Investment in Alpha Stocks for extra returns

Why invest in alpha stocks

Alpha It is the excess return on and above the risk-adjusted return of a stock. The performance of any portfolio is usually compared against some benchmark index on a risk adjusted basis. One of the measures of risk-adjusted return is the return obtained through the capital asset pricing model (CAPM). So first lets understand what is CAPM? CAPM No matter how much we diversify our investments, it's impossible to get rid of all the risk. As investors, we deserve a rate of return that compensates us for taking on risk. The capital asset pricing model (CAPM) helps us to calculate investment risk and what return on investment we should expect. CAPM's starting point is the risk-free rate - typically a 10-year government bond yield. To this is added a premium that equity investors demand to compensate them for the extra risk they accept. This equity market premium consists of the expected return from the market as a whole less the risk-free rate of return. The equity risk premium is multiplied by a coefficient that called "beta". What is Beta? According to CAPM, beta is the only relevant measure of a stock's risk. It measures a stock's relative volatility - that is, it shows how much the price of a particular stock jumps up and down compared with how much the stock market as a whole jumps up and down. If a share price moves exactly in line with the market, then the stock's beta is 1. A stock with a beta of 1.5 would rise by 15% if the market rose by 10%, and fall by 15% if the market fell by 10% Now you would have understood the meaning of Beta and CAPM. Now what is Alpha? Alpha It is the excess return on and above the risk-adjusted return of a stock. The performance of any portfolio is usually compared against some benchmark index on a risk adjusted basis. A positive alpha of 1.0 means the fund has outperformed its benchmark index by 1%. Correspondingly, a similar negative alpha would indicate an underperformance of 1%. For example - If a CAPM analysis estimates that a stock should earn 10% based on the risk of the stock but the stock actually earns 12%, the stocks alpha would be 2%. For a savvy investor, any positive alpha means the excess return on and above the risk-adjusted return expected out of that stock. So, it is very important for any investor to be aware of the stocks which have the potential to generate positive and negative alpha. Following are some stocks which have generated positive alpha from last 7 years continuously and they have calculated taking into consideration following points 1. While calculating the CAPM return for a particular year, the beta is considered of the individual stock for each fiscal year. 2. Similarly, the yield on 10-year Treasury bill has been considered as risk-free rate. 3. The CAPM return is finally subtracted from the actual return for the year to arrive at the alpha. The five stocks are 1. Aban Offshore 2. Crompton Greaves 3. Kotak Mahindra Bank 4. HDFC and 5. Asian Paints The average alpha for all these stocks ranges from a low of 15% to as high as 108%. The average annual return for all these stocks in the past seven years ranges from 42% to 132% CONSISTENT ALPHA - GENERATING STOCKS Note - Figures represent the average values of past seven years. There are still many stocks which have performed reasonably well. If we remove the constraint of consistency and following are few stocks which have generated positive alpha in six out of seven years.

The top three in this list are relatively smaller stocks - Balkrishna Industries (148%), Jubilant Organosys (125%) and Godrej Industries (88%) and others are Axis Bank, Bharat Heavy Electricals (Bhel), Siemens, Sun Pharma. But there are seven stocks which have generated negative alpha in six of the past seven years. These seven stocks are Castrol India, Cipla, Himachal Futuristic, MTNL, Mysore Cement, NIIT and Zee Entertainment. Most of them have generated an average alpha of -15%. Investors are advised to be careful while picking up these stocks for their portfolio. Please note - Though the past performance is no guarantee for the future and this analysis is given only for study purpose and any investment done will be solely on investors risk. Please read disclaimer.