outlook (you should!) then you need to invest in this sector. If FMCG stocks appear expensive now - so did they five years back.

Brittania

The stock has been consolidating in a broad range for two years, but looks poised to break out upwards. The gradually rising 200 day EMA indicates a bull market.

Colgate-Palmolive

Colgate has gone nowhere in the past two years. A strong move above 1037 will be required for bulls to get the upper hand. It may be able to do so after a bit of correction.

Dabur India

Dabur's stock appears to be forming a large 'rounding bottom' pattern that can lead to an upward break out above 308. But it may take 2-3 months more to complete the bullish pattern.

Emami

Emami is trading below its three EMAs in bear territory. The correction may continue till it reaches the support level of 955.

Glaxo Healthcare

Glaxo is trading within a 'flag' pattern below its falling 200 day EMA in a bear market. A convincing move above its Mar '17 top of 5532 is required for bulls to regain control.

Godrej Consumer

The stock is consolidating within an 'ascending triangle' pattern near its lifetime high. The expected break out from the 'triangle' is upwards.

Hindustan Unilever

HUL has been stuck in a broad range for two years. The 200 day EMA is forming a 'rounding bottom' pattern that can propel the stock to a new high.

ITC

The stock is consolidating after touching a lifetime (bonus-adjusted) high. It has entered the dairy business, and plans to enter healthcare business - in an effort to reduce dependence on tobacco.

Marico

Marico is correcting overbought conditions after touching a lifetime high. It should continue to move higher.

Nestle

The stock has been in a down trend for almost 9 months. A false break out above the blue down trend line can lead to some more correction or consolidation.

[So, which of these stocks would be worth adding at current market price? Do a bit of due diligence during the long weekend.]

Technical updates – Colgate and HUL

FMCG company stocks should find a place in every investor’s portfolio for several reasons – steady performance through bull and bear cycles, negligible debt, tons of cash, consistent dividend payments and predictability of earnings.

There is a downside also. Valuations tend to be high. That makes timing of entry an important factor in overall returns. Those who are not comfortable about timing entry or exit can start a SIP – but the plan needs to be continued over the long term to reap benefits.

Two of the best stocks in the FMCG sector are Colgate and Hind Lever. The charts show that both are currently quoting well below their all-time highs. Both companies continue to perform well – but as often happens with FMCG stocks, they have their own bull/bear cycles that do not coincide with market cycles.

Colgate

Colgate’s stock touched a peak of 1580 on Jan 1, ‘13 but formed a ‘reversal day’ pattern (higher high, lower close) and started correcting. It subsequently touched two lower tops and dropped to 1190 on Aug 28 ‘13 – a correction of 25% from its peak that pushed it into a short bear market.

The stock has since been in an up trend, and after returning to bull territory rose quickly to touch a high of 1489 on Apr 25 ‘14. But strong resistance from the down trend line (in blue) has dropped the stock to its 50 day EMA.

Technical indicators are looking bearish. MACD is positive, but falling below its signal line. (MACD has formed a ‘cup and handle’ pattern that has bullish implications.) ROC has crossed below its 10 day MA into negative territory. Slow stochastic is dropping swiftly towards its oversold zone. Only RSI is showing bullish signs by bouncing up from its 50% level.

A test and possible breach of the down trend line is likely.

HUL

 

The chart of HUL is dominated by a huge upward ‘gap’ of about 47 points that occurred on Apr 30 ‘13 when news about a buy-back at 600 hit the market. After consolidating sideways below the 600 level for a couple of months, the stock price spiked up on strong volumes to touch a lifetime high of 725 on Jul 24 ‘13. But it formed a ‘reversal day’ pattern and started correcting.

Note how the ‘gap’ zone has provided strong support to the stock during the past 5 months. Even if the ‘gap’ gets filled – which looks unlikely at this stage – the stock price is likely to resume its up move thereafter.

Technical indicators are looking quite oversold. All three EMAs have converged together. A sharp move is likely to follow. Which direction? No prizes for guessing correctly!

Stock Chart Pattern - Hindustan Unilever (An Update)

These were the concluding comments in the previous update to the stock chart pattern of Hindustan Unilever back on Sep 21, ‘11 (marked by grey vertical line in chart below): “Valuations are not cheap, but the stock is worth its weight in gold. Regular dividends are an added attraction. Use dips to accumulate.”

The stock price had closed at 339.30 on Sep 21 ‘11. A few days later (on Oct 5 ‘11), the stock price closed at 322. That was the lowest closing price the stock touched in the last 15 months. At today’s (Jan 10 ‘13) closing price of 516.65, the stock has gained an annualised 42% since the previous post – not counting the substantial dividends paid.

