‘Pharma sector weight in Sensex to hit an 8-year low says Motilal Oswal study’ REPORTS the financial newspaper, THE Businessline, Dated 15th June 2018, page 10 Chennai edition
The weight of healthcare in the S&P BSE Sensex will be at an eight-year low with the exclusion of Dr. Reddy’s Laboratories, said Motilal Oswal Securities in a report. The S&P BSE Sensex is all set for a reshuffle on Monday as Vedanta will be replacing Dr. Reddy’s Labs.
The drop in weight is also due to the significant underperformance of the sector over the last two years. Sun Pharma (weight: 1.7 percent) will be the only healthcare stock in the benchmark index.
The above article caught our attention and made us think whether the Healthcare sector which outperformed the BSE SENSEX by miles in the year 2015 and has given the highest returns amongst all sector has suddenly become insignificant to the economy and deserves the weight of under 2%. Does merely two years of underperformance warrant such an underrating to the sector to such extent?
In order to investigate further, we decided to see the trend in a reshuffling of the constituents of THE BSE SENSEX since the year 2004 on the basis of the data which we could collect in the short period of time. We do not claim the data to be complete. We put in the maximum efforts to find as much as we can without any prejudice. We will appreciate your efforts in correcting and help us in finding the missing links and data.
The year 2004 saw one of the finest addition to the BSE Sensex which is even today one of the leaders and outperformer. Maruti limited replaced L&T in Sensex on 19th May 2004.L&T was replaced as it was probably due to the Demerger of its cement division Ultratech Cemco which we vividly remember.L&T re-entered Sensex replacing MTNL on 27th Sep 2004. This was one of the most intelligent and meaningful change with Maruti still contributing to a lot both to the Indian Economy and The BSE SENSEX whereas MTNL which was quoting around 142 at that time made a high of 229 after one and the half year after being replaced to slump to all-time low of 9.75 and turned sick.
NTPC and TCS were added to the Sensex replacing HPCL and Zee on 6th Jun 2005. We could not find any merit or reasons necessitating the change. TCS moved from 170 at that time to 1850 now, multiply the wealth 11 times. Similarly, NTPC which was quoting 83 at that time is now is at 156 approximately doubling the wealth.
ZEE & HPCL which were replaced also matched the performance, Zee multiplying approx 9 times from 62 to 555 and HPCL from 68 to 306, approx;5 times till date. The only positive and the most important objective which is achieved is the introduction of TCS in the very nascent stage of the growth cycle and probably the best decision taken by the Index Management cell of BSE.
Sensex saw the another rejig on 15th May 2006 wherein RCOM was included in it in place of Tata Power. The only logic which we could think was the booming telecom sector and the investor’s frenzy at that time prompted the BSE index cell to include it. The price on monthly close for RCOM and Tata Power was Rs 268/- and Rs 48.4 respectively. RCOM and Tata power rallied to a new high of Rs845 and Rs159 till January 2008, both of them gave almost identical returns in percentage term. Now, look at the price action of both till August 2011 where Rcom exited from the Sensex. The monthly close of RCOM and Tata power at that time was 79.55 and 101 respectively. RCOM gave a negative return of approx. 70% and Tata power gave a positive return of approx. 108% from the date of rejig till Rcom was replaced from Sensex.
The booming realty sector and the automobile sector prompted BSE to rejig its index, the SENSEX again in Nov2007, by including DLF and M&M in place of DR Reddy and Hero Honda. The monthly close at that time for DLF was 944, M&M was at 182.5 DR Reddy at 630 and Hero Honda at 630. Now, look at the price action during the crash of Dec 2008 where DLF made a low of 124 losing almost 70% of its value.M&M made a low of 58.75 also losing almost 68% whereas Hero Honda remained in the sideways direction practically losing nothing and Dr. Reddy lost approx 40% of its value. The Scrips which were excluded from Sensex outperformed and beat comprehensively the those included. We could not trace out when DLF was excluded from the Sensex but it hardly matters as it never regained its lost glory and still is way below its listed price. The remainders were amongst the first to advance and make meaningful gains.
