10 Things to Watch Out for When Investing in the Stock Market
Everyone wants his money to make even more money. And if you can do that without putting the principal at peril, it’s even better. But risk and reward are intrinsically linked, particularly in the case of equity markets. The ET Intelligence Group decodes some of the tricks of the trade to help an investor avoid common pitfalls and make a more informed decision
Equity investments are touted as the best form of long-term investments. But the twists and turns on the route to the stock market are sure to put off many a lay investor. Interesting trading patterns tell a story to an experienced hand, but it may all be Latin and Greek for a newcomer. He may learn only by making mistakes, some of them costly.
ET Intelligence Group throws light on a few of these myths, interesting trends and market gimmicks. Not only can they save an investor from investment disasters, but one can also use them to make significant gains
1 The Big Public Offer Impact
What is common to Reliance Power, Coal India, Reliance Petroleum and DLF other than the fact that they were the four biggest IPOs to hit the Indian stock market? The answer lies in what happened after these offers. All four IPOs were followed by a correction in the overall stock market. Coincidence? A strong one, if at all it was that.
Though the Reliance Power IPO mess is well-known, not many would have linked the corrections that followed the other three IPOs. The BSE Sensex corrected 9% post the Coal India IPO, 7% after the DLF offer and 16% after Reliance Petroleum’s IPO. (See chart: The Great Fall).
These facts lead us to believe that there is a link between overall market performance and a large public offer. One thing is certain that these IPOs, when over-subscribed several times, suck out the liquidity from markets. For example, Coal India’s IPO was over-subscribed 15.2 times. This locked up nearly 2.34 lakh crore for over two weeks till allotments were made and shares started trading. Such a huge strain on the liquidity front is bound to result in markets going down. Many bac
k the view that big IPOs come typically when the market valuation of the company is at a peak, and hence a correction is only natural. At the same time, there is no dearth of people who deny any linkage between the two and calling these instances as pure coincidence.
Nevertheless, one cannot deny empirical evidence that a correction follows a large IPO. The next big public offer expected to hit the market is ONGC’s followon public offer or FPO of around 11,500 crore. Once the FPO dates are announced, an investor may go short in index futures to benefit from a possible correction.
2 Insider Selling
If you had not figured out the last one, try this. What is common to GTL, Satyam and Orchid Chemicals? Company insiders sold stock in large quantities in the open market before the share price crashed. The trend was visible in all four companies.
Promoters and key employees have access to information that an ordinary retail shareholder may not have. When such investor groups start selling their shares, it should send an alert signal. Don’t be surprised if a company’s stock falls sharply after they have offloaded a large chunk of their stake in the company
Announcing a share buyback from the open market is one way a company tries to protect its share price in a weak market. These open market share buybacks are typically open for a long time, give a ceiling price below which the company would buy shares and earmark a specific sum to be expended for the purpose. This sends a signal to the market that the company would be ready to buy if the price falls below a certain level, thereby helping the share price. For example, Reliance Infrastructure has completed three such buyback schemes and is now in the midst of a fourth one. Similarly, Sasken Communications carried out a buyback in 2010 after a not-too-impressive performance for a few quarters and couldn’t succeed in gaining investors attention.
However, this is entirely a voluntary exercise and there is no compulsion on the company to buy shares if the price falls below the acceptable limit. Also, the company can discontinue the scheme at any point in time. Thus, in practice the buyback offer wouldn’t do anything more than boosting shareholder sentiment. In fact, the practice has already lost its sheen and fewer companies are taking this route to protect their market value
When it comes to the game of buying low and selling high, one can’t blame the promoters if they wish that the value of their companies falls before they move to buy it out. What typically happens is the exact opposite. A delisting or buyback rumour could drive the share price skywards. Still, seen in retrospect, there appears to be a trend that immediately before going in for a delisting the quarterly earnings numbers start to deteriorate.
This trend was visible in companies such as Binani Cement, Sulzer India, Parry Agro, GE Capital Transportation Financial Services and Rayban Sun Optic that have delisted in last couple of years. Even in the case of Nirma, which got delisted in May 2011, the FY11 profits were down 69% yo-y, when other FMCG players showed a decent profit growth.
There are notable exceptions. Atlas Copco and Micro Inks continued to give substantially strong earnings growth numbers till their delisting. Of course, they had to pay dearly to convince retail shareholders to tender their shares.
“All publicity is good publicity” may be the motto for a few, but there are others who would use every possible way to stay out of the public eye when things are bad. This becomes evident if one closely follows the results calendar. A vast majority of corporate results that are published on the weekend or on the last day of the results season are typically bad. On the contrary, the initial results of a season are invariably good.
The inverse of this fact infers that companies about to report bad earnings tend to announce them late on Friday evenings, weekends or towards the end of the results season. Why would they do that? To avoid media attention and a negative impact on their share prices.
Not that it helps their valuations when the markets open next. However, the cooling off period of a couple of days certainly helps in muting the impact.
