Therefore, in this story of Money Today, we went around identifying the investment strategies commonly used in the Indian stock markets. Then we went and met or called people who were using it and asked their experience. Additionally we also had conversation with experts, and looked into the myths & realities in the investing strategies used in India by retail investors.
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It is not often that I would update an old post. But here in making an exception is perhaps necessary. Just in case if you are more interested in reading the original draft and a cruder version then it's given below.
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Myths & Realities
of Investment Strategies
Introduction
Has it happened to you that a broker, a friend, a colleague
has shared a good story about a stocks that would have convinced you that it is
the one stock that can change your fortunes?
These stories sound persuasive and reasonable as they are
backed up by strong evidence—either in the form of an anecdote, or with lots of
different statistics—that these strategies work. And when you will try
implementing the strategy, then either the stock stops performing or the
strategies pays off initially, and after some time it falters. For some reason
the success on paper or in the story seems very hard to achieve.
This results in many people losing out on their hard earned
money and then either declaring that stock market is like a gambler’s den or
deciding to never again invest in equities. Quite often when the raging bulls
take over the stock markets, they may forget the lessons of past mistake and
become the easy prey for ‘the next big stock story’.
Most of these stories have some background either because
some investment guru had used or at a nice graph showing how in the previous
years the strategy had completely outperformed the market benchmark or there
was a famous study endorsing the strategy with similar results.
At the end of the day, all of these stories have some common
roots. Aswath Damodaran, Prof at New York University, in his book ‘Investment
Fables’ has captured the essence of the stories very well, “While there are
literally hundreds of schemes to beat the market in circulation, they are all
variants of about a dozen basic themes that have been around for as long as
there have been stocks to buy and sell. These broad themes are modified, given
new names and marketed as new and different investment strategies by
salespeople to a new generation of investors.”
We have identified some of the common investment strategies
that carries appeal to many investors in the Indian stock market, and
investigate if they are only Myths, in the form of a good story, or if there is
some reality of making money through these stock picking strategies.
1. Dividend giving companies:
Myth: Dividend giving stocks are as safe as debt investments. And a company that has announced that it will be giving high dividend in this year, are a good opportunity to invest in.
Reality: Investors with very little risk appetite tend to prefer the safety of government bonds or FDs than investing alongside the risk of stocks. The belief is that these instruments are risk free since the government is backing it. So to such investors, the story sold is that they should invest in a dividend giving stocks as there would be regular income from the dividend, at the same time, one would also get the benefit of capital appreciation.
This strategy of investment was very common in United States (US). Dr Vikas Gupta, fund manager, Alpha L50 (India), Arthveda Fund Management Pvt Ltd shed some light on its history: “In 1960s in US one idea that was commonly accepted and applied was, you should invest in dividend giving companies if its dividend yield is twice the long-term bond.”
At the time many large pension funds and investment trust were following this as a thumb rule as part of their investment policy. This forced the large companies, typically market leaders, to give out dividends regularly so that they can qualify as an investment grade stocks for such investors. That is why this is considered to be an indicator of high quality. Sometimes even when the company has had lesser profits due to business cyclicality in one-or-two years, the company would borrow money and give out dividends.
Adding to that Gupta says, “In India the best dividend giving companies have a dividend yield that is approximately half of the risk free rate, therefore, it would not be possible to implement the same strategy in entirety.”
So the natural questions for Indian investors should look at how long has the company been paying its dividend and was the company consistent? Also look for companies that are very large in size. Whether the industry is cyclical and how the company is paying dividend during its cycles? Was the company able to pay dividend in the worst of its cycle? How does it get the money for paying dividend?
Dipen Shah, Head of Private Client Group Research, Kotak Securities, believes that fundamentals should be the focus of choosing a stock. Sharing his views on the safety of the strategy he says, “This will give me more comfort that at least I have more protection that even if the stocks fall by 5-7%, I have tax-free dividend that will come to me. At least there is some protection.”
Taking a dig at the type of companies that will show in a dividend yield list Rupesh Patel, Fund Manager, Tata Asset Management Ltd says that three types of companies will feature if one runs this screen.
A company which has a very strong business model and they have lots of free cash flow. And despite investing money for future growth the company is still left with sufficient cash to payout to its investors. There can also be a case that the company is generating a lot of free-cash but the incremental avenues to invest may not be there, so the payout ratios is very high but one will not witness the compounding effect of growth in such companies.
Anindya Bera, a retail investor from Kolkata says, “I prefer safety over risk. High dividend yielding stocks are relatively safe bet in an otherwise risky investment landscape. Most of the high dividend yield stocks tend to be mature companies with stable revenue stream giving me more comfort.”
The second type of company would be those which have sold part of their business or brand or land for that matter, and have suddenly received excess cash for which they do not have any avenue to deploy. “In which case they could give out a one-time special dividend. So when you are looking at dividend yield it will certainly look high but this is not sustainable,” says Patel.
“Another important point to look at would be how consistent is the dividend, at least look at data from last three years and try and see whether consistent dividend has been given out by these company,” says Shah.
Kiran Kavikondala, Director WealthRays says, “We have been recommending dividend giving stocks that have a long dividend giving history but we stick to large-cap companies, one of the important items is to look at the agenda.”
Ayush Mittal, an investor from Lucknow shares his experience, when after rigorous research he bought Mayur Uniquoters and MPS Ltd, two good examples of small companies with consistent dividends and an exhibited earnings growth. Where he made substantial profits. Based on his experience he says, “Rather than just looking at the dividend percentage being paid, investors must look at the dividend payout percentage of the net profits being distributed by the company (a good dividend payout for a manufacturing company is of >25% of net profits though it depends on a company's business).”
Patel says, “Another good type of company would be those companies which have been paying regular dividend but because of a specific situation either related to stock market in general or industry or company, prices have corrected.” He adds this would also lead to high dividend yield. Therefore, when the tide turns investors will also witness capital appreciation. “Here the importance should be given to understand why the price has fallen.”
“Our experience is that investors who are in the 45 and more years of age group most of the time prefer a public sector company over a private sector company,” says Kavikondala. He further adds: “Although when I look at the numbers there is no evidence that the public sector pays higher dividend than the private sectors. So our advice is that one who is focusing on the dividend strategy need not keep their portfolio skewed towards PSU.” If investors don’t plan to invest with a long horizon then only they should look at dividend strategy.
Currently we are in a high dividend yield period but this will not remain the same. Therefore this can’t use it as a long term investment strategy because at some point this will not be the case. “I can buy all the high yielding and consistent dividend paying stocks right now but then I can’t trade. And in future when I get additional fund but then I may not have the right dividend yield to deploy at that point in time,” says Dr. Gupta.
Explaining on who should not invest in dividend giving stocks Kavikondala says “If capital appreciation is the focus of the investor then perhaps dividend investment is not the best approach for investors. Dividend investment strategy in akin to real estate investment.”
Adding caveat to this investment strategy, all experts agreed that valuation is important, it is imperative that one shouldn’t buy any dividend giving stock at any price; the price and valuation is important to decide the timing of investment in the company. Also this investment strategy may deliver less returns in a bull phase.
2. Fast Growth companies
Myth: Fast growing companies are best investment. You can buy it at any level as it will grow all the more.
Reality: The story for fast growing company is that any market leader would start as a fast growing company at the early stage. Therefore, till it becomes the largest company in the sector it has the potential to grow fast.
As Damodaran writes in Investment Fables: “If you put your money into the companies with the highest earnings growth in the market, you are playing the segment of the market that is most likely to have an exponential payoff or meltdown.”
Kavikondala says, “Investing in fast growing company is actually a high risk strategy. We look at things like the background of the promoter, what kind of market do they cater to, projects in the pipeline, operating margins, and their expansion plans to decide if it would be worth investing in.”
Since growth shows a very high rate of increase in the earnings growth it usually trade at high multiples of earnings and are usually risky. But the risk-seeking investors do not get affected by any of these concerns as their focus is more on for price appreciation instead of dividends. Their argument being that high earnings multiples will result in even higher prices as the earnings increase over time.
Shah says, "For a fast growing company, it may seem a bit expensive for now. But my understanding of the company should give me the comfort that it is a fast growing company. Then two years down the line the growth of the stock may have showed me that it was a good investment.”
Any investor should put in the effort to understand if this growth can be continued. Past growth may not be replicated. So if there is a company that has been growing for last two-three years for 30-40% then it is a good reference point. But question to ask and understand is if it can continue this? This fast growth can be because it is in a fast growing company. A company may be fast growth in a saturated market, this would in most likelihood be because the company caters to a niche market.
This investment strategy also has flaws. “The pitfall in using this screen can be that one would end up looking at the revenue growth or earnings growth. Now I can boost my earnings by borrowing more money and then investing it. Now many investors would say that the company is having such a high EPS and revenue is also increasing for last few years, so let me buy this,” says Dr. Gupta. He adds, that though growth can be seen but simultaneously the company is getting extremely leveraged. Now for any reason the growth is not according to plan then the company can default on its debt.
Hence, Dr Gupta recommends that investors should look for companies that are fast growth but not much leverage and growth is mostly supported via internal accruals. Understanding from where the growth is coming from is very important.