Not bad for a stock whose valuations appear expensive to most small investors. Gold appears expensive too, but many investors would rather by gold than HUL stock – despite the fact that gold pays zero dividends.

What does the 2 years closing chart pattern of Hindustan Lever show us? It is still in a bull market, but undergoing a period of consolidation. Is this a good time to enter?

Note that over the past 2 years, the stock had undergone three prolonged periods of consolidation (marked by light blue ellipses) which lasted between 3 to 4 months each. The current consolidation has been going on for more than 2 months.

The stock price had broken out upwards from the three previous consolidations, and each time negative divergences in the daily technical indicators (which failed to touch new highs – marked by blue arrows) led to the next period of consolidation.

Will the pattern get repeated this time as well? All four daily technical indicators are showing positive divergences by touching higher bottoms while the stock price has been moving sideways. However, the technical indicators are bearish, which means the consolidation may not be over.

The company continues to deliver on both sales and profit fronts and generates a ton of cash. The best way for small investors to accumulate the stock is to start a monthly SIP by buying 5 or 10 stocks each month (about the cost of a night out with friends at a pub or restaurant).

Bottomline? The stock chart pattern of Hindustan Unilever is in a bull market, making steady rather than spectacular progress. Growth and margins are back on the upswing. Valuations are not cheap, but the stock is worth its weight in gold. Regular dividends are an added attraction. Use dips to accumulate. (This is a repeat of the concluding paragraph of the previous update – did not see any reason to change it.)

Is this a good time to enter FMCG stocks?

The answer to that question has already been provided in the previous update on FMCG sector stocks: “FMCG is my favourite sector to invest in, regardless of the state of the stock market and the economy. Strong brands, positive cash flows, low debt, generous dividends, bonus issues and stock splits make this sector worth every Rupee you invest in it.”

The secret to making money in the stock market was revealed by Warren Buffett: Be fearful when others are greedy and be greedy when others are fearful. In investing terms, it means buy when there are a lot of sellers and sell when there are a lot of buyers. That doesn’t mean all the stocks in a sector are worth buying – one has to use discretion.

Given below are the daily closing chart patterns of 10 stocks from the FMCG sector for the period Nov ‘10 till date. The period was chosen for comparison with the Sensex, which touched its all-time high in Nov ‘10 and is currently trading almost 20% lower.

Brittania

Brittania’s chart looks very bullish, but ripe for a correction. After dropping below all three EMAs in Feb ‘11, the stock spiked up sharply in May ‘11 after all three EMAs came close together (marked by light blue oval). Several months of sideways consolidation was followed by another sharp up move in Feb ‘12. However, all four technical indicators touched lower tops as the stock moved higher. The negative divergences can lead to a correction. Use the likely dip to enter.

Colgate-Palmolive

After briefly slipping below its three EMAs in Feb ‘11, Colgate’s stock has been in a steady up move, touching higher tops and higher bottoms. Negative divergences in all four technical indicators can cause a correction or sideways consolidation. This is a stock that one can buy on a regular basis instead of chasing after mythical multibaggers.

Dabur India

Dabur’s stock hasn’t performed as well as its MNC peers, but it has still outperformed the Sensex by moving higher than its Nov ‘10 high. The stock had a long correction from its Jun ‘11 peak to its Jan ‘12 trough – probably due to the unrest in the Middle East where Dabur has manufacturing and distribution facilities. The stock appears to be resuming its bull market and can be bought on dips.

Emami

Emami is the only stock that is trading below its Nov ‘10 peak. Though it reached a higher top in Jul ‘11, the subsequent correction dropped the stock’s price to a lower bottom, which is bearish. The rally from the Jan ‘12 bottom has not yet confirmed a return to a bull market. The technical indicators are looking overbought. The main promoter, who is also a director in a private hospital, was arrested due to a fire incident that caused many deaths. Avoid.

Glaxo Healthcare

Glaxo Healthcare’s stock has been in a steady up trend after the correction from the Nov ‘10 top got support from the rising 200 day EMA. Just goes to show what strong brands (e.g. Horlicks) can do to stock’s fortunes. Technical indicators are looking overbought. Use dips to add.

Godrej Consumer

After trading sideways for more than a year, Godrej Consumer’s stock has finally broken out upwards. Negative divergences in the technical indicators may lead to a correction or consolidation. Dips can be used to enter.

Hindustan Unilever

HUL’s stock formed a bullish cup-and-handle continuation pattern from which it has broken out upwards to touch an all-time high. The cup-and-handle break out has a target of 460. Hold with a trailing stop-loss.