One classic example of this is HUL. In 2009, the company posted three out of four results on weekends. The ones posted on weekends were perceived to be very disappointing, while the one, which was perceived to be good, came out on a Tuesday. Another example of this is ICICI Bank. Its December 2008 result was perceived to be bad with a 35% decline in its earnings. This result was released on Saturday evening, the first day of a long weekend. A recent example is Reliance Communications. Its financial performance was perceived to be below expectation for the previous three quarters and each time, whether it was a coincidence or not, results were declared on a Saturday evening. While one shouldn’t take it for granted, a company scheduling its results board meeting on a weekend or delaying it for no apparent reason could be a hint of insipid earnings performance
Traders and analysts often recommend stocks of holding companies or of companies with assets such as land, property etc. The rationale is that the value of these assets is much higher than the market capitalisation of these companies. But to what extent does that impact how the market values such companies.
Not much if the value remains locked up. A number of holding companies are traded in the stock market — UB Holding, JSW Holding, Bajaj Holding, Kalyani Investments etc. These are companies from different business houses and hold stakes in various group companies. If one were to value their investments at current market prices, their market capitalisation appears to be extremely cheap. However, this is natural as the companies being part of the respective promoter groups are highly unlikely to sell any part of their investments. Therefore, due to this lack of marketability these holding companies will always trade at a substantial discount to their net asset value.
At the same time, a company like Tata Capital, which is in the investment business, but holds investments in varied listed companies outside the Tata Group, tends to attract a lesser discount, as it sells its investments from time to time.
Somesectors gain more market attention in certain seasons like agrochem before monsoon or fertliser and education etc before the Budget.
The volatility in equity markets, which might appear chaotic, has some method to it. Just like the weather, equity markets and various stocks have seasons of their own. Knowing that a January or September is typically good for the markets and March and May are bad is a helpful piece of information.
January and February typically see Budget-sensitive companies garnering market attention. This includes names like Navneet Publication, Educomp, Jain Irrigation and the fertiliser sector. Companies working for the railways sector — Kalindee Rail, Texmaco, Titagarh Wagon etc - are also in the limelight ahead of the Railway Budget.
The summer season with all its load shedding finds the power industry attractive, which can charge higher rates for merchant sales. As summer ends and monsoon is about to start, the agro-input sectors such as fertiliser, agrochemicals and seeds gain market favour. The post-monsoon harvest season, which is full of festivities and increased consumer spending, finds cement, construction, paints, consumer durables, retail etc sectors gaining currency.
An investor can benefit from these trends if he can invest in companies sufficiently before they become the market flavour and exit when they are at top of their valuations. This investment strategy is also known as ‘Tactical Asset Allocation’.
Initial public offers (IPOs) are much-publicised affairs for any company seeking funds from the market for the first time. Of course, the hullabaloo is much more when the IPO is from a large company. It is interesting to note that such large IPOs almost always help improve the valuation of the entire sector. DLF is a classic example. Its IPO was preceded by a rally in all real estate stocks. Gitanjali Gems’ IPO in February 2006 also had improved the valuations of gems & jewellery firms. Cox & Kings IPO in December 2009 had pushed up Thomas Cook’s market value.
When hydropower major SJVN’s IPO came in May 2010, its peers NHPC and JP Power Ventures witnessed renewed investor interest. Similarly, the recent IPO of Orient Green Power helped valuation of its peer Indowind Energy.
A large company would always like to charge a premium for its IPO from investors looking to participate in its growth story. This has a rub-on effect on the already listed companies in the sector, which see their valuations improve. In such scenarios, staying invested in companies from industries that are likely to see major IPOs coming in near future could be a good idea. Of course, one can limit the applicability of this observation to bull rallies.
9 Dividend March
Once the March quarter kicks in, it is common to see a flurry of advertisements relating to equity-linked savings schemes or ELSS. This is a typical gimmick adopted by the mutual fund industry to attract new customers looking for avenues to save tax. An investor would be attracted by schemes that give out maximum dividends.
However, unlike companies, where dividend implies a share in the profits of the company, a dividend payout in the case of mutual funds is simply a portion of capital appreciation returned back to the investor. There is thus a corresponding decline in the value of the investment (net asset value) in the mutual fund scheme equivalent to the value of the dividend declared by the scheme.
When a company is about to raise funds from capital markets for the first time, the only information potential investors have is through its prospectus. Many a time one finds that financial numbers of such companies have suddenly improved in the financial year prior to the IPO. Unfortunately, this growth trajectory fails post the IPO.
Surely any company would like to list when the going is not just good but great so as to get the best valuation possible. However, the additional capacities for which the IPO funds are raised take time to materialise. This could be a possible explanation of this trend.
On the other hand, there are companies that try to push up sales by extending excessive credit to pump up the pre-IPO profit numbers. A check of the cash flows and working capital can reveal the reality.
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