Mittal also invests in Fast Growing companies and shared about some of his pick like, Astral Polytechnik and Avanti Feeds. He says, “One must have noticed the mention of Astral Polytechnik in Dabang 2 or in the recent cricket matches advertising its pipes used in plumbing solutions. The company is one of the leading producers of CPVC pipes which are fast replacing the traditional GIC pipes in Indian markets. The company has been among first few players to introduce CPVC technology in India, and has well compounded on this huge opportunity size. The company is among the rare few companies with a revenue growth of over 25%, year-on-year, for each of the last 10 years.
“Then Avanti Feeds is one of the largest players in the shrimp industry. The industry underwent a major positive change with the introduction of a new species of shrimp - Vannamei which is healthier and more disease resilient as compared to earlier variety. The company well capitalized this opportunity and has been growing quickly at a compounded rate of 45% p.a. for last 5 years.”
Meanwhile, he also shared about some of the fast growing companies which did poorly like Tanla Solutions, ICSA.
3. Low PE Stocks
Myth: Stocks trading at low multiples of earnings are a good buy as they are both cheap and relatively safe equity investments.
Reality: Patel explains, “This is also a value investing metric. At an essential level, PE ratio shows my payback period.” Supposedly, if the PE of a company is 5x, then at the current earnings level it will take the investor 5 years to recover their investment, provided they are the 100% owner of that company.
A challenge that investors would feel is what is low PE? This will come up especially since FMCG companies will mostly have a PE of more than 20x meanwhile infrastructure companies can witness their PE at less than 10x. “Therefore, if there is a low PE company one should always look at the PE for companies in the same industry and compare industry PE as well,” says Patel. The focus should be to understand ‘why market is quoting a low PE?’ (Industry reasons or company specific reason). It can be due to bargaining power of the supplier, or because it has few major customers. So the right way to compare the PE would be against its industry average.
Another way to decide on when the low PE is better is by comparing the yields of stock against the bond or FD. Dr. Gupta breaks it further and says, “If you reverse the PE then it becomes earning yield (earnings per share (EPS)/price or EP), in the case of a completely stable, regular dividend giving company is taken up where you have a clear view on the cash flows, that it is robust and doesn’t fluctuate then you know what would be the earning’s yield. If that yield is comparable to your fixed income or maybe if it’s a little bit higher than the fixed income then it’s a worth a buy.”
Dr. Gupta says, “If I am buying any company then I should research properly and select the ones that are actually mispriced. As individuals it is difficult to buy all low PE stocks, so we should screen with low PE and then look for the gems.” Giving an example, he said, “Britannia was at one point available at 11x PE when Wadia’s Kalabakan Investments and Groupe Danone were fighting, investors were worried about the uncertainty but as far as the business was concerned it was in excellent shape. Once the period of uncertainty ended its price went up and PE also increase making it a multi-bagger for investors.”
Shah says, “If my view on the market is that it will remain subdued then I will not be looking at low PE because my view is that the market will remain low, and the sector is not doing well. But when I see that the sector is not doing as bad and the stocks have been beaten down for some news related reason then let me look at low PE stocks.”
Explaining his method further Shah says, “From there I will look at all companies to understand if they all deserve to be low PE or some of them have been beaten down irrationally.” Only if he is comfortable on PE and the growth prospects are good, then Shah will study more on them before picking up the stocks.
He opines, “If someone is using only using a low PE strategy and they take this as an end result and buy based on this, they might be in for a rude surprise. As they mightstill witness some more fall and they would see that the stock has continued being a low PE making them more frustrated.
Nikunj Gandhi, an investor who stays in Navi Mumbai while sharing his experience said, "I would look into when these companies are being sold at a relatively low PE as against their industry average. In forming the industry average I would look at only the large and mid-cap companies." He explained that exclusion of Small cap companies is important from the industry because their stock price could be different because of high volatility. "It’s one of the most important things that I consider before buying the stocks," says Gandhi.
"Since I keep reading about these stocks, their annual results and have gained some idea on what to expect from their businesses, therefore I make estimates when the PE of the stock is below intrinsic value, says Gandhi."
4. MNC models
Myth: Buy into MNCs because to delist they will be buying the stocks from investors and they will pay any premium to get full control. MNCs corporate governance is the benchmark.
Reality: The buy-back story is very recent. This narration has come up in the media, and was vehemently discussed on different platforms and by many experts since SEBI, the market regulator, had stated that all companies must have atleast 25% shares floating on the exchange.
Kavikondala says “Buy-back strategy is something that we have been looking and considering the investment only over the last one or two years.” He adds that this comes into play after the announcement comes from the companies. There can only be two situation either the investor holds the stock or they don’t have it. “This is somewhat similar to the IPO. The important thing one needs to look at is what the prospect of the company is?” He suggests that an aggressive investor can use this as strategy for about 15-20% of their portfolio for such a strategy.
Meanwhile Patel opines “In terms of the buy-back strategy is a speculation. One can make a guess that because of the history one company would be delist but that is maximum what one can do.”
He says that MNCs as a strategy can be worked because they have good corporate governance, good brand names, good management quality, they are efficient users of capital and they are here for long-term; which works great in favour of a long term investor.
Dr Gupta says, “The biggest trust is on the PSU accounts, and then on the MNCs accounts. So if the MNC account is showing cash then it is probably true.”
Over the last few years more and more people are looking into multinationals because the governance level is very high. This can further be backed by looking at the MNC index as it has outperformed the Nifty over the last few years.
Deepak Ladha, Executive Director, Ladderup Corporate Advisory says, “We use a combination of factors to decide on an investment in a company, so buyback is not a strategy. There are MNCs which are not necessarily fast growing but they give consistent dividend. There are some multinational which do not give dividend but they tend to register higher growth.
“But if you really see, the MNC strategy at its core has also worked earlier. There are not too many MNCs in the Indian stock market. But if you really see around the market, the way returns have happened for Glaxo Pharmaceutical, HUL, Siemens, etc. There are multiple examples of MNC strategy working.”
He reiterates that if the MNC is not showing appreciation on the stock market in the immediate term, you still get dividend yields which can make you comfortable with some of these companies.
Marking a caveat Patel says, “The grey area where investors should be very careful is, sometimes these MNCs may have wholly-owned subsidiaries. At times one may not get a clear picture of what costs are being charged to the listed entity and which ones are being charged to the wholly-owned subsidiary. So it is not clear if this is at arm’s length and what kind of services are provided.”
“In the past they have clearly shown that they will delist when the price is depressed like Cadbury. The second thing is that at any point in time the MNC can decide to increase their Royalty, and this is not in the best interest of the shareholder. Dividend giving is fine as even the minority investors’ benefit, but not royalty,” adds Dr. Gupta.
Ladha also agrees, “The downside is that the MNCs may transfer their cash generating business to a wholly owned subsidiary, a case in point would be what Maruti was trying. And that is a risk one will have to understand and keep evaluating.”
What an investors should look at what sectors the MNCs is in and try to understand why and when it will work? Ladha explains further: “For example, Siemens is in the engineering sector and hence it will benefit if there is a stable government and the infrastructure work picks up; whereas if you take Glaxo Pharmaceuticals, it is a perpetual story. Pharma’s will grow at a certain rate continuously.”
“Therefore, it is essential to understand what kind of sector is it and what is the prospect of the sector. Coming back to the example of Siemens, the company’s PAT has come down, so it would be having a higher PE ratio, but if the infrastructure space witnesses’ activity and Siemens PAT goes back to its previous level then it will result windfall gains for the investors.”
The MNC strategy is very good at this point in time because the entire focus in the Indian market has been on the Pharma and IT, which is more export focused and some of it would be domestic but it is not related to the GDP or the industrial growth. Whereas in the MNC at least on the corporate governance side you are protected, so the principal in all likelihood should be protected.
5. Following the FIIs
Myth: One of the common misconceptions that retail investors have is that if foreign institutional investors (FIIs) or domestic institutional investors (DIIs) sell the stock of a particular company, then the company may put up a bad performance or some negative developments may take place.
Reality: Here, what most retail investors ignore is that FIIs or DIIs have their own guidelines, parameters and external factors that impact their investment decisions. Pankaj Pandey, head of research, ICICIdirect says, “If FIIs are facing a liquidity crunch then they may tend to sell even good stocks to tide over the situation temporarily. In this case, a retail investor who follows FIIs or DIIs and sell the stock tend to miss the upside opportunity that a good stock may provide in future.”
There are certain cases when a stock gives negative return even when FIIs increased their stakes in a company. In the BSE 100 index, there are 26 companies in which FIIs have been increasing their stakes since March 2013. Out of these, 9 gave negative return to investors during April 2013-February 2014. Similarly, during March-December 2012, there were 34 companies in the index in which FIIs raised their holdings, out of them 13 gave negative return to investors during the financial year 2012-13.
For instance, FIIs have increased their holdings in Tata Power Company from 24.54% in the quarter ended March 2013 to 24.78%, 25.05% and 26.03% in the sequential quarters ended June, September and December 2013. However, on account of muted cash flows, the share price of the company plunged 17% to Rs 79.45 on February 26 this year against Rs 95.8 on April 1 last year.
