Buy under-valued, under-performing stocks: Given the pace of the rally, we believe the market is vulnerable to a correction. We believe even if the market uptrend continues, the outperformers may see some rotation. We, therefore, screen for stocks that have under-performed the current rally and are cheap relative to their history as a means of identifying ideas for investors. Some of the large cap stocks that look attractive on this screen are Reliance, Zee, BHEL, Sterlite, Wipro and Maruti. These are not necessarily stocks on which our fundamental analysts have a Buy rating currently.

Stocks vulnerable to a correction: Similarly, stocks that have outperformed the market sharply and are expensive relative to history are most vulnerable in a correction. As expected these include many stocks in the financial space like SBI, ICICI, HDFC Bank and HDFC and other large cap names like Bajaj Auto, Ambuja Cements, Bharti and ONGC. Similar to the list above, these are not necessarily stocks we are negative on from a fundamental point of view but stocks that tactically could under-perform in a market correction.

For identifying laggards, we have taken the base as the market lows in May, 2010. The market has bounced over 20% from these lows. Other stocks that have lagged in the rally include Lupin Labs, which is one of our preferred stocks. We continue to like stocks like Tata Motors and United Spirits that have been sharp outperformers in the rally.

Given the speed of the rally, markets are vulnerable to correction. We screened for stocks that have under-performed and are under-valued as stocks that may relatively perform better in an uncertain market environment.

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

(ii) Stocks that have outperformed in the recent rally: 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 and Hindalco, etc.

(iii) Stocks cheap relative to historic valuations: 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. A few stocks may be expensive on PE (price-to-earnings) basis but are cheap with respect to their average PB (price-to-book) value, e.g. Maruti.

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

Methodology for identifying the stocks: Identifying cheap stocks: We ran screens to identify stocks which are not expensive compared to their historical valuations on a PE and PB parameter. We calculated the mean PER (PE ratio) and PBV (PB value) of stocks from March 2005 onwards and compared it with the current PER and PBV multiples respectively. For the PER multiple we have removed the stocks that have posted losses in the previous years. Cheap or inexpensive stocks were trading at a discount or small premium to their mean values.

Based on the methodology we identify software (Firstsource, Educomp, Wipro, Patni etc.), commodities (RIL, Sterlite), telecom (Bharti, Idea), Zee & BHEL which are trading at discounts to their historic mean PER. Select cement stocks like Shree Cement, Maruti etc are trading at discount to their historic mean PB ratio.

Identifying laggards: We screen for stocks that have underperformed the Sensex from May ?10 lows. Markets have tended to ignore some of these stocks, given near-term issues. The May ?10 lows stocks that have underperformed are: , Hero Honda, Maruti, India Cements, Reliance Industries, Zee, Sterlite, BHEL, JSPL, IVRCL, GMR Infra, Wipro etc.