The Stocks Which Dampened Your Investment Spirit And Portfolio

Kantibhai Mehta of Ghatkopar becomes nostalgic whenever you talk to him about his investment decisions—he goes back to his B through the investment path way back in the ‘80s. His eyes start beaming, his expressions become more confident. Then he talks about how an investment decision to put meagre amount of Rs 10,000 in 100 shares of Wipro has made him ‘crorepati’ in just 36 years. Mehta had taken a wise decision in the year 1980—invested Rs 10,000 in the IT company’s stocks without even telling his wife, Bhagwatiben. Today, Mehtas are sitting on a whooping corpus of Rs 535 crore. Yes, it is not a typo. It is Rs 535 crore exactly.

A classic example of wealth creation taking the equity investment routes in India. Wipro and Mehtas are just part of a long list of such investors and companies. You can add Eicher Motors, Dr Reddy’s Lab, Titan and see how the list is growing longer. But let me here dampen your sudden excitement little bit by reminding you that tale of every tell having two sides.

You may not lucky everytime and there are ample cases also about hundreds of listed companies which simply robbed its investors and those investors’ stories have turned into stories of riches to rags. In the last decade or so we have seen a lot of companies’ stock prices collapsing like a pack of cards resulting into decimate of one’s portfolio.

So taking a note of both the sides of the story, here we chose to pen down an exhaustive report based on some case studies of the listed companies where we have noted extreme drop in the stock price and so, extreme fall in worth of investors. The explanation behind the sharp abatements in the stock prices may vary from company to company. For some situations, we have seen deceptive practices, while in some of the cases, we have seen management irregularities.

Case Studies:

Why analysing or briefings of case studies are important?

There is a small story of Thomas Edison. Thomas Edison tried two thousand different materials to make a filament for the electric bulb. When none worked satisfactorily, his assistant complained, “All our work is in vain. We have learned nothing.”

Edison replied very confidently to his assistant, “Oh, we have come a long way and we have learned a lot. We know that there are two thousand elements which we cannot be used to make a good light bulb.”

The moral of the story-we can also learn from our mistakes. Hence, it becomes important to analyse the case where the stocks have nose-dived and find out traces why it happened so and how one can dodge such oversights in future.

1.    ZYLOG SYSTEMS:

BACKGROUD OF THE COMPANY:

Zylog systems namely ZSL in USA and Zylog in other geographies was established in 1995 by Sudarshan Venkataraman. The company, is known as a CMMI certified provider of onshore, offshore and nearshore technological solutions and services to enterprises and technology companies across the globe.

The Steep fall in the price: What triggered the sell-off?

It got into an endless loop as the promoters had heavily pledged their shares. There were claims by brokers that promoters had a tough time in October, 2012 and were not able to meet the margin requirement by the lenders. Responding to this situation, moneylenders sold the pledged shares which brought down the share price of the company. This was led by Karvy Financial Services which sold 2.5 lakh shares through a bulk deal on BSE. This heavy selling triggered off the lower circuit filter. After that, each and every day was trailed by overwhelming offering, by the other lenders of the pledged shares, including JM Financial.  

Sudarshan Venkatraman, Zylog’s Chairman & CEO, had issued a statement that attributed the stock price fall to ‘panic’ created by speculators. “Promoters and large institution have increased their share holding over the past two weeks, coinciding with the fall in the share price,” he said adding that there was no adverse impact on the company’s business.

In the case of Zylog System, it was the case of pledged shares out of proportion which led to the fall of its stock prices.

2.    CASTEX TECHNOLOGIES:

BACKGROUD OF THE COMPANY:

Castex Technologies, a subsidiary of auto component major, Amtek Auto is a leading provider of iron cast automotive components in India. The company’s product portfolio consists of a range of components for 2-3 wheelers, cars, tractors, light commercial vehicles, heavy commercial vehicles and stationary engines.

The steep fall in the prices: What triggered sell-off?

Castex Technologies issued two sets of FCCBs in FY13-one of $130 million in April 2012 and the other of $70 million in September 2012. Both carried a 6 per cent coupon rate. The conversion clause for the two sets came into effect in April and July, respectively. The clause states that if Castex Technologies stock continues to trade at over Rs 160 for a month, the company can call for a mandatory conversion of the bonds.