Likewise, concerns over high debt and soaring interest cost keeping the share price of Jaiprakash Associated under pressure. As a result, its share price dipped over 38% to Rs 41.90 on February 28 this year against Rs 67.95 on April 1. However, FIIs are looking positive on the company as they have increased their stake from 22.77% in March 2013 to 27.41 in December 2013.
Pandey of ICICIdirect says, “The risk appetite of retail investors and their investment horizon and holding power tend to be different from that of institutional investors. Hence, peculiarly, if an investor enters a stock in which FIIs have entered and this stock declines in the near to medium term, retail investors with not so deep pockets and liquidity concerns often tend to sell these shares and end up with negative returns.”
According to Vikram Dhawan, director, Equentis Capital, the strategy to follow FIIs is suitable to long-term investors that have the discipline and the resolve to accumulate at every sizeable corrections or short-term traders that have strict profit and loss targets.
Patel says, “One also needs to understand that what may look like a huge stake to you in terms of FII maybe a very minuscule portion in their portfolio so they can just dump and get out at any moment creating a run on the stock.” So this is not the best of strategies to implement for retail investors. Also we are not aware the reasons based on which the FII has bought.
6. Following the Promoters
Myth: There are misconceptions that the share price of a company can go up when promoters show confidence in the company.
Reality: Most of the market experts believe that a hike in promoters’ shareholding sends positive message to investor community that promoters see value in their company at current levels or there may be some positive development in the business in future.
However, the data shows no direct correlation with the given logic. Consider this: In the BSE 500 index, there are around 270 stocks in which promoters have been increasing their stakes or keeping it constant. Out of these, 140 stocks gave negative return to investors in the past five quarter till December 2013.
Paresh Shah, managing director, equities, Centrum Broking says, “In the given case a stock can give negative return to investors due to lower earnings growth vis-à-vis other companies in the sector. Some of the other reasons are decisions taken by management which can impact market value or future earnings potential of a company, selling by institutional investors due to market conditions, financial institutions selling off where stake is kept as collateral (pledged) and overall sell off in domestic and global markets (as seen in 2008) can also dragged down the share price down.”
Rei Agro, Ruchi Soya Industries, Parsvnath Developers, JBF Industries, Future Retail are some of the companies in which their promoters have been increasing their stakes since December 2012, however, the stock price of each of the company pluged over 30% each since the beginning of the ongoing financial year till March 3.
Rajesh Sharma, Director Capri Global Capital, says, “Following promoters is perhaps one of the best possible way of investing. But it requires a lot of hard-work.”
He suggests is that one must read about the promoter, and the management. Look into how much of disclosures do they give. Make sure that the company has low debt or manageable debt. The company has a good brand and their product will not become redundant in near future. There is scope for their product to increase market share. And check how the industry is faring as a whole. Look at how the management has functioned during a downturn and how were they rewarded. How did the stock do during this up and down period? Sharma says “Following a promoter like Ajay Piramal, Mahindra etc. has been very rewarding for investors. But if you don’t understand the company and its business and did not do proper due diligence about their promoters and business associates then you will run the risk of investing of losses.”
Dr Gupta, says, “It’s a good indicator but even this should not be followed blindly. A case in point would be Deccan Chronicle, they picked up shares from the market for nearly Rs 300 crore but we know how its stock has performed.
Then another would be Texmaco Rail, it is the largest rail company, they make those wagons. Now Texmaco Rail was split off into Texmaco Infrastructure and Texmaco Rail around 2010-11. And Texmaco Infrastructure had 30% share of Texmaco rail so everyone sold off Texmaco Infra because all the operations was with Texmaco Rail. Now Texmaco Infra had 30% in Texmaco Rail, and some investments and lands were held in its book. After that all of the promoter associated companies and have been buying Texmaco Infrastructure but they are not talking what they plan to do with the land holdings. Since there is no clarity on the land bank, therefore there is an element of risk. What if, they come with their own private company and then start developing the land, and this is done on such terms that it’s the private company that benefits rather than the original company – Texmaco Infrastructure.
“This is the kind of risk that one can look at therefore it’s very important that you follow all the announcement,” says Dr Gupta.
Following the promoters is a good screener but that screener can only be followed when the track record of the promoter is very good. It is also important that while reviewing such screeners one should understand and look at how the promoter uses the subsidiaries and group companies.
7. Initial Public Offerings
Myth: There are number of misconceptions related to investing in initial public offerings. Firstly, companies going public are flourishing and have grown financially. Secondly, it is believed that issue price is the fair value and one could not lose money by investing at that price and lastly, some investors think if the issue is oversubscribed, then it is a must buy.
Reality: There are companies who go public at a very early stage in their life cycle before proving their financial feasibility. What is therefore important to understand is whether the company going public is in need of money for expansion or is it in need of money for clearing its debt. It is obvious that you may want to avoid the latter unless you are very convinced with the business model and other aspects of the company’s business.
For those who believe that the IPO is available at fair price and chances of losing money is minimum. Chethan Shenoy, vice president, investment products, Anand Rathi Private Wealth Management explains, this is not true as the fair value of the company can be ascertained after taking into account various financial parameters and macro environment. There are instances where if the market fundamentals are not supportive, good companies too have fallen below their issue price on listing day. Investors would generally make good gains by investing in an IPO and selling on listing in years when there is a bull run which is considered a fertile environment for IPOs and when the market sentiments are positive and vice versa.
For example, in year 2007 when the stock markets were going through a bull phase there were around 100 IPOs and quite a few generated triple digit returns on listing like Everonn Systems (241% gain on listing), Allied computers (214% gain on listing), Religare Enterprises (182% gain on listing), Mundra Port (118% gain on listing) to name a few.
Similarly in 2008 and 2011 when we were going through a bear phase companies like Tree House, Reliance Power, Omkar Speciality, etc. have registered a fall in price on listing. In 2008, around 50% of the IPOs listed in the year gave negative returns on listing whereas in 2005 around 12% of the IPOs gave negative returns on listing. In 2008 and 2011, the BSE Sensex retreated around 110% and 25%, respectively.
For those who think investment in an oversubscribed IPO can give good returns on listing. According Chethan Shenoy of Anand Rathi Private Wealth Management, oversubscription does not guarantee performance and misreading the initial demand can have big consequences. Whenever you see news being flashed on oversubscription of the issue it represents a picture that the IPO is a worth investment and those sitting on fence are lured to invest into it. However, one should invest in an IPO after detailed due diligence and being convinced that it is a good buy.
While there can be a number of success stories there would be an equal number of stories of stocks that failed to perform on listing. For instance, CARE announced its IPO in December 2012 for an issue size of Rs 540 crore at a price of Rs 750 per share and was oversubscribed 40.98 times. On the day of listing, the stock closed at Rs 923.95 registering a gain of 23.19%. Similarly, ICRA announced its IPO in March 2007 for an issue size of Rs 85 crore at a price of Rs 330 per share and was oversubscribed 75 times. On the day of listing, the stock closed at Rs 797.6 registering a gain of over 140%.
However, there have been some big flops too like Reliance Power which announced its IPO in February 2008 at a price of Rs 450, got oversubscribed by 75 times and on the day of listing lost 17%.
Market experts believe IPO investing or equity investing should not be looked at from a trading perspective but from a long term perspective. Investing in an IPO is similar to investing in stocks in the secondary market with only difference being the company who announces an IPO does not have a track record of price movement that can be analysed. As such an investor who wants to invest in any IPO should first analyse if the price at which it is being offered is right. An investor should check the price to earnings ratio (P/E) and price to book value (P/BV) of the company, the earnings growth and the revenue model of the company vis-à-vis its peers and industry in which it operators to check if the issue price is undervalued, fairly valued or overvalued. If it is overvalued then it means that you should be cautious while considering them however if it is undervalued or fairly valued he should definitely consider them for next level of check.
S Ranganathan, head of research, LKP Securities says, “An IPO investor should also study the promoter background, competitive positioning of the company in the market place, pricing power of its product and valuation before subscribing to an IPO so that he is better prepared to take his call on listing.”
“IPOs as a strategy does not work anymore because the culture has changed,” says Dr. Gupta. He explains this further, “In IPOs the idea earlier was to value the stock conservatively, and leave something at the table so that retail investors hold the stock for some time and still make money. So the pricing has changed.
“Since 2006 many of the MNC investment bankers’ where the culture is different, their aim is to price it as high as possible and raise the maximum fund for the promoter, and this was also because their fees is linked to the amount raised. And as long as you can take the price higher on the day of listing then no one can blame the investment banker. In a bubble market this is not difficult, so all sins gets washed away.” Since earlier the IPOs were listed at a discount, the retail investors got further discount so it was a very easy way of making money. Therefore, there were investors who would just make IPO investment and not put money anywhere else.
Sharma adds, “IPOs as a strategy has stopped working because of QIPs.” Ever since the introduction of QIPs, the IPO market has become more efficient in terms of pricing of stocks. He says, “With the introduction of QIPs, the price discovery mechanism has improved.”
