Background
PSU or public sector units are those companies in which 51% or more shares are held by the Government of India or state governments or other Public Sector Enterprises. The largest and most profitable of the PSU’s are what are called CPSE’s or Central Public Sector Enterprises. CPSE’s are further classified into Strategic sector and Non strategic Sector. Depending on their size and financial performance, CPSE’s are granted the status of Maharatna, Navratna and Miniratna companies.
PSU’s as stock market investments
As stock market investments, PSU stocks have historically flattered to deceive. They always look attractive in terms of P/E ratios and have the seal of sovereign backing. They also pay handsome dividends. More than half the stocks in the BSE PSU index have a dividend payout ratio exceeding 30 percent, while more than a third have a dividend yield higher than 5%.
They also have large assets and resources, with large land holdings. Moreover, many PSU’s have quasi monopoly presence in strategic sectors like defense, transportation and infrastructure.
However none of these advantages, have translated into returns for shareholders. In the last 10 years, only six companies in the BSE PSU index has outperformed the Sensex, while in the last 5 years, only three have done so.
Historical Drag
The table gives an indication of the extent of PSU underperformance over a ten year period.
The reasons are many but the primary one is the lack of management drive. PSU’s are besotted by bureaucracy and lack the proper incentive system for performing better. These companies are also thought to perform not on economic incentives.
Turnaround
The background of poor performance makes the turnaround in the performance PSU stocks since 2022 all the more remarkable. This was truly an inflexion point and those who spotted it early have reaped huge rewards.
The catalyst has been government policy. The Indian economy is at the moment characterized by slow consumption, but high capital good expenditure driven by government policy. The prime beneficiaries of this expenditure are government companies.
There is talk in the markets about the Modi premium, because every third PSU stock has doubled last year.
Spotting it early
The momentum in PSU stocks actually started in 2022. In a Mint interview in December 2022, I had talked about PSU bank stocks as a good investment prospect for 2023. https://lamronanalysts.com/media/psu-banks-likely-to-sustain-momentum-in-2023/
A 15 stock portfolio comprising of primarily PSU stocks as the one indicated below has given a return of 121% in about 9 months which brings the annualized rate to 170%
A return of 170% from large and midcap stocks is absolutely astounding. Remember these are not obscure smallcap stocks. Indeed many of the names in the portfolio are virtually household names such as Bank of Baroda, PNB, Indian Oil and Gail. This is an indication of the impact a portfolio can have if constructed in a timely manner.
Will the trends continue? There are two components to the trend.
The first is growth. Growth will continue if the government doesnot divest and there is more steam because of increased government capital expenditure. Much of the government spending is being directed towards public sector companies and their order books are to capacity. However it all depends on how well they execute the orders. This is the growth part of the story.
Then there is the reversion to the mean. In the bull market of 2002 to 2007, many PSU companies gave splendid returns and contributed greatly to the wealth creation that happened during that period. However since the debacle of 2008, PSU stocks languished as the markets got caught up in other themes.
Gradually, PSU stocks, inspite of their strengths came to be hated or at least ignored. They languished at single digit PE ratios while the rest of the market was trading at PE ratios in the low to mid twenties. But the differentials between the PSU’s and the private sector was not that great. There was complete disregard for the fact that they had valuable underlying assets and were often in monopolistic or quasi monopolistic sectors.
These inherent strengths are bound to surface at some point as the market shifts its attention to this sector.
Conclusion
The legendary Wall Street fund manager is reported to have said that more money is lost in anticipation of the correction than in the correction itself. Investors who are invested in the PSU stocks can do without fretting about the direction of the trend. There will be big headlines during periods of corrections. But if you have been wise enough to invest in this trend early like those in the portfolio above, a run of the mill correction will do no harm.
Wealth is made by investing in the right stocks and holding them for the long term.