We saw the inclusion of Sterlite and Tata Power in place of Ambuja Cement and Cipla on 23rd June 2008. Both of the stocks included in Sensex underperformed than those who were thrown out. Sterlite had the monthly close of 174.45 which crashed to 41.3 to close at 71 in October 2008, a loss of approx 59%. Similarly, Tata Power’s monthly close in June 2008 was 102 from where it slid to 51to close at 66.6 in OCT 2008, a loss of approx 35%. During the same period, Ambuja Cement lost approx, 18% and Cipla lost only 16% of its value. They outperformed by a wide margin as the markets recovered from the October 2008 low.
In the year 2009, we saw the inclusion of Hero Honda back into the Sensex in place of Ranbaxy which got delisted. There is nothing to compare and talk about in this replacement.
The year 2010 saw three changes in Senxex. Cipla replaced SunPharma, Jindal Steel and Power replaced Grasim and Bajaj Auto replaced ACC. Cipla went from 338 to753, Sun pharm from 179 to a high of 1200, Jindal Steel and power went from 654 to 56 and Grasim from 292 to 644, all during the same period from the date of being included in Sensex till April 2015.
This continued all during the following year, Sun Pharma Replacing Rcom in August 2011 and Coal India replaced Reliance Infra, Adani Port replaced Vedanta in DEC 2015 when it was at its low and multiplied 6 times, Hindalco was also replaced near its bottom by Asian Paints. In all the above cases except Sun Pharma replacing Rcom, those excluded from the Sensex performed much better than those included after the changes come into effect.
In December 2017, we saw Kotak Bank, IndusInd Bank, Yes Bank and Tata Motor DVR replace Cipla, GAIL, and Lupin and on 18th June 2018 Vedanta replace Dr. Reddy Lab in the Sensex. It is too early to take a call in these changes and will like to wait and watch the movement before taking a call on these changes. Maybe, this time it is different.
Based on the above observations we drew the following conclusions which you may agree or disagree.
- The replacements and changes made in the BSE Index ‘The Sensex’ follow a typical Retail Investor psychology of Entering near the highest point and Exiting near the bottom. We have covered almost all the changes which we could find, made in Sensex since 2004. We could not find the changes made in the year 2012,2013,2014 for we regret. The examples given in our analysis justifies our stand.
- The market has a tendency to reward traders in a random manner by giving small profits after the series of losses. This instinct keeps the hope (of making a profit or recovering losses) alive and makes them stay in the market. The same holds true in case of Index. L&T replacing MTNL and entry of Maruti in 2004 and TCS in 2005, Power Grid replacing BHEL are a prime example.
- Almost 40% constituents of Sensex are replaced in last decade, making the portfolio mirroring the Index as a long-term investment strategy very difficult and expensive affair. The stock which is being replaced usually loses a lot of value and incur huge loss at the time of exit.
- Most of the changes made in the Index are usually when the sector catches the investor’s fancy, typically in its final leg of their cycle are included and those which are in process of bottoming out are excluded. The notable exception to this rule is the exit of real estate sector in FY 2011-12. This sector still underperforms. Index failed to meet the criteria of ‘ Catch them young’ or during the beginning or early stage of growth of the cycle.
We can continue writing and find flaws in the methodology of selection in stocks and the weight assigned to the various sectors which constitute the SENSEX, but our objective is quite different. Has the Pharma Sector BOTTOMED out?
Pharma Sector had the weight of 2.7% in Sensex and the P/E of approx 48, in the year 2012 from where the sector began to perform. The weight increased to 8.3% and the P/E of approx 76, in 2015 when it outperformed the Sensex and was the lead sector contributing to the Sensex. It dropped to below 3% in Dec 2017 with the exit of Cipla and Lupin. With the exit of DR Reddy Lab on 18th JUN 2018, the weight of this sector has gone to an eight-year low of 1.7% and P/E of approx 48 with Sun Pharma, the only stock in the Sensex.
Technically on analyzing charts of these Pharma Stocks and with the sentiment very low in this sector, we feel this sector has completed almost 30 months of correction and is poised for the rally which was never seen before.
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