ITC

ITC’s stock dropped below its 200 day EMA in Feb ‘11, giving a great entry opportunity. It recovered quickly and has been in a steady up trend ever since. Of late, the stock has moved up quite rapidly to touch an all-time high and is looking overbought. Hold with a trailing stop-loss.

Marico

Marico’s stock price is in a bull market. It formed a cup-and-handle continuation pattern from which it has broken out upwards. The upward target is 196. Hold with a trailing stop-loss.

Nestle

Nestle’s stock chart pattern should be an example for those who don’t believe in a long-term buy-and-hold investment strategy. Buy-and-hold doesn’t work for all stocks, but stalwart stocks can give fabulous returns over many years. This is another stock that can be added on a regular basis.

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Stock Chart Pattern - Hindustan Unilever (An Update)

In the previous update to the technical analysis of the chart pattern of Hindustan Unilever, way back in Jan ‘10, the stock had been in a correction after climbing to an intra-day peak of 306 in Jul ‘09. The stock fell down to an intra-day low of 218 in Mar ‘10, a 29% drop from the peak.

The 8 months of correction broke the three years long up-trend line; the ‘death cross’ of the 50 day EMA below the 200 day EMA in Feb ‘10 confirmed a bear market. There were growth and margin pressures on the company, which were reflected in the stock’s price.

A look at the 2 years closing chart pattern of Hindustan Unilever should convince investors of different experiences and propensities why this is a must-have stock among the several thousand being traded on the BSE and NSE.

There is an old saying: “You can’t keep a good man down.” That expression could just as well describe the HUL stock. Note that when the stock dropped to its new closing low of 220 in Mar ‘10, all four technical indicators reached higher bottoms (marked by blue arrows). The positive divergences signalled the end of the bear period.

The stock embarked on a fresh bull rally within an upward-sloping channel that is still intact. From Sep ‘10 through Jan ‘11, the stock reached three closing tops – each a little higher than the previous one. This time, the technical indicators all touched lower tops. The negative divergences led to a sharp drop below the 200 day EMA, followed by a triple-bottom reversal pattern from Feb to May ‘11.

Once again, positive divergences from all four technical indicators that touched higher bottoms, hinted at a resumption of the rally. The stock reached a new closing high of 343 in Jun ‘11 at the upper-end of the upward-sloping channel. Negative divergences in the technical indicators warned of a correction.

There are two points of interest here. The first is that the stock’s price movements provide long-term trading opportunities, as it swings up and down within the upward-sloping channel. The second, more important one, is that between Nov ‘10 and Sep ‘11 the stock has gone up to touch new highs, and is in a bull market - even as the Sensex and Nifty are in clear down trends.

All three EMAs are rising and the stock is trading above them – a sign of a bull market. The strategy should be to use dips towards the lower end of the upward-sloping channel to add. All four technical indicators – MACD, ROC, RSI and slow stochastic are correcting an overbought situation. The correction from the new closing high of 353 may continue a bit longer.

Bottomline? The stock chart pattern of Hindustan Unilever is in a bull market, making steady rather than spectacular progress. Growth and margins are back on the upswing. Valuations are not cheap, but the stock is worth its weight in gold. Regular dividends are an added attraction. Use dips to accumulate.

Which stocks are keeping the Sensex down?

The BSE Sensex index comprises 30 stocks. 16 of them are currently trading above their 200 day EMAs – indicating bull markets. 14 are trading below their 200 day EMAs, preventing the Sensex from reaching new highs.

Here are brief thumb sketches of the laggards:

BHEL: Bounced up sharply from a low of 1905, but found resistance from the 200 day EMA; currently trading just below the long-term moving average.

CIPLA: Touched a low of 286 before a sharp rally to 332 – above its 200 day EMA; now consolidating between the 50 and 200 day EMAs.

DLF: The rally from the low of 209 stopped well short of the falling 200 day EMA; the stock has dropped down to seek support from its 50 day EMA.

Hero Honda: The stock touched a low of 1378; a spirited rally was stalled at its falling 200 day EMA; the stock has started to drop towards its 50 day EMA.

HUL: The stock dropped below its 200 day EMA on Jan 27 ‘11; it has been trading sideways since then, alternately going above and below the long-term moving average.

Jaiprakash Assoc.: From a low of 70, the stock reached a high just short of the 100 mark but well below its falling 200 day EMA; it has dropped down to seek support from its 50 day EMA.

L&T: The stock is trading sideways in a narrow range, just above its 50 day EMA but well below its falling 200 day EMA.

Maruti: Trading below the 200 day EMA for the past three months, the stock had a day’s close above the long-term moving average, only to drop below its 50 day EMA.

NTPC: The stock has been trading below the 200 day EMA since end-Oct ‘10; a couple of brief forays above the long-term average saw strong selling pressure; currently trading below its 50 day EMA.