Subsequently, on July 31 in 2012, Castex announced the mandatory conversion of all the outstanding bonds (around $80.8 million worth) out of the FCCB issue of $130 million, with the conversion date being September 10. Further, the company also decided to mandatorily convert all the outstanding bonds ($56.6 million) of the FCCB issue out of $70 million, with the conversion date being September 25.

This didn’t go well with the FCCB holders. They informed market regulator SEBI about the happenings in the company. They alleged that the stock of the company was manipulated to rise, triggering the mandatory conversion of all outstanding bonds.

In the case of Castex Technologies, the astronomical rise of its stock prices was not easy for one to digest and second concern was the alleged put up by the FCCBs holder that the stock price was manipulated to rise, which triggered the mandatory conversion of all outstanding bonds.

3.    RICOH INDIA:

BACKGROUND OF THE COMPANY:

Ricoh India’s 73.6 per cent was owned by Ricoh Group headquartered in Tokyo.  The company deals in printing and document equipment and also offers solutions to IT service providers and operators of such communication systems. Ricoh acts as one stop solution for complete office automation by dealing with variety of products & solutions (also known as IT peripherals) supported by IT services.
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The steep fall in the prices--What triggered the sell-off?

It began with the company announcing a change in its auditors in July, 2015 to M/s. BSR & Co. LLP, Chartered Accountants from M/s. Shani Natarajan and Bahl, Chartered Accountants. From that point, the company neglected to report its quarterly results for almost two quarters. This with the management persistently consoling exchanges and shareholders that business operations are normal and results will be reported soon.

In the interim, the stock exchange moved the company’s stock from ‘B’ to the ‘Z’ category, which meant the stock would be settled on trade-for-trade basis, with no speculative trading allowed and delivery of shares and payment of consideration amount being mandatory.

On March 29, 2016 the company informed the stock exchanges that some employees have been requested to avail leave with pay as a matter of standard practice. This was followed up with a disclosure of the names of these employees, which included the MD & CEO, Manoj Kumar, the CFO, Arvind Singhal and the COO, Anil Saini.

In the case of Ricoh India, the red flag was the company delaying filing of its quarterly results after auditors raised alarm over certain financial transaction.

There is a famous saying “Tell me and I forget, teach me and I may remember, involve me and I learn.”

Here are important findings or lessons to be learnt from the past:

1.    Misled momentum and chasing “Hot Stocks”:

One of the fundamental errors investors make while selection of stocks for investing purpose is that they bounce into a hot stock for no other reason than they are going up quickly. For an illustration if a company XYZ is trading around Rs 100 in the month of January and by the end of March, the stock trades at Rs 180, so that is an astounding 80 per cent in just a span of three months. Since, the investor has missed the start of the run he laments and hence, he thinks the trend is up and the stock prices will continue to surge higher and he ends up buying the stock in hope of making quick gains on the back of the stocks freight train like momentum. In many of the cases we heard this story from investors where they said as soon as they bought it, the stocks prices started to crash. Recollect the year 2007-2008 where numerous realty stocks like Unitech, DLF etc rode the bull market without much of earning supports and investors were clearly misled by the momentum. Hence, it’s important not to chase the hot stock. If you still want to trade study the financial thoroughly and get an advice from financial expert.

2.    Assuming the past is a guide to future performance:

Generally, it has been observed numerous retail investors tail this methodology assuming a stock has performed well in the past they anticipate that it will proceed to perform well in the coming months or years. For example, if the stock of the company ABC has gone up from the levels of 200 to 500 in the past three years and then suddenly the stock crashes due to some negative news flow or any major fundamental changes occurred in the stock and many of investors take this as buying opportunity. They think this is a value buy without having fair amount of idea why the stock corrected heavily within a short time. The market is a highly cyclical beast and a particular stock or sector is very unlikely to outperform for exceptionally long periods. The period of time during 2014-16 had been tough for crude oil as its price witnessed a drop up to levels of $ 26/barrel and in turn it affected upstream oil companies like Cairn India. The stock initially was trading at levels of Rs 370-385 in mid-2014. The stock almost touched levels of Rs 100 beginning of January 2016, the stock reacted negatively to the fall in international crude oil prices.  

