Stocks that would perform in the next rally: A Merrill Lynch analysis

In a recent strategy report BoA-ML says given the speed of the rally, markets are vulnerable to correction and in this situation stocks that have underperformed and are undervalued may perform better than stocks that are expensive and already run up

With the market whooshing past in a frenzy in the last few thousand points, it is very possible that many investors missed the bus. Even if they haven't, the question on most investors' minds is, what now? In a recent strategy report to its institutional investors, BoA-ML says that it might be better to invest in undervalued stocks now since the pace of the rise suggests that a correction might be imminent. Even if there is no correction, and the market uptrend continues, the outperformers may see some rotation.

To arrive at a list of stocks which they believe could outperform from here on, BoA-ML ran some screens. It calculated the mean price to earnings ratio and price to book value of stocks from March 2005 onwards and compared it with their current PER and PBV multiples respectively (excluding stocks that have posted losses in between). The brokerage found that cheap or inexpensive stocks were trading at a discount or small premium to their mean values. Essentially what it found was that most auto, financials, consumers, and some cement names are trading expensive to historic valuations. Real estate, telecom, some pharma, commodity, media and engineering names are trading cheaper than historical valuations.

The report says that some of the large cap stocks that look attractive on this screen are Reliance, Zee, BHEL, Sterlite, Wipro and Maruti. Stocks that could be the most vulnerable in a correction could be SBI, ICICI Bank, HDFC Bank, HDFC, Bajaj Auto, Ambuja Cements, Bharti and ONGC. BoA-ML says that among the stocks that have lagged in the rally, Lupin Labs is one of its preferred stocks while it still continues to like stocks like Tata Motors and United Spirits that have been sharp outperformers in the rally.

Here are some more details from the report:

Stocks that have underperformed in the recent rally: Patni, Hero Honda, Maruti, India Cements, Reliance Industries, Zee, Sterlite, BHEL, JSPL, IVRCL, GMR Infra, Wipro.

Stocks that have outperformed in the recent rally: Tata Motors, Bajaj Auto, SBI, LIC Housing Finance, select PSU banks, DLF, ICICI Bank, Hindalco, Bharti, REC, Power Finance, Asian Paints, Godrej Consumers, Titan, M&M, Hindalco.

Stocks cheap relative to historic valuations: Real estate (like DLF, Purvankara, Omaxe, Anantraj etc.); software (Firstsource, Educomp, Wipro, Patni etc.); commodities (RIL, Sterlite); pharma (Biocon, Glenmark); telecom (Bharti, Idea), Zee and BHEL.

Stocks expensive relative to historic valuations: Autos (like Bajaj Auto, M&M); cement names (India Cement, Shree Cement); financials (LIC Housing Finance, REC, Shriram Transport, Federal Bank and select PSU banks); consumers (Asian Paints, Nestle, Dabur, Godrej); commodities (JSPL, NALCO, SAIL) and pharma ( Dr Reddy's, Cadila, Lupin).