8. Buying and selling on 52 week low-52 week high
Myth: Contrarian investors will try to keep the price of securities back to the fair value levels by adopting strategies like “winners are punished” and “losers and purchased”. There are many investors who sell stocks which are above its previous 52-week high on expectation that share prices will correct and there are investor’s who buys stocks which are below its 52-week lows.
Reality: According to market experts, the investor who always sells stocks when it is above its 52-week high is unknowingly taking a high risk; in a bullish market good stocks will move first and later the poor quality stocks will follow suits. If the investor does not know the fundamental values of the stocks (which are above its 52 week high) but wants to create short positions he may end with in huge losses.
However, in a bearish market all fundamentally poor stocks will find new lows at every day. Buying these stocks can spoil the investor’s wealth. In a bullish market if stocks find a new 52-week low then there must be a certain reason for it. Without knowing the reason if the investors invest in these stocks then they will end up in loss. The classical examples are infrastructure sector stocks, they all lost 30 -75% value in the past four year period till December 2013.
Alex Mathews, head of research, Geojit BNP Paribas Financial Services says, “Both strategies are workable in some cases in a moderately good market. But there are risks also, in a bullish market all most all stocks are likely to test its 52 week high, fundamentally sound or fundamentally poor also.”
However, Sahil Kapoor, chief technical strategist, retail capital markets, Edelweiss Financial Services says, “Technical analysis goes by the belief in buying strength and selling weakness. Hence, a stock which has made new 52-week high means that it has strong relative strength as compared to other stocks and buyers are very active in trading a 52-week high stock. A 52-week high breakout after a consolidation has even more significance as there is a range expansion and the stock is ready for a strong and a sustainable trend.”
Markets generally prefer quality and stocks which sustainably trade above 52-highs have dedicated buyers convinced about the future performance of the stock. Stocks which are battered and are unable to reverse from lows are generally not favoured.
“An important reason to avoid bottom fishing in 52-week-low stocks is the difficulty to spot the winners. If one were to split purchases in a portfolio of stocks making 52-week lows, the probability of losing money is higher than lower. If we were to buy stocks which are making new highs the probability that you pick more winners than losers is higher,” says Kapoor.
For example, Hindustan Unilever (HUL) made a new 52-week high in September 2010 by crossing Rs 300 after 10 years. Investors would have earned handsome returns if they had bought the shares of HUL at Rs 300 levels. The stock price has jumped by more than 100% to make a high of Rs 718.90 in July 2013. On 4 March 2014, it was trading around Rs 555.
Similarly, IVRCL made a new 52-week low in 2010 by breaking Rs 140. On 4 March 2014, it was trading at Rs 11.06.
For investment in a stock which have recently hit its 52-week high or low, Kapoor of Edelweiss Financial Services says, “Investors shall maintain a 5-7% stop loss once a stock makes 52 week high. If the strength and range expansion persists then there is a high probability that the stock will give 20% plus returns in medium term. Investors who have some basic trading skills and discipline about their trades should use the above style. If a stop loss is hit, then the investor should not get bogged down and loose the focus of trading.”
9. Sidecar/Copy-cat investment
Myth: Following an expert’s portfolio is very rewarding.
This is more about looking out for companies that has been bought by an expert. This is something that many people try via media, all the news that comes that Rakesh Jhunjhunwala has invested in a stock, or if someone notices that Prashant Jain has increased his stake in a company then these stocks get attention.
Dr Gupta says, “There is no proper way of doing that. The major hurdle in this is that you would be not know when they would have sold, also the truth is you may not even know when they had bought it infact. The information flow cannot be as slow, as six months’ time-gap because then it is not useful, at the most the information can be delayed by a 2-3 weeks.
“Then this strategy can be used and investments can be deployed. This is workable in only undervalued companies or a contrarian style can be followed using this strategy. The contrarian approach takes a long time to workout. You need patience. For momentum this strategy cannot be employed. In US it is because of the 13F filing that one gets all the information. So at the most the information is delayed by a quarter.”
The perennial question for an investor following this strategy is “Why someone bought it? How long they plan to hold?”
Kavikondala says, “Not many people are aware of the term. We call it a replicator at our company. We tend to suggest people stocks from among the dividend based mutual funds or an opportunity based fund. This is not required on a hand holding basis, but the investors who tend to do their own research and for which once in a while they would require some level of guidance.”
Considering that Indian stock market, as it doesn’t have a very long history of investment experts’ nor does it have depth or breadth in the stock market, also there is more scope of transparency. Combining all of these aspects make this a challenging strategy. Those who plan to use such strategy should understand the temperament of the people whom they plan to copy-cat. It is also necessary that proper due-diligence is done on such stocks.
10. Penny stocks
Myth: Penny stocks are usually bought with the perception that they are priced so cheap that they may make a person rich overnight. The other misconception among investors is that such companies do not have funds availability and they may misuse investors’ money.
Reality: Yashpal Gupta, executive vice president, IDBI Capital Market Services says, “Penny stocks aren’t great options if one is looking for a way to get rich quickly. When one invests in penny stocks, earning a huge profit isn’t always guaranteed. Just because a stock is very cheap does not necessarily mean that it is a good bargain. Hence, the investors must do their research and be ready to hold such stocks for a longer time frame in order to reap benefits.”
The other most common reason behind buying these stocks is that these are available at low prices and can be bought in huge numbers with a small capital. People perceive these stocks to be ‘cheap’ and a way to over-night fortunes.
Rakesh Goyal, senior vice president, Bonanza Portfolio says, “Stocks cannot be tagged as cheap or pricey solely on the basis of its market price. Stocks are valued on the basis of their fundamentals–their net worth, business potential, income growth etc. So if a stock is trading at low prices, it is primarily because markets do not value it much in terms net worth or growth. Thus, every penny stock may not be a ‘bargain’. People are also seen buying penny stocks with the idea that small addition to the price can bring in huge profits.”
For example, if someone buys Rs 10,000 worth of a stock at Rs 2 a share and if the share price reaches Rs 3, it would entail an upfront profit of Rs 5,000 on an investment of just Rs 10,000. However, for the stock to give a return of Rs 1, it would have to move by 50% in a particular period. “It is not practically impossible unless there is substantial rise in the general interest of public in the stock or if there is steep rise in general market indices,” says Goyal.
There are number of penny stocks which changes fortunes of investors. For example, stocks such as Core Education & Technologies which was trading at Rs 0.12 on 1 March 2004 jumped over 122 times to in the past 10 years to Rs 14.44 on March 3 this year. Similarly, share price of Rander Corporation jumped 12,360%, or 124.5 times, from Rs 0.56 on 1 March 2004 to Rs 69.95 on 3 March 2014.
On the other hand, the share price of penny stocks such as SMS Techsoft (India) plunged over 76% in the past 10-year period to Rs 0.09 on March 3 this year. Likewise share price of Nu-Tech Corporation Services plunged over 66% to Rs 0.33 on 3 March 2014 against Rs 0.98 on 1 March 2004.
On the above returns given by penny stocks in the past ten years, Gupta of IDBI Capital Market Services says, “Penny stocks are high-risk stocks in which chances of huge profit are usually coupled with even bigger chances of making loss. Hence the best strategy for risk-averse investors is to refrain from investing in such stocks. However, if the investor has the necessary risk appetite and wishes to take a chance, then it is advisable to understand the fundamentals and financials of the company, risks involved and time horizon for which the investor wishes to hold such stocks. Good picks may emerge from penny stocks due to changes in business fortune or management, favourable policy changes, takeover by good companies or by better management.”
It is advisable to investors that you may start investing in a penny stock after reading through the financial statement of the company and doing proper research relating to future business plan and strategy of the management to determine whether it is a stock worth investing in. “One should stop investing in penny stock when the company is not showing good financial performance or when it is not performing within the estimated time horizon. Further, if there is a negligible possibility of a company turning around then also one should stop investing in such stocks,” says Gupta.
Conclusion
All of the 10 strategies have worked at some point and can work at another point of time again. The most basic thing that all investors should understand is that there is no escape from hard work and patience when investing in stock market. It has been rightly said, ‘every penny is a hard-earned money’. This is truer in the stock market that anywhere else.
Some of these strategies namely – Dividend, Fast Growth, Low PE, Following promoter and MNC – are good as for selecting few stocks on which you can concentrate or further research but none of strategies alone can make you rich and there is no quick buck in this business.
One of the problem that an investor will face is that at times the strategy will seem to not be working. This will be test the patience of any investor.
The most important points to remember include that you don’t change the strategy just because it didn’t work in a one or two years. In given period of any five years, chances are that one strategy would not have consistently and continuously outperformed the market.
If the stock pick is good, it’s a leader in its segment but the business cycle is not supporting it. Let’s see if in a rising business cycle it goes up or not? Wait for the business cycle to actually turn. If even after the business cycle has turned and all its peers and related stocks are rising but the stock that you are holding is not going up then it means that you have made a wrong decision. A case in point that requires evaluation: if there is a problem with the management, if the stock is not performing well because of an inherent weakness in the business, a huge debt with the company, etc. “Another important point to understand is that the business cycle in each sector is different,” says Shah.
Investors such as Gandhi, sharing their experience, state: "The first challenge is to not get swayed away. People will tell you tips. Your broker will call up and suggest stocks. No matter whatever happens one should do their homework and not try to employ any short-cuts. Maintaining this discipline is the one challenge."