ONGC: The bonus and stock split didn’t help the stock much; a day’s close above the 200 day EMA was followed by a steep drop below its 50 day EMA.

Rel. Comm.: A rally on strong volumes could only sustain above its 50 day EMA briefly, and has fizzled out already; the stock is well below its 200 day EMA.

Reliance: The stock has been trading in a broad sideways range, oscillating around its 200 day EMA – giving no returns to its investors; currently trading just below the long-term moving average.

Rel. Infra.: Another ADAG stock with equally disastrous results – a brief rally on good volumes above the 50 day EMA that is showing signs of weakness; the stock is trading way below its 200 day EMA.

Sterlite: A sharp rally accompanied by a volume spike took the stock from a low of 45 to a high of 68; but it stopped short of its falling 200 day EMA and started correcting.

Unless some of these 14 stocks start to rally soon, the Sensex may remain range-bound. Technically, the most likely candidates to help propel the Sensex upwards are BHEL, CIPLA, HUL, L&T, Maruti and Reliance. Dropping Rel. Comm. and Rel. Infra. from the index would not hurt either.

The Interest Rate hike was expected – why did the market fall?

As expected, the RBI hiked the repo rate and reverse repo rates by 25 basis points. For the uninitiated, that means a 0.25% rise. The repo rate (the interest rate at which banks borrow short-term funds from the RBI) is now 6.5%, and the reverse repo rate (the interest rate that banks receive for parking short-term funds with the RBI) is now 5.5%. Two other rates – the CRR and SLR – have been left unchanged.

Why was the interest rate hike expected? Primarily because core inflation (non-food) has been rising and 6 rate hikes in 2010 had little effect in cooling off prices. Every one knows that food inflation has almost gone out of control, and the Indian housewife is at her wit’s end trying to put nutritious food on the table within the family budget.

If 6 previous rate hikes haven’t managed to cool off inflation, will the 7th (1st in 2011) fare any better? That is a good question, and the RBI Governor knows it. He took pains to explain to the media that his choices were limited. Inflation needs to be controlled, otherwise high prices of essential commodities will increase input costs for India, Inc. That would dent bottom lines and may slow down expansion and capital expenditure. The severe crack in Hindustan Unilever’s stock price today is a clear example of investor nervousness.

Raising interest costs too much at one go will increase borrowing costs and hurt the growth prospects of companies. The RBI has chosen the middle path of a gradual increase in interest rates. If inflation continues to rise, another round of rate hikes may be inevitable. Already, the RBI Governor has relaxed the target core inflation rate to 7% from the earlier 5.5%. There lies the first clue to the market’s fall today. So far, the RBI and finance ministry officials have been making positive noises about controlling inflation through monetary measures coupled with the ‘base effect’ of higher inflation in the year gone by. This was the first official admission that things haven’t worked as planned.

The second clue is the unambiguous message that the RBI Governor sent to the commercial banks: Curb lending and increase deposit rates. That may be music to the ears of retirees who stay far away from the stock market and depend on fixed income avenues. Fixed deposit rates at banks will hit the double-digit mark soon. What is meat for retirees is poison for stock market investors. The combination of higher interest rate with lending curbs will throw a spanner in the works of India’s growth story.

Rate-sensitive stocks took a beating today, and don’t be surprised if the stock market cracks further after the Republic Day holiday. As small investors, there are a couple of things we should do. One, don’t panic and sell off everything. But if you are in profit in second rung stocks, book some or all of it. Two, prepare for a bigger correction by making a list of fundamentally strong stocks that offer some Margin of Safety. Let the correction play out. The next positive trigger may come from the Budget. Buy then.

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When stock markets slide, FMCG is the sector where investors can hide

FMCG is my favourite sector to invest in, regardless of the state of the stock market and the economy. Strong brands, positive cash flows, low debt, generous dividends, bonus issues and stock splits make this sector worth every Rupee you invest in it.

But when stock markets start to slide sharply – with or without any logical reasons – investors learn to really appreciate the FMCG sector. Why? Because the stocks in the sector tend not to fall as much as the broader market. The high-flying momentum stocks with promises of bright futures may give you phenomenal returns in quick time, but there won’t be any place to hide when those same stocks start tanking.

The Indian markets have underperformed global indices for the past two months by correcting about 10% from its Nov ‘10 top. It is not a huge fall for a bull market that rose from 8000 in Mar ‘09 to 21000 in Nov ‘10. But investors are already showing signs of fear and panic. Corrections are part and parcel of investing in the stock market. If you lose sleep every time the market corrects, be overweight in the FMCG sector.

