Check Promoter-Holding Before You Make A Buy Decision

The year 2015 has not been very encouraging for most of the Investors in India even as S&P BSE Sensex generated annual return of -5% and Nifty -4%. The reasons were associated to the issues on policy implementations, growth in earnings, global issues relating to China and USA and finally withdrawal of money by FPI and FII etc.

Whatever be the reasons, equity investing is all about putting your hard earned money in a business which you expect to do well in future. In our studies we have focussed on how sector specific investments can be helpful in building greater portfolios and we then identified that in times of uncertainty, three sector have performed much better than others and they are consumer goods, technology and health care (Industry classification benchmark (ICB)). Our research findings also suggest that shares where promoter holdings are high, generate higher returns than shares where promoter earnings are lower.  In this study we focus on the time tested ratio known as return on net worth (RONW) with our previous findings to suggest a simple method of identifying a stock with huge potential.

RONW measures the profit earned on the owner’s fund. Shareholder fund is defined as Capital Invested plus all Reserve & Surplus of the company. RONW measure profitability earned on the Shareholder funds and is a benchmark of comparing one company with other and company’s performance over the years. Increase in RONW can be caused by any of the factor like higher profit margins, higher capital turnover, higher financial cost ratio, higher financial structure ratio and lastly due to change in tax structures. If we have to look at this ratio from an Investor’s perspective what is important is that a minimum RONW should be achieved year on year and it should be consistent over the years. We consider RONW of 15% as a minimum expectation of shareholder and the key is consistency in earning above 15% year on year.

We consider all listed companies on BSE and NSE and apply two filters:

1.       Companies in consumer goods, technology and health care (ICB classification)

2.       RONW of 15% or more between 2011-2015

Out of more than 2500 companies now our portfolio consist of merely 91 companies and we calculate Price CAGR assuming that investor would purchase these securities on 31 December of every year.

As we can see even in the financial year 2014-2015 the average returns is around 50% as compared to the BSE Sensex and NIFTY returns of -4%. Even the Median return which is around 18% beats the Index returns. In the last one year Maximum return of 771% was given by GM Breweries which have increased from Rs. 90 to Rs. 790 and minimum return of -55% was in Kaveri Seeds which has fallen from Rs. 771 to Rs.351.

Across all the four years, the average return is more than 50% and this compensates for the risk that an investor takes. Portfolio with a holding period from 2011-2015 has generated a minimum return of 9% and average return of 51%.

This method of portfolio formation is back tested but if we add one more level of filtering, which is Promoter stake it increases the average return generated.

Here Promoter stake is defined as Indian promoter or foreign promoter holding more than 50%.

Average returns in the last one year as observed from Table-1 was around 50%, which can be maximised up to 82% by adding one more level of filter of promoter stake in companies.

While making an investing decision Investor; should look at indicators like RONW and consistency in RONW. Focus should be on key industries or sectors which are likely to grow or benefit from policy changes. Lastly observe if promoters are invested in the company or are exiting. Databank of DSIJ has data on all the three filter level used and should be used by investors for constructing efficient portfolios.