And Bera points that for him the biggest challenge is: “Investment is a time consuming activity. With full time job it is very difficult to monitor ones portfolio. Keeping a portfolio of stocks means you need to be making regular adjustments to them so that they still remain relevant. Buy and forget, might work for other investment avenues but it doesn't produce the expected dividends when you are investing in stocks.”
Any strategy can work, what an investor must understand is that there are 6000 stocks listed in the market and the idea of a screener will shortlist the stocks to a more manageable number like 30-50. Once the list is more manageable then you have to do a bottom-up stock picking, after doing due diligence. Another important point to remember which is often less talked or written about is that you need to check once a year if your assumptions were correct and the companies are on target.
Myth: Dividend giving stocks are as safe as debt investments. And a company that has announced that it will be giving high dividend in this year, are a good opportunity to invest in.
Reality: Investors with very little risk appetite tend to prefer the safety of government bonds or FDs than investing alongside the risk of stocks. The belief is that these instruments are risk free since the government is backing it. So to such investors, the story sold is that they should invest in a dividend giving stocks as there would be regular income from the dividend, at the same time, one would also get the benefit of capital appreciation.
This strategy of investment was very common in United States (US). Dr Vikas Gupta, fund manager, Alpha L50 (India), Arthveda Fund Management Pvt Ltd shed some light on its history: “In 1960s in US one idea that was commonly accepted and applied was, you should invest in dividend giving companies if its dividend yield is twice the long-term bond.”
At the time many large pension funds and investment trust were following this as a thumb rule as part of their investment policy. This forced the large companies, typically market leaders, to give out dividends regularly so that they can qualify as an investment grade stocks for such investors. That is why this is considered to be an indicator of high quality. Sometimes even when the company has had lesser profits due to business cyclicality in one-or-two years, the company would borrow money and give out dividends.
Adding to that Gupta says, “In India the best dividend giving companies have a dividend yield that is approximately half of the risk free rate, therefore, it would not be possible to implement the same strategy in entirety.”
So the natural questions for Indian investors should look at how long has the company been paying its dividend and was the company consistent? Also look for companies that are very large in size. Whether the industry is cyclical and how the company is paying dividend during its cycles? Was the company able to pay dividend in the worst of its cycle? How does it get the money for paying dividend?
Dipen Shah, Head of Private Client Group Research, Kotak Securities, believes that fundamentals should be the focus of choosing a stock. Sharing his views on the safety of the strategy he says, “This will give me more comfort that at least I have more protection that even if the stocks fall by 5-7%, I have tax-free dividend that will come to me. At least there is some protection.”
Taking a dig at the type of companies that will show in a dividend yield list Rupesh Patel, Fund Manager, Tata Asset Management Ltd says that three types of companies will feature if one runs this screen.
A company which has a very strong business model and they have lots of free cash flow. And despite investing money for future growth the company is still left with sufficient cash to payout to its investors. There can also be a case that the company is generating a lot of free-cash but the incremental avenues to invest may not be there, so the payout ratios is very high but one will not witness the compounding effect of growth in such companies.
Anindya Bera, a retail investor from Kolkata says, “I prefer safety over risk. High dividend yielding stocks are relatively safe bet in an otherwise risky investment landscape. Most of the high dividend yield stocks tend to be mature companies with stable revenue stream giving me more comfort.”
The second type of company would be those which have sold part of their business or brand or land for that matter, and have suddenly received excess cash for which they do not have any avenue to deploy. “In which case they could give out a one-time special dividend. So when you are looking at dividend yield it will certainly look high but this is not sustainable,” says Patel.
“Another important point to look at would be how consistent is the dividend, at least look at data from last three years and try and see whether consistent dividend has been given out by these company,” says Shah.
Kiran Kavikondala, Director WealthRays says, “We have been recommending dividend giving stocks that have a long dividend giving history but we stick to large-cap companies, one of the important items is to look at the agenda.”
Ayush Mittal, an investor from Lucknow shares his experience, when after rigorous research he bought Mayur Uniquoters and MPS Ltd, two good examples of small companies with consistent dividends and an exhibited earnings growth. Where he made substantial profits. Based on his experience he says, “Rather than just looking at the dividend percentage being paid, investors must look at the dividend payout percentage of the net profits being distributed by the company (a good dividend payout for a manufacturing company is of >25% of net profits though it depends on a company's business).”
Patel says, “Another good type of company would be those companies which have been paying regular dividend but because of a specific situation either related to stock market in general or industry or company, prices have corrected.” He adds this would also lead to high dividend yield. Therefore, when the tide turns investors will also witness capital appreciation. “Here the importance should be given to understand why the price has fallen.”
“Our experience is that investors who are in the 45 and more years of age group most of the time prefer a public sector company over a private sector company,” says Kavikondala. He further adds: “Although when I look at the numbers there is no evidence that the public sector pays higher dividend than the private sectors. So our advice is that one who is focusing on the dividend strategy need not keep their portfolio skewed towards PSU.” If investors don’t plan to invest with a long horizon then only they should look at dividend strategy.
Currently we are in a high dividend yield period but this will not remain the same. Therefore this can’t use it as a long term investment strategy because at some point this will not be the case. “I can buy all the high yielding and consistent dividend paying stocks right now but then I can’t trade. And in future when I get additional fund but then I may not have the right dividend yield to deploy at that point in time,” says Dr. Gupta.
Explaining on who should not invest in dividend giving stocks Kavikondala says “If capital appreciation is the focus of the investor then perhaps dividend investment is not the best approach for investors. Dividend investment strategy in akin to real estate investment.”
Adding caveat to this investment strategy, all experts agreed that valuation is important, it is imperative that one shouldn’t buy any dividend giving stock at any price; the price and valuation is important to decide the timing of investment in the company. Also this investment strategy may deliver less returns in a bull phase.
Important things to remember
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2. Fast Growth companies
Myth: Fast growing companies are best investment. You can buy it at any level as it will grow all the more.
Reality: The story for fast growing company is that any market leader would start as a fast growing company at the early stage. Therefore, till it becomes the largest company in the sector it has the potential to grow fast.
As Damodaran writes in Investment Fables: “If you put your money into the companies with the highest earnings growth in the market, you are playing the segment of the market that is most likely to have an exponential payoff or meltdown.”
Kavikondala says, “Investing in fast growing company is actually a high risk strategy. We look at things like the background of the promoter, what kind of market do they cater to, projects in the pipeline, operating margins, and their expansion plans to decide if it would be worth investing in.”
Since growth shows a very high rate of increase in the earnings growth it usually trade at high multiples of earnings and are usually risky. But the risk-seeking investors do not get affected by any of these concerns as their focus is more on for price appreciation instead of dividends. Their argument being that high earnings multiples will result in even higher prices as the earnings increase over time.
Shah says, "For a fast growing company, it may seem a bit expensive for now. But my understanding of the company should give me the comfort that it is a fast growing company. Then two years down the line the growth of the stock may have showed me that it was a good investment.”
Any investor should put in the effort to understand if this growth can be continued. Past growth may not be replicated. So if there is a company that has been growing for last two-three years for 30-40% then it is a good reference point. But question to ask and understand is if it can continue this? This fast growth can be because it is in a fast growing company. A company may be fast growth in a saturated market, this would in most likelihood be because the company caters to a niche market.
This investment strategy also has flaws. “The pitfall in using this screen can be that one would end up looking at the revenue growth or earnings growth. Now I can boost my earnings by borrowing more money and then investing it. Now many investors would say that the company is having such a high EPS and revenue is also increasing for last few years, so let me buy this,” says Dr. Gupta. He adds, that though growth can be seen but simultaneously the company is getting extremely leveraged. Now for any reason the growth is not according to plan then the company can default on its debt.
Hence, Dr Gupta recommends that investors should look for companies that are fast growth but not much leverage and growth is mostly supported via internal accruals. Understanding from where the growth is coming from is very important.
Mittal also invests in Fast Growing companies and shared about some of his pick like, Astral Polytechnik and Avanti Feeds. He says, “One must have noticed the mention of Astral Polytechnik in Dabang 2 or in the recent cricket matches advertising its pipes used in plumbing solutions. The company is one of the leading producers of CPVC pipes which are fast replacing the traditional GIC pipes in Indian markets. The company has been among first few players to introduce CPVC technology in India, and has well compounded on this huge opportunity size. The company is among the rare few companies with a revenue growth of over 25%, year-on-year, for each of the last 10 years.
“Then Avanti Feeds is one of the largest players in the shrimp industry. The industry underwent a major positive change with the introduction of a new species of shrimp - Vannamei which is healthier and more disease resilient as compared to earlier variety. The company well capitalized this opportunity and has been growing quickly at a compounded rate of 45% p.a. for last 5 years.”
Meanwhile, he also shared about some of the fast growing companies which did poorly like Tanla Solutions, ICSA.
Important things to look out for
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3. Low PE Stocks
Myth: Stocks trading at low multiples of earnings are a good buy as they are both cheap and relatively safe equity investments.