Here are the chart patterns of 10 leading stocks from the FMCG sector in alphabetical order. The sector is a great defensive bet but not all stocks are worth investing in at this point in time.

Brittania

The Brittania chart pattern looks the weakest. Right after the 5:1 stock split in Sep ‘10, the stock hit a high of 535 (split-adjusted), made a high-volume reversal day pattern and moved into a down-trend. Of late, it has dropped below its 200 day EMA and is likely to breach the long-term support of 355. Avoid.

Colgate-Palmolive

The Colgate chart pattern shows consolidation within a symmetric triangle after the stock touched a high of 996 and a low of 815 in Nov ‘10. A likely break below the triangle can test support from the rising 200 day EMA. Partial profit booking may be in order.

Dabur India

After the 1:1 bonus in Sep ‘10, the Dabur stock hit a high of 112 (bonus-adjusted) before correcting down below its 200 day EMA to the support level of 91 in Nov ‘10. A sharp pullback took the stock above all four EMAs. It has been consolidating sideways between 99 and 105 for the past month. Accumulate.

Emami

Following the 1:1 stock split in Jul ‘10, the Emami stock steadily moved up to touch a high of 512 (split-adjusted) in Oct ‘10. It started to drift down and then suddenly collapsed below its 200 day EMA, down to 312 in Dec ‘10. A quick pullback has taken the stock above its long-term moving average, but the stock is trading below its falling 50 day EMA. Hold, with a stop-loss at 405 (200 day EMA).

Glaxo Healthcare

The Glaxo Healthcare chart pattern is in a bull market. After reaching a high of 2460 in Nov ‘10, the stock has been consolidating in a symmetrical triangle from which the likely break out is upwards. The stock is trading above its rising 100 day and 200 day EMAs. Buy, on a high volume break out above the triangle.

Godrej Consumer

The chart pattern of Godrej Consumer entered a downward-sloping channel after touching a high of 480 in Sep ‘10. It slipped below its 200 day EMA to get twin support from the level of 354 and the lower end of the channel in Dec ‘10. It has moved up to the upper end of the channel. Buy only on a high-volume break out above the channel.

Hindustan Unilever

From Jan ‘10 to May ‘10, the HUL stock traded well below its 200 day EMA, trying the patience of its long-term investors. It started its up move from Jun ‘10 and hit a high of 320 in Sep ‘10. It has since consolidated in a rectangular channel between 320 and 283. An upward break out earlier this month on decent volumes saw no follow-up buying, and the stock is back within the rectangular channel. The stock is trading above its rising 100 day and 200 day EMAs. Note that HUL reached a higher top than the one in Nov ‘10, while the Sensex made a lower top. Accumulate.

ITC

After the centenary 1:1 bonus issue, the ITC stock rose steadily to reach a high of 185 before starting a sideways consolidation between 166 and 181. The stock is trading above its rising 100 day and 200 day EMAs. Like HUL, the ITC stock touched a slightly higher top in Jan ‘11. Accumulate.

Marico

Like the Godrej Consumer stock, Marico is trading in a downward-sloping channel. After hitting a high of 153 in Oct ‘10, the stock fell below its 200 day EMA and the support level of 119 down to 115 in Dec ‘10 – a 25% correction. The recovery has been tepid. Buy only on a high-volume break out above the channel.

Nestle

The Nestle chart pattern is in a strong bull market. It touched a high of 4199 in Nov ‘10 and has been consolidating sideways, with good support from the rising 50 day EMA. The 100 day and 200 day EMAs are also rising. Use dips to accumulate.

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It is Q2 results season – can you spot good earnings management?

Now that the Coal India IPO is successfully out of the way (i.e. with considerable oversubscription), one of the major uncertainties about the future direction of the Indian stock markets has been removed. There was no large-scale selling visible in the secondary markets – as the FIIs brought in new funds to subscribe to the IPO.

The focus has now shifted to the Q2 results season. The continued volatility in the Sensex and Nifty is an indication that the investing community is uncertain about how the results will pan out. The uncertainty is compounded by the fact that the Sensex is trading around the 20000 level – just below its Jan ‘08 all-time high.

Those who believe that expected good results have already been ‘discounted’ by the current stock market index levels are bearish, and worried about a huge 2008-like fall. Those who think that earnings will surprise on the up side are bullish, and betting on a 25000 Sensex target.

Why does the quarterly results season generate so much tension, anxiety and uncertainty amongst traders and investors? Earnings, or net profits, are often treated as the most important factor in a financial statement. For estimating the ‘intrinsic value’ of a company, the present value of its future earnings is calculated using the Discounted Cash Flow (DCF) method. Increased earnings has a salutary effect on the stock’s price. A drop in net profit leads to selling.

