Reputation is the key

There are more than 5,000 listed stocks on the Indian stock, exchanges with various qualitative traits, like good, bad and ugly. But even some of the ugliest-to-touch are also doing roaring business on the bourses. Millions of such shares change hands everyday, though even the company managements have no pretensions about the company fundamentals. A case in point is Unitech. Till a few months back, its stocks were clocking bewildering volumes, though the company has nothing to offer an investor except troubles.

This happens because a majority of investors and traders believe that just because a stock had done well at one point of time, it would make a comeback. In that hope, they keep themselves glued to that stock. Traders are still saved massive trouble, as they sell a stock after it breaks their stop loss levels. But investors are hopelessly stuck with the stock.

A historical study would show that rare does a sector witness a repeat of a bull run with the same breadth. Look at the IT sector; how many IT stocks have touched the levels they had hit in the year 2000? Even if they did, how long did it take for them?

The worst case examples are infrastructure stocks. Even after ten years, infrastructure sector companies are still languishing. Even after losing 90 per cent or more value, the stocks are still forming new 52-week lows.

It is not just in India that once a sector get off the high pedestal, it never regains it. Even globally, once a de-rating has happened, stocks from that sector have not got same discounting again.

It has been more than one year that mid- and small-cap stocks have been correcting and so many of them now look optically cheap. But the reality is that, they are still expensive stocks, because they can hardly reclaim their lost glory.

Similarly, a sector that is going in the way of information technology and infrastructure is the non-banking finance company space. The last three months had seen a turmoil in that space. While the troubles of housing finance companies had been in the news, the other segments of NBFCs had also not been doing well. Some results from the NBFC space have come out and over the next couple of weeks more are going to come in. At the peak og the crisis, many NBFCs were assuring all stakeholders that they faced no major issues other than minor liquidity mismatch. But now, when numbers are coming, it is getting clear who was swimming naked.

When a housing finance company’s disbursements had come down by 80 per cent in the last quarter, it shows the difference between reality and soothsaying. There are many bad apples in the NBFC space and some of them would try and cover their track at least in this financial year by juggling numbers. Though it is tough to figure out when a finance company decides to fudge numbers, investors should still keep an eye on the companies’ fresh loan disbursements in the third quarter.

Investors need to understand that even if a business continues to grow, the sector and stock may not get the same discounting from the market and that de-rating is enough to ensure that a stock underperforms for years. So, why even look at a stock where there is a possibility of trouble? Even if one doesn’t want to miss that space, buy only marquee names, never doubtful ones.

Last Tuesday, a company announced that it would be selling its business, which was held under a subsidiary, to a French company. The news had hit the market just before it opened for trade and the stock opened at 20 per cent upper circuit filter levels. But after some time, it started shedding all the weight and by the end of the day, it moved into the red zone. Yes, the company management claims that it would share the spoils with the minority shareholders, but should it be taken at face value? There are numerous examples of management not sharing even a penny with the minority investors in such deals, with the money evaporating in thin air. Even assuming that the management will share the spoil, what will be left in the company after the dividend is paid? It will be virtually be a shell company, with a promise that the management will start a new line of business! But why should an investor park his money in a stock for the management to find a footing in a new business line?

In the last one year many instances of companies facing trouble from negative auditor reports have come up. Some of these companies are now reporting real numbers and their profits are down 90 per cent and sales, by more than 75 per cent. Still their stocks hit upward circuits.

The moral of these stories is that before buying into stocks investors should remember that business cycles do come with their ups and downs and it is not difficult to adjust to those cycles if the management is capable and honest. But if the promoters are deceitful, they are bound to show their true colour some day and when that happens nothing can save minority shareholders. SO, check management quality before anything else.

(Rajiv Nagpal is consulting editor, Financial Chronicle)

Rajiv Nagpal