Reality: Patel explains, “This is also a value investing metric. At an essential level, PE ratio shows my payback period.” Supposedly, if the PE of a company is 5x, then at the current earnings level it will take the investor 5 years to recover their investment, provided they are the 100% owner of that company.
A challenge that investors would feel is what is low PE? This will come up especially since FMCG companies will mostly have a PE of more than 20x meanwhile infrastructure companies can witness their PE at less than 10x. “Therefore, if there is a low PE company one should always look at the PE for companies in the same industry and compare industry PE as well,” says Patel. The focus should be to understand ‘why market is quoting a low PE?’ (Industry reasons or company specific reason). It can be due to bargaining power of the supplier, or because it has few major customers. So the right way to compare the PE would be against its industry average.
Another way to decide on when the low PE is better is by comparing the yields of stock against the bond or FD. Dr. Gupta breaks it further and says, “If you reverse the PE then it becomes earning yield (earnings per share (EPS)/price or EP), in the case of a completely stable, regular dividend giving company is taken up where you have a clear view on the cash flows, that it is robust and doesn’t fluctuate then you know what would be the earning’s yield. If that yield is comparable to your fixed income or maybe if it’s a little bit higher than the fixed income then it’s a worth a buy.”
Dr. Gupta says, “If I am buying any company then I should research properly and select the ones that are actually mispriced. As individuals it is difficult to buy all low PE stocks, so we should screen with low PE and then look for the gems.” Giving an example, he said, “Britannia was at one point available at 11x PE when Wadia’s Kalabakan Investments and Groupe Danone were fighting, investors were worried about the uncertainty but as far as the business was concerned it was in excellent shape. Once the period of uncertainty ended its price went up and PE also increase making it a multi-bagger for investors.”
Shah says, “If my view on the market is that it will remain subdued then I will not be looking at low PE because my view is that the market will remain low, and the sector is not doing well. But when I see that the sector is not doing as bad and the stocks have been beaten down for some news related reason then let me look at low PE stocks.”
Explaining his method further Shah says, “From there I will look at all companies to understand if they all deserve to be low PE or some of them have been beaten down irrationally.” Only if he is comfortable on PE and the growth prospects are good, then Shah will study more on them before picking up the stocks.
He opines, “If someone is using only using a low PE strategy and they take this as an end result and buy based on this, they might be in for a rude surprise. As they might
Nikunj Gandhi, an investor who stays in Navi Mumbai while sharing his experience said, "I would look into when these companies are being sold at a relatively low PE as against their industry average. In forming the industry average I would look at only the large and mid-cap companies." He explained that exclusion of Small cap companies is important from the industry because their stock price could be different because of high volatility. "It’s one of the most important things that I consider before buying the stocks," says Gandhi.
"Since I keep reading about these stocks, their annual results and have gained some idea on what to expect from their businesses, therefore I make estimates when the PE of the stock is below intrinsic value, says Gandhi."
Things to remember
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4. MNC models
Myth: Buy into MNCs because to delist they will be buying the stocks from investors and they will pay any premium to get full control. MNCs corporate governance is the benchmark.
Reality: The buy-back story is very recent. This narration has come up in the media, and was vehemently discussed on different platforms and by many experts since SEBI, the market regulator, had stated that all companies must have atleast 25% shares floating on the exchange.
Kavikondala says “Buy-back strategy is something that we have been looking and considering the investment only over the last one or two years.” He adds that this comes into play after the announcement comes from the companies. There can only be two situation either the investor holds the stock or they don’t have it. “This is somewhat similar to the IPO. The important thing one needs to look at is what the prospect of the company is?” He suggests that an aggressive investor can use this as strategy for about 15-20% of their portfolio for such a strategy.
Meanwhile Patel opines “In terms of the buy-back strategy is a speculation. One can make a guess that because of the history one company would be delist but that is maximum what one can do.”
He says that MNCs as a strategy can be worked because they have good corporate governance, good brand names, good management quality, they are efficient users of capital and they are here for long-term; which works great in favour of a long term investor.
Dr Gupta says, “The biggest trust is on the PSU accounts, and then on the MNCs accounts. So if the MNC account is showing cash then it is probably true.”
Over the last few years more and more people are looking into multinationals because the governance level is very high. This can further be backed by looking at the MNC index as it has outperformed the Nifty over the last few years.
Deepak Ladha, Executive Director, Ladderup Corporate Advisory says, “We use a combination of factors to decide on an investment in a company, so buyback is not a strategy. There are MNCs which are not necessarily fast growing but they give consistent dividend. There are some multinational which do not give dividend but they tend to register higher growth.
“But if you really see, the MNC strategy at its core has also worked earlier. There are not too many MNCs in the Indian stock market. But if you really see around the market, the way returns have happened for Glaxo Pharmaceutical, HUL, Siemens, etc. There are multiple examples of MNC strategy working.”
He reiterates that if the MNC is not showing appreciation on the stock market in the immediate term, you still get dividend yields which can make you comfortable with some of these companies.
Marking a caveat Patel says, “The grey area where investors should be very careful is, sometimes these MNCs may have wholly-owned subsidiaries. At times one may not get a clear picture of what costs are being charged to the listed entity and which ones are being charged to the wholly-owned subsidiary. So it is not clear if this is at arm’s length and what kind of services are provided.”
“In the past they have clearly shown that they will delist when the price is depressed like Cadbury. The second thing is that at any point in time the MNC can decide to increase their Royalty, and this is not in the best interest of the shareholder. Dividend giving is fine as even the minority investors’ benefit, but not royalty,” adds Dr. Gupta.
Ladha also agrees, “The downside is that the MNCs may transfer their cash generating business to a wholly owned subsidiary, a case in point would be what Maruti was trying. And that is a risk one will have to understand and keep evaluating.”
What an investors should look at what sectors the MNCs is in and try to understand why and when it will work? Ladha explains further: “For example, Siemens is in the engineering sector and hence it will benefit if there is a stable government and the infrastructure work picks up; whereas if you take Glaxo Pharmaceuticals, it is a perpetual story. Pharma’s will grow at a certain rate continuously.”
“Therefore, it is essential to understand what kind of sector is it and what is the prospect of the sector. Coming back to the example of Siemens, the company’s PAT has come down, so it would be having a higher PE ratio, but if the infrastructure space witnesses’ activity and Siemens PAT goes back to its previous level then it will result windfall gains for the investors.”
The MNC strategy is very good at this point in time because the entire focus in the Indian market has been on the Pharma and IT, which is more export focused and some of it would be domestic but it is not related to the GDP or the industrial growth. Whereas in the MNC at least on the corporate governance side you are protected, so the principal in all likelihood should be protected.
Things to remember
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5. Following the FIIs
Myth: One of the common misconceptions that retail investors have is that if foreign institutional investors (FIIs) or domestic institutional investors (DIIs) sell the stock of a particular company, then the company may put up a bad performance or some negative developments may take place.
Reality: Here, what most retail investors ignore is that FIIs or DIIs have their own guidelines, parameters and external factors that impact their investment decisions. Pankaj Pandey, head of research, ICICIdirect says, “If FIIs are facing a liquidity crunch then they may tend to sell even good stocks to tide over the situation temporarily. In this case, a retail investor who follows FIIs or DIIs and sell the stock tend to miss the upside opportunity that a good stock may provide in future.”
There are certain cases when a stock gives negative return even when FIIs increased their stakes in a company. In the BSE 100 index, there are 26 companies in which FIIs have been increasing their stakes since March 2013. Out of these, 9 gave negative return to investors during April 2013-February 2014. Similarly, during March-December 2012, there were 34 companies in the index in which FIIs raised their holdings, out of them 13 gave negative return to investors during the financial year 2012-13.
For instance, FIIs have increased their holdings in Tata Power Company from 24.54% in the quarter ended March 2013 to 24.78%, 25.05% and 26.03% in the sequential quarters ended June, September and December 2013. However, on account of muted cash flows, the share price of the company plunged 17% to Rs 79.45 on February 26 this year against Rs 95.8 on April 1 last year.
Likewise, concerns over high debt and soaring interest cost keeping the share price of Jaiprakash Associated under pressure. As a result, its share price dipped over 38% to Rs 41.90 on February 28 this year against Rs 67.95 on April 1. However, FIIs are looking positive on the company as they have increased their stake from 22.77% in March 2013 to 27.41 in December 2013.
Pandey of ICICIdirect says, “The risk appetite of retail investors and their investment horizon and holding power tend to be different from that of institutional investors. Hence, peculiarly, if an investor enters a stock in which FIIs have entered and this stock declines in the near to medium term, retail investors with not so deep pockets and liquidity concerns often tend to sell these shares and end up with negative returns.”
According to Vikram Dhawan, director, Equentis Capital, the strategy to follow FIIs is suitable to long-term investors that have the discipline and the resolve to accumulate at every sizeable corrections or short-term traders that have strict profit and loss targets.
Patel says, “One also needs to understand that what may look like a huge stake to you in terms of FII maybe a very minuscule portion in their portfolio so they can just dump and get out at any moment creating a run on the stock.” So this is not the best of strategies to implement for retail investors. Also we are not aware the reasons based on which the FII has bought.