What is earnings management and why do companies indulge in it? Simply put, earnings management (as opposed to ‘cooking the books’ a la Satyam Computers) means using legal accounting methods to ‘dress up’ the net profit figure to meet or exceed analysts’ expectations.

Why would a company resort to earnings management? The cynical answer is: the top executives want to save their skin and ensure that their own company stock holdings don’t drop in value. Even a well-respected multinational like Hindustan Unilever resorted to earnings management when they declared their Q2 results yesterday.

The headline in the business page of a leading daily was: ‘Lever posts 32% rise in net’. To be fair, the company did mention that exceptional gains of Rs 40 Crores during the period compared with exceptional costs of Rs 135 Crores in the same period of the previous year led to the 32% growth. Without the exceptional items, the profit grew only 6.8%.

How can you spot whether a company is resorting to earnings management or not? The disclosure details during quarterly results announcements are not adequate to spot all the legal (and illegal) accounting methods adopted by different company managements. But investors would do well to look beyond the headlines and interim dividend announcements to check the details that are published.

Any unusual increase or decrease in earnings is a ‘red flag’ and needs to be investigated further. Some times, excellent earnings announcements by not-so-excellent companies are accompanied by various fund-raising plans. The idea being to cash-in on the good feelings generated amongst the investing community.

Pay careful heed to the reasons for the fund-raising. If it is for increasing production capacities or entering new geographical territories, it is a positive. But raising money to reduce/pay-off earlier debts, or to pay taxes and dividends on earnings that do not generate a corresponding positive cash flow from operations is a negative.

Managers that always promise to ‘make the numbers’ will at some point be tempted to ‘make up the numbers’ – Warren Buffett

Is every drop in the Sensex a buying opportunity?

There is no easy answer to that question. A drop in the Sensex can happen due to several reasons. Some external event like a terror attack or war can cause a sudden fall. Stock markets recover from such shocks pretty quickly - so it provides a buying opportunity.

It could also be an external event of a more 'fundamental' nature. The recent economic downturn had its origins in the financial excesses of the western world. But its ripple effects - large scale withdrawal by FIIs - caused a major bear market in the Sensex that lasted more than a year.

Many investors who were facing a bear market for the first time made the error of jumping in during April/May 2008 - only to find that the Sensex fell steeply thereafter making a big dent in their savings.

Newsworthy internal events can also induce a sharp fall. Remember the Satyam scam hitting the front pages in Jan 2009? The Sensex had a sharp downward reaction in the middle of a bear market that lasted two months. Most news driven index falls last only 2 or 3 days, and can be bought into.

Internal events of a more fundamental nature - a deteriorating economy or a major stock market scam (a la Harshad Mehta or Ketan Parekh) can cause the Sensex to change its trend from bull to bear in a flash. Bear markets are not the time to buy - except when it is close to, or emerging from, a major bottom.

Being able to identify such reversal points constitute the "Holy Grail" of stock market investment success. Which means it is easier said than done. But it isn't impossible.

One of the thumb rules for the Sensex that I have observed is the widening distance between the 50 day and 200 day EMAs. A reversal or correction occurs when the gap stretches to about 2000 points. Please remember that this is not a rule, but an observation.

The 'correct' answer to the question is another question: Why does it matter? Small investors don't buy the Sensex. They may invest in an index fund or an index ETF. In which case, they should be following a SIP method and be oblivious to Sensex gyrations.

Even if a small investor decides to buy individual stocks, it is unlikely that a particular stock's bull or bear phase will coincide with that of the Sensex.

HUL had a long bull market from 2006 to 2009 - right through the Sensex bear market. It hit its peak in July '09, 6 months before the recent Sensex top, and has been correcting for 8 months.

The bear phase in Tata Motors preceded the Sensex by a good 20 months. The bear market bottoms in the stock and the Sensex were formed together. The subsequent bull rally by the Tata Motors stock hugely outperformed the Sensex.

Keep close track of the individual stocks in your portfolio. Otherwise, the noise and hype created by the media about Sensex movements may confuse you into making a poor investment decision.

Stock Chart Pattern - Hindustan Unilever (An Update)

When I analysed the stock chart pattern of Hindustan Unilever more than 8 months ago, this was one of my comments:-

'If you want to preserve your capital during vicious bear attacks and like steady returns from tax-free dividends, there are very few stocks that can match HUL. This is not a stock for day traders. But there are plenty of opportunities for longer term trading.'

Now that the world indices are facing a co-ordinated bear attack by the FIIs, it may be a good time for a re-look at one of the favourite defensive stocks of all time.