3.    Jump in promoter pledges:

Shares or stocks are considered as assets and thus, banks consider shares as security to raise loans. At whatever point a crisis emerges related to funds in the company, shares can be quickly pledged to raise funds. Pledging of shares is a process when the promoters keep the shares of the company that they own as collateral for debt. Pledging of shares is done with banks or non-banking finance institution offering loan to promoters. Generally, pledging of shares is the last resorts for promoters try for raising fund. This means that no one else is ready to provide loan because either the company is in bad business whose future prospect is not bright or the company has high debt and might be under financial constraints, hence pledging remains they only option left. Pledging of shares become extremely risky when it increases beyond a certain limit and the company finds itself in a position to do nothing. In the past, many of the companies with high pledging had seen a run up but during the stressful times these companies are always a pain in the neck. Hence, avoid companies where the pledging is too high or pledging is on a rise. Elder Pharmaceuticals is one of the examples where the promoters had high pledging and the stock which was quoting above Rs 400 in the year 2012 is trading at around Rs 25 at present. 

1.    Mob Mentality:

It has been noticed that most of the retail investors’ investing choice is influenced by the activities of his contacts, neighbours or relatives. If my neighbours, relatives or friend is investing in particular stocks, I am also supposed to do the same. One of the best cases for the MOB mentality strikes a chord is of Reliance Power IPO. It was that time where every Tom, Dick and Harry wanted to apply for Reliance Power IPO in the light of the fact their friends, colleagues, neighbours or relatives were applying for this IPO. But this strategy backfired as Reliance Power had a very subdued listing and thereafter stock prices slumped.

2.    Cooked the books:

Satyam is a great case of companies who cooked the books. This is one of only a handful of rotten ones that get all the headlines. Companies like Satyam that claimed billions in assets but promptly fall apart when their false claims were exposed. Hence, it’s important to keep tracking the financial books of the companies and if investors find some cooked up or suspicious, simply press the way out catch and stay away.

3.    Governance Issue:

We have had a number of scams in India. However, none is so far bigger than the scam involving procedure of allocating unified access service licenses. A Raja, the then telecom minister who as per the CAG evaded norms at every level as he carried out the dubious 2G license awards in 2008 at a throw away price which were pegged at 2001 prices. Telecom stocks affected after this scam were identified. One more example is of Financial Technology, where there was a corporate governance issue and the stock crashed heavily.

4.    End of Monopolies:

Companies like MTNL had monopolies before the economic liberalisation in the ‘90s. Nonetheless, they couldn’t withstand the competition and step by step slipped into superfluity. Henceforth, investors should be cautious with such companies.

I’ll end this report with a quote of a legendary investor--“You only have to do a very few things right in your life so as long as you don’t do too many things wrong.”

Factors to keep in mind in short-listing the companies: Jagannadham Thunuguntla Head Karvy Research

We give strong emphasis to those companies who have debt/equity ratio below 1x. We find difficult with those companies who have high debt/equity ratios. Enormous wealth destruction has taken place in those companies and sectors where companies have massive debt on their books. There are several companies in the real estate and infrastructure industries have burden of massive debt.

Similarly, investors shall adopt enormous amount of caution on those companies where there are high levels of promoter share pledge. Generally, high levels of promoter share pledge make companies vulnerable to any sharp correction in share prices; as such scenarios can trigger margin calls from the lenders to such promoters.

High levels of debt and high levels of promoter share pledge can create massive investors’ wealth destruction; and several companies find it difficult to recover from such burden.

We give significant importance to following factors in short-listing the companies for investment:

1.    EBITDA Margins (Operating Profit Margins) %

2.    PAT Margins (Net Profit Margins) %

3.    Return on Equity (RoE) %

4.    Return on Capital Employed (RoCE) %

5.    Debt / Equity Ratio (x)

EBITDA Margins, PAT Margins, RoE and RoCE are higher the better; and Debt/Equity Ratio is lower the better.

Besides these fundamental factors, investors shall also see the growth rates of revenue, EBITDA and PAT of the company, to check whether this company is growing faster or in-line that of that particular industry.

Once the selection of the companies is done based on some of the above mentioned factors, investors shall focus on the aspect of valuation. It’s always good to focus on companies when they are undervalued and when the markets significantly correct.

When markets correct, almost all the stocks fall, whether they good or bad. During such times, investors shall focus on investing in companies which are fitting in the above parameters. Fundamentally speaking, it’s always good to invest when P/E ratios (Market Price / Earnings Per Share) are at low levels, that is when they are below 15x.