6. Following the Promoters
Myth: There are misconceptions that the share price of a company can go up when promoters show confidence in the company.
Reality: Most of the market experts believe that a hike in promoters’ shareholding sends positive message to investor community that promoters see value in their company at current levels or there may be some positive development in the business in future.
However, the data shows no direct correlation with the given logic. Consider this: In the BSE 500 index, there are around 270 stocks in which promoters have been increasing their stakes or keeping it constant. Out of these, 140 stocks gave negative return to investors in the past five quarter till December 2013.
Paresh Shah, managing director, equities, Centrum Broking says, “In the given case a stock can give negative return to investors due to lower earnings growth vis-à-vis other companies in the sector. Some of the other reasons are decisions taken by management which can impact market value or future earnings potential of a company, selling by institutional investors due to market conditions, financial institutions selling off where stake is kept as collateral (pledged) and overall sell off in domestic and global markets (as seen in 2008) can also dragged down the share price down.”
Rei Agro, Ruchi Soya Industries, Parsvnath Developers, JBF Industries, Future Retail are some of the companies in which their promoters have been increasing their stakes since December 2012, however, the stock price of each of the company pluged over 30% each since the beginning of the ongoing financial year till March 3.
Rajesh Sharma, Director Capri Global Capital, says, “Following promoters is perhaps one of the best possible way of investing. But it requires a lot of hard-work.”
He suggests is that one must read about the promoter, and the management. Look into how much of disclosures do they give. Make sure that the company has low debt or manageable debt. The company has a good brand and their product will not become redundant in near future. There is scope for their product to increase market share. And check how the industry is faring as a whole. Look at how the management has functioned during a downturn and how were they rewarded. How did the stock do during this up and down period? Sharma says “Following a promoter like Ajay Piramal, Mahindra etc. has been very rewarding for investors. But if you don’t understand the company and its business and did not do proper due diligence about their promoters and business associates then you will run the risk of investing of losses.”
Dr Gupta, says, “It’s a good indicator but even this should not be followed blindly. A case in point would be Deccan Chronicle, they picked up shares from the market for nearly Rs 300 crore but we know how its stock has performed.
Then another would be Texmaco Rail, it is the largest rail company, they make those wagons. Now Texmaco Rail was split off into Texmaco Infrastructure and Texmaco Rail around 2010-11. And Texmaco Infrastructure had 30% share of Texmaco rail so everyone sold off Texmaco Infra because all the operations was with Texmaco Rail. Now Texmaco Infra had 30% in Texmaco Rail, and some investments and lands were held in its book. After that all of the promoter associated companies and have been buying Texmaco Infrastructure but they are not talking what they plan to do with the land holdings. Since there is no clarity on the land bank, therefore there is an element of risk. What if, they come with their own private company and then start developing the land, and this is done on such terms that it’s the private company that benefits rather than the original company – Texmaco Infrastructure.
“This is the kind of risk that one can look at therefore it’s very important that you follow all the announcement,” says Dr Gupta.
Following the promoters is a good screener but that screener can only be followed when the track record of the promoter is very good. It is also important that while reviewing such screeners one should understand and look at how the promoter uses the subsidiaries and group companies.
Things to remember
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7. Initial Public Offerings
Myth: There are number of misconceptions related to investing in initial public offerings. Firstly, companies going public are flourishing and have grown financially. Secondly, it is believed that issue price is the fair value and one could not lose money by investing at that price and lastly, some investors think if the issue is oversubscribed, then it is a must buy.
Reality: There are companies who go public at a very early stage in their life cycle before proving their financial feasibility. What is therefore important to understand is whether the company going public is in need of money for expansion or is it in need of money for clearing its debt. It is obvious that you may want to avoid the latter unless you are very convinced with the business model and other aspects of the company’s business.
For those who believe that the IPO is available at fair price and chances of losing money is minimum. Chethan Shenoy, vice president, investment products, Anand Rathi Private Wealth Management explains, this is not true as the fair value of the company can be ascertained after taking into account various financial parameters and macro environment. There are instances where if the market fundamentals are not supportive, good companies too have fallen below their issue price on listing day. Investors would generally make good gains by investing in an IPO and selling on listing in years when there is a bull run which is considered a fertile environment for IPOs and when the market sentiments are positive and vice versa.
For example, in year 2007 when the stock markets were going through a bull phase there were around 100 IPOs and quite a few generated triple digit returns on listing like Everonn Systems (241% gain on listing), Allied computers (214% gain on listing), Religare Enterprises (182% gain on listing), Mundra Port (118% gain on listing) to name a few.
Similarly in 2008 and 2011 when we were going through a bear phase companies like Tree House, Reliance Power, Omkar Speciality, etc. have registered a fall in price on listing. In 2008, around 50% of the IPOs listed in the year gave negative returns on listing whereas in 2005 around 12% of the IPOs gave negative returns on listing. In 2008 and 2011, the BSE Sensex retreated around 110% and 25%, respectively.
For those who think investment in an oversubscribed IPO can give good returns on listing. According Chethan Shenoy of Anand Rathi Private Wealth Management, oversubscription does not guarantee performance and misreading the initial demand can have big consequences. Whenever you see news being flashed on oversubscription of the issue it represents a picture that the IPO is a worth investment and those sitting on fence are lured to invest into it. However, one should invest in an IPO after detailed due diligence and being convinced that it is a good buy.
While there can be a number of success stories there would be an equal number of stories of stocks that failed to perform on listing. For instance, CARE announced its IPO in December 2012 for an issue size of Rs 540 crore at a price of Rs 750 per share and was oversubscribed 40.98 times. On the day of listing, the stock closed at Rs 923.95 registering a gain of 23.19%. Similarly, ICRA announced its IPO in March 2007 for an issue size of Rs 85 crore at a price of Rs 330 per share and was oversubscribed 75 times. On the day of listing, the stock closed at Rs 797.6 registering a gain of over 140%.
However, there have been some big flops too like Reliance Power which announced its IPO in February 2008 at a price of Rs 450, got oversubscribed by 75 times and on the day of listing lost 17%.
Market experts believe IPO investing or equity investing should not be looked at from a trading perspective but from a long term perspective. Investing in an IPO is similar to investing in stocks in the secondary market with only difference being the company who announces an IPO does not have a track record of price movement that can be analysed. As such an investor who wants to invest in any IPO should first analyse if the price at which it is being offered is right. An investor should check the price to earnings ratio (P/E) and price to book value (P/BV) of the company, the earnings growth and the revenue model of the company vis-à-vis its peers and industry in which it operators to check if the issue price is undervalued, fairly valued or overvalued. If it is overvalued then it means that you should be cautious while considering them however if it is undervalued or fairly valued he should definitely consider them for next level of check.
S Ranganathan, head of research, LKP Securities says, “An IPO investor should also study the promoter background, competitive positioning of the company in the market place, pricing power of its product and valuation before subscribing to an IPO so that he is better prepared to take his call on listing.”
“IPOs as a strategy does not work anymore because the culture has changed,” says Dr. Gupta. He explains this further, “In IPOs the idea earlier was to value the stock conservatively, and leave something at the table so that retail investors hold the stock for some time and still make money. So the pricing has changed.
“Since 2006 many of the MNC investment bankers’ where the culture is different, their aim is to price it as high as possible and raise the maximum fund for the promoter, and this was also because their fees is linked to the amount raised. And as long as you can take the price higher on the day of listing then no one can blame the investment banker. In a bubble market this is not difficult, so all sins gets washed away.” Since earlier the IPOs were listed at a discount, the retail investors got further discount so it was a very easy way of making money. Therefore, there were investors who would just make IPO investment and not put money anywhere else.
Sharma adds, “IPOs as a strategy has stopped working because of QIPs.” Ever since the introduction of QIPs, the IPO market has become more efficient in terms of pricing of stocks. He says, “With the introduction of QIPs, the price discovery mechanism has improved.”
Trivia
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Things you should consider before investing in an IPO
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8. Buying and selling on 52 week low-52 week high
Myth: Contrarian investors will try to keep the price of securities back to the fair value levels by adopting strategies like “winners are punished” and “losers and purchased”. There are many investors who sell stocks which are above its previous 52-week high on expectation that share prices will correct and there are investor’s who buys stocks which are below its 52-week lows.
Reality: According to market experts, the investor who always sells stocks when it is above its 52-week high is unknowingly taking a high risk; in a bullish market good stocks will move first and later the poor quality stocks will follow suits. If the investor does not know the fundamental values of the stocks (which are above its 52 week high) but wants to create short positions he may end with in huge losses.
However, in a bearish market all fundamentally poor stocks will find new lows at every day. Buying these stocks can spoil the investor’s wealth. In a bullish market if stocks find a new 52-week low then there must be a certain reason for it. Without knowing the reason if the investors invest in these stocks then they will end up in loss. The classical examples are infrastructure sector stocks, they all lost 30 -75% value in the past four year period till December 2013.
Alex Mathews, head of research, Geojit BNP Paribas Financial Services says, “Both strategies are workable in some cases in a moderately good market. But there are risks also, in a bullish market all most all stocks are likely to test its 52 week high, fundamentally sound or fundamentally poor also.”