Let us peruse the 9 months bar chart pattern of Hindustan Unilever (HUL) to check how the stock chart has played out since May '09:-

The stock peaked at 306 in Jul '09 on high volumes, but a 'reversal day' formation ended with a 3 weeks long sharp correction to 248 in Aug '09, where it got good support from the 200 day EMA. The stock subsequently made lower tops of 295 in Oct '09 and 288 in Nov '09 before sliding down below the 200 day EMA, which is very bearish.

But technical analysis requires verification from several other indicators for a confirmation. Look at the On-balance Volume (OBV). While the stock was making lower tops in Oct and Nov '09, the OBV was making higher ones - a positive divergence.

Even though the stock dropped below the 200 day EMA, it made a higher bottom of 252 last Friday, Jan 22 '10 and is trying to move up above the long-term moving average.  Note that after falling below the 50 day EMA, the 20 day EMA is resting on the 200 day EMA.

The RSI bounced off the oversold zone and reached the 50% level before dipping down. The OBV has been moving sideways with an upward bias as the stock corrected for the past two months. The MACD is in negative territory, but has given a bullish cross above its signal line.

Are you all confused with the conflicting bullish and bearish signals? Time to take a look at a longer term chart - a 3 years closing chart pattern of HUL which gives a completely different picture:-

Now you know why I keep harping about long-term investing! The bull rally in the HUL stock that started in 2007, and progressed upwards right through the bear market in 2008, remains in tact.

The last 2 months' corrective move has merely brought the stock down towards the lower end of the upward trending channel (which can be drawn by connecting the tops and bottoms of the 3 years chart pattern) - giving an opportunity to enter.

Bottomline? With the Sensex undergoing a much needed correction, the HUL stock chart pattern looks poised for another rise within its bullish up-trend channel. Existing investors should hold on. New entrants can expect a 25% gain in the near term - but remember to maintain a tight stop-loss.

About assets, liabilities and the curious case of HUL

Dissecting balance sheets and getting to the root of financial statements are not really the stuff that gets me all energised. Assets, liabilities, inventories, cash and bank balances are insipid compared to the engineers' arsenal of double derivatives (no pun intended) and triple integrals.

But as uninteresting as brushing one's teeth, or eating 'karela' (bitter gourd) may be, they are a necessity for good hygiene and health. Likewise, being able to read between the lines of balance sheets, Profit & Loss and Cash Flow statements is a necessity for better health of one's stock portfolio.

Today's discussion was triggered off by reader Rishi's query last week. Why is it that a stalwart company like HUL is showing negative Net Current Assets on its balance sheet year in and year out? I was taken aback. How could that be possible? A market bellwether and leading FMCG multinational has more liabilities than its assets? After generating huge cash flows and paying continuous dividends?

Unfortunately, I could not locate last year's Annual Report. It came more than a year back and after a quick review to check every thing was in order, I didn't need to refer back to it any more. So I checked up at the Rediff money site, and guess what? Five straight years of negative Net Current Assets.

Now, any semi-intelligent high school graduate will be able to tell you that Net Current Assets (i.e. Current Assets - Current Liabilities) should be zero at worst, never negative. In other words, any company should own enough readily accessible assets to cover what it owes to others in the near term (within the financial year).

Ideally, the ratio of Current Assets to Current Liabilities should be 2 or more. But 1.5 is an acceptable number. That would indicate that a company has more than enough money to pay off the loans due and its creditors.

Unable to locate the HUL Annual Report to check the details, I checked up ITC's report instead. Sure enough, the Current Assets to Current Liabilities ratio was a respectable 1.58. Cummins India's? 1.67. Glaxo Pharma's? 1.91.

Now I was getting a bit jittery. Without the Annual Report, how will I respond to Rishi? Suddenly, I remembered my friend Nasir, who is an experienced Chartered Accountant in a multinational company. He had kindly offered to help me out with accounting intricacies if I faced problems.

Nasir's response was prompt and detailed. HUL's modus operandi is unique in corporate India. At the beginning of the year, they collect advance payments from their distributors. No distributor has the temerity to say 'No'.

These substantial advance payments are reflected in their books as a "Current Liability", though the company has no intention of paying back the money. What they do instead, is to supply their various products to the distributors throughout the year against the advance payments.

Consequently, the 'Debtors' figure under the head of "Current Assets" is negligible or nil. And the company is always flush with cash. Funny thing is, I knew about all this because an acquaintance used to be a HUL distributor.

Why do the HUL distributors effectively fund the company's operations? This is what happens when a company becomes so large and so popular, that it almost becomes a monopoly and can negotiate advantageous business terms with its suppliers and distributors.