However, Sahil Kapoor, chief technical strategist, retail capital markets, Edelweiss Financial Services says, “Technical analysis goes by the belief in buying strength and selling weakness. Hence, a stock which has made new 52-week high means that it has strong relative strength as compared to other stocks and buyers are very active in trading a 52-week high stock. A 52-week high breakout after a consolidation has even more significance as there is a range expansion and the stock is ready for a strong and a sustainable trend.”
Markets generally prefer quality and stocks which sustainably trade above 52-highs have dedicated buyers convinced about the future performance of the stock. Stocks which are battered and are unable to reverse from lows are generally not favoured.
“An important reason to avoid bottom fishing in 52-week-low stocks is the difficulty to spot the winners. If one were to split purchases in a portfolio of stocks making 52-week lows, the probability of losing money is higher than lower. If we were to buy stocks which are making new highs the probability that you pick more winners than losers is higher,” says Kapoor.
For example, Hindustan Unilever (HUL) made a new 52-week high in September 2010 by crossing Rs 300 after 10 years. Investors would have earned handsome returns if they had bought the shares of HUL at Rs 300 levels. The stock price has jumped by more than 100% to make a high of Rs 718.90 in July 2013. On 4 March 2014, it was trading around Rs 555.
Similarly, IVRCL made a new 52-week low in 2010 by breaking Rs 140. On 4 March 2014, it was trading at Rs 11.06.
For investment in a stock which have recently hit its 52-week high or low, Kapoor of Edelweiss Financial Services says, “Investors shall maintain a 5-7% stop loss once a stock makes 52 week high. If the strength and range expansion persists then there is a high probability that the stock will give 20% plus returns in medium term. Investors who have some basic trading skills and discipline about their trades should use the above style. If a stop loss is hit, then the investor should not get bogged down and loose the focus of trading.”
9. Sidecar/Copy-cat investment
Myth: Following an expert’s portfolio is very rewarding.
This is more about looking out for companies that has been bought by an expert. This is something that many people try via media, all the news that comes that Rakesh Jhunjhunwala has invested in a stock, or if someone notices that Prashant Jain has increased his stake in a company then these stocks get attention.
Dr Gupta says, “There is no proper way of doing that. The major hurdle in this is that you would be not know when they would have sold, also the truth is you may not even know when they had bought it infact. The information flow cannot be as slow, as six months’ time-gap because then it is not useful, at the most the information can be delayed by a 2-3 weeks.
“Then this strategy can be used and investments can be deployed. This is workable in only undervalued companies or a contrarian style can be followed using this strategy. The contrarian approach takes a long time to workout. You need patience. For momentum this strategy cannot be employed. In US it is because of the 13F filing that one gets all the information. So at the most the information is delayed by a quarter.”
The perennial question for an investor following this strategy is “Why someone bought it? How long they plan to hold?”
Kavikondala says, “Not many people are aware of the term. We call it a replicator at our company. We tend to suggest people stocks from among the dividend based mutual funds or an opportunity based fund. This is not required on a hand holding basis, but the investors who tend to do their own research and for which once in a while they would require some level of guidance.”
Considering that Indian stock market, as it doesn’t have a very long history of investment experts’ nor does it have depth or breadth in the stock market, also there is more scope of transparency. Combining all of these aspects make this a challenging strategy. Those who plan to use such strategy should understand the temperament of the people whom they plan to copy-cat. It is also necessary that proper due-diligence is done on such stocks.
10. Penny stocks
Myth: Penny stocks are usually bought with the perception that they are priced so cheap that they may make a person rich overnight. The other misconception among investors is that such companies do not have funds availability and they may misuse investors’ money.
Reality: Yashpal Gupta, executive vice president, IDBI Capital Market Services says, “Penny stocks aren’t great options if one is looking for a way to get rich quickly. When one invests in penny stocks, earning a huge profit isn’t always guaranteed. Just because a stock is very cheap does not necessarily mean that it is a good bargain. Hence, the investors must do their research and be ready to hold such stocks for a longer time frame in order to reap benefits.”
The other most common reason behind buying these stocks is that these are available at low prices and can be bought in huge numbers with a small capital. People perceive these stocks to be ‘cheap’ and a way to over-night fortunes.
Rakesh Goyal, senior vice president, Bonanza Portfolio says, “Stocks cannot be tagged as cheap or pricey solely on the basis of its market price. Stocks are valued on the basis of their fundamentals–their net worth, business potential, income growth etc. So if a stock is trading at low prices, it is primarily because markets do not value it much in terms net worth or growth. Thus, every penny stock may not be a ‘bargain’. People are also seen buying penny stocks with the idea that small addition to the price can bring in huge profits.”
For example, if someone buys Rs 10,000 worth of a stock at Rs 2 a share and if the share price reaches Rs 3, it would entail an upfront profit of Rs 5,000 on an investment of just Rs 10,000. However, for the stock to give a return of Rs 1, it would have to move by 50% in a particular period. “It is not practically impossible unless there is substantial rise in the general interest of public in the stock or if there is steep rise in general market indices,” says Goyal.
There are number of penny stocks which changes fortunes of investors. For example, stocks such as Core Education & Technologies which was trading at Rs 0.12 on 1 March 2004 jumped over 122 times to in the past 10 years to Rs 14.44 on March 3 this year. Similarly, share price of Rander Corporation jumped 12,360%, or 124.5 times, from Rs 0.56 on 1 March 2004 to Rs 69.95 on 3 March 2014.
On the other hand, the share price of penny stocks such as SMS Techsoft (India) plunged over 76% in the past 10-year period to Rs 0.09 on March 3 this year. Likewise share price of Nu-Tech Corporation Services plunged over 66% to Rs 0.33 on 3 March 2014 against Rs 0.98 on 1 March 2004.
On the above returns given by penny stocks in the past ten years, Gupta of IDBI Capital Market Services says, “Penny stocks are high-risk stocks in which chances of huge profit are usually coupled with even bigger chances of making loss. Hence the best strategy for risk-averse investors is to refrain from investing in such stocks. However, if the investor has the necessary risk appetite and wishes to take a chance, then it is advisable to understand the fundamentals and financials of the company, risks involved and time horizon for which the investor wishes to hold such stocks. Good picks may emerge from penny stocks due to changes in business fortune or management, favourable policy changes, takeover by good companies or by better management.”
It is advisable to investors that you may start investing in a penny stock after reading through the financial statement of the company and doing proper research relating to future business plan and strategy of the management to determine whether it is a stock worth investing in. “One should stop investing in penny stock when the company is not showing good financial performance or when it is not performing within the estimated time horizon. Further, if there is a negligible possibility of a company turning around then also one should stop investing in such stocks,” says Gupta.
Before investing in penny stocks, one must look into the following points:
• Historic liquidity (preferably last 12 months or more)
• Daily, weekly, monthly price volatility
• Credentials of the top management
• How steady the prices remain at different price levels
• Sensitivity to broader market indices (correlation)
• Sensitivity to macro-economic and financial data (GDP, inflation, RBI Policy, quarterly earnings etc.)
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Conclusion
All of the 10 strategies have worked at some point and can work at another point of time again. The most basic thing that all investors should understand is that there is no escape from hard work and patience when investing in stock market. It has been rightly said, ‘every penny is a hard-earned money’. This is truer in the stock market that anywhere else.
Some of these strategies namely – Dividend, Fast Growth, Low PE, Following promoter and MNC – are good as for selecting few stocks on which you can concentrate or further research but none of strategies alone can make you rich and there is no quick buck in this business.
One of the problem that an investor will face is that at times the strategy will seem to not be working. This will be test the patience of any investor.
The most important points to remember include that you don’t change the strategy just because it didn’t work in a one or two years. In given period of any five years, chances are that one strategy would not have consistently and continuously outperformed the market.
If the stock pick is good, it’s a leader in its segment but the business cycle is not supporting it. Let’s see if in a rising business cycle it goes up or not? Wait for the business cycle to actually turn. If even after the business cycle has turned and all its peers and related stocks are rising but the stock that you are holding is not going up then it means that you have made a wrong decision. A case in point that requires evaluation: if there is a problem with the management, if the stock is not performing well because of an inherent weakness in the business, a huge debt with the company, etc. “Another important point to understand is that the business cycle in each sector is different,” says Shah.
Investors such as Gandhi, sharing their experience, state: "The first challenge is to not get swayed away. People will tell you tips. Your broker will call up and suggest stocks. No matter whatever happens one should do their homework and not try to employ any short-cuts. Maintaining this discipline is the one challenge."
And Bera points that for him the biggest challenge is: “Investment is a time consuming activity. With full time job it is very difficult to monitor ones portfolio. Keeping a portfolio of stocks means you need to be making regular adjustments to them so that they still remain relevant. Buy and forget, might work for other investment avenues but it doesn't produce the expected dividends when you are investing in stocks.”
Any strategy can work, what an investor must understand is that there are 6000 stocks listed in the market and the idea of a screener will shortlist the stocks to a more manageable number like 30-50. Once the list is more manageable then you have to do a bottom-up stock picking, after doing due diligence. Another important point to remember which is often less talked or written about is that you need to check once a year if your assumptions were correct and the companies are on target.
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