Does all this smack of sharp business practices? Not at all. The company has worked hard over the years to create good products and establish strong brands. They spend hundreds of Crores in advertising to maintain their leadership position in the FMCG segment.

Why shouldn't they cut the best deal possible for themselves, and their shareholders? Microsoft does it. I would do it if I was able to garner that kind of market domination.

After all, a company exists to make profits. Not to win popularity contests. If it can do so without violating the law of the land, more power to them. Whether its Current Assets are more or less than its Current Liabilities.

Related Posts

How to pick Stocks for Investment - Part III

Stock Chart Pattern - Hindustan Unilever

About portfolio suggestions and a stock not to be picked

How to Select Stocks within Infrastructure Sector

Stock Chart Pattern - Hindustan Unilever

One look at the stock chart pattern of Hindustan Lever (sorry, Unilever - I'm just too comfortable with the older name) and you will know why it is my all-time favourite 'defensive' stock.

HUL is unlikely to give you multi-bagger returns. The days of super growth in the detergent-soap-toothpaste segment of the FMCG sector are over. That happened back in the 1970s and 80s.

If you want to preserve your capital during vicious bear attacks and like steady returns from tax-free dividends, there are very few stocks that can match HUL. This is not a stock for day traders. But there are plenty of opportunities for longer term trading.

Without further ado, let's take a look at the long term weekly closing chart pattern of Hindustan Unilever:-

  

(Please right-click on the chart; open it in a new tab or window for a better view.)

After making a low of 166 on Mar 7, '07 the stock entered a long term bull market of its own, trading within the up trend (green) channel that is not only intact but remained so right through the bear market from Jan '08 onwards.

A 'buy-and-hold' investor would have made a decent gain of 70% in a little less than two years, had he bought at 166 and sold at 267 in Dec '08 (including the dividends in between).

Also look at the trading opportunities for a more adventurous person. Every time the stock has come near the lower end of the channel it has jumped up.

The recent up trend in the Sensex from Mar '09 onwards has seen some selling in HUL and it has once again dropped down towards the lower end of the channel.

The RSI is about to enter the oversold region. The MACD and ROC are just below their zero lines. The slow stochastic is below the 50% line but still above the oversold zone. The stock may drift down a little more before it takes support at the lower trend line.

Bottomline? With the stock market undergoing a much needed correction, the HUL stock chart pattern looks poised for another rise within its bullish channel. Existing investors should hold on and await the dividend of Rs 4 per share announced recently. Bravehearts can enter now with a stop-loss at Rs 200.

Lessons from the Satyam scam

What started out as an aborted acquisition deal among family members has turned out to be the worst scam in the history of corporate India.

It is no wonder that Buffett said: 'You only find out who is swimming naked when the tide goes out.' Economic and stock market downturns have a habit of revealing the naked swimmers.

Yes, the plural is intended. Satyam is unlikely to be the only one. Many companies which have been declaring bumper profits quarter on quarter during the bull run have probably been 'cooking' their accounts as well.

I would be particularly sceptical about the infrastructure and realty companies - specially those with negative operational cash flows. As the bear phase meanders along, be prepared for more skeletons tumbling out of different cupboards.

Here are a few lessons that not only need to be learned, but internalised as well, so that we can benefit from similar occurences in future.

1. "There is never just one cockroach in the kitchen". This stock market adage has been proven once again by Satyam. Management trickery is never a one-off deal. Satyam had been involved in several questionable deals over the years. The latest scam is the culmination of past transgressions. Once corporate integrity is in doubt, avoid that particular stock.

(In this blog post I had mentioned that Jagran Prakashan was my favourite among the newspaper stocks. I removed it from my 'buy' list when I found out that they had recently appointed several sons/nephews of the promoter group to top positions on fat salaries.)

2. Just because a stock looks cheap (because it has fallen a lot from its recent high) doesn't mean it can't get any cheaper. Satyam has dropped from above 400 to 180 to 40 and now 20. Quite a few small investors got excited and bought the stock when it dropped to 100 and then 40. That's throwing good money after bad.

3. Markets usually 'discount' good news and bad news in advance but have little clue about what Nassim Nicholas Taleb calls 'black swan events'. These are unexpected events that seem to happen out of the blue. But more so during distressed times. 9/11 was one such event - soon after the dot.com bust.

A good way to take advantage of such situations is to strictly follow an asset allocation discipline (discussed in this blog post).

4. As a small investor, stick to industry leaders. If you are interested in FMCG, don't look beyond HUL, ITC. If you like metals, TISCO, Hindalco should suffice. In financials, choose HDFC, SBI. Alternatively, invest in index funds. There is no point in chasing the no. 4 (like Satyam) or the no.20 in the hope of making a killing.