Should you invest in loss-making companies?

May 16, 2011

In this issue:
» QE-III on the cards?
» 'No concern for aam aadmi'?
» Prices of wheat set to fall?
» Should a retail investor buy silver?
» ...and more!

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The March quarter result season is almost half way done. There have been positive surprises. However, the negatives have been much more. Several of the companies have reported losses in the current quarter. They have blamed higher input prices as well as rising interest rates for their woes. And the worst part is a large part of these companies have stated that such bad times are expected to continue over the next few quarters. So a question that would definitely worry a retail investor is should he continue to hold on to such a stock or should he book losses and sell it?

The answer to this question lies in the age-old philosophy of fundamental analysis propagated by the likes of Warren Buffett and Benjamin Graham. One should look at holding a stock if and only if the underlying fundamentals of the company command it. It is important to identify why the company has incurred a loss? Is it something to do with its business model? Or is it a temporary blip? The company should have a good business model as well as an excellent management. Combined with this it should be in an area of business that is expected to do well over the long term and should reward its shareholders over a longer period of time. Such rewards should be funded out of its own better operations and not through additional debt. In such a case, a few bad quarters actually present a good opportunity to accumulate more of the stock and hence bring down the average cost of purchase.

But if the losses are due to faulty management practices or decisions, then it is better to book losses and sell the stock. Such stocks only present long term pains. And averaging them would mean adding on to the pain for the investors. In any case, the idea is to look at the long term fundamentals copy of the company. Rather than being dictated by short-term events like quarterly results.

Do you sell the stocks of companies that incur losses or do you average your cost of purchase? Share your comments with us or post your views on our facebook page.

 Chart of the day
We have discussed time and again the spectacular performance of emerging markets vis--vis their peers in the developed world. Today's chart of the day shows the advantage that the emerging market companies have enjoyed in terms of higher growth. As per a report by leading consultant, McKinsey & Co, emerging market companies have outperformed their peers in the developed world in terms of growth. Even in terms of geographic segments, business in emerging markets has growth much faster as compared to the business from developed markets.

Data source: McKinsey & Co.

Do you know which is the most creditworthy instrument in the world? Also the asset whose yield sets the floor for interest rates across the world? Well, notwithstanding the recent decline, it is indeed the US treasury bonds. Imagine what will happen if US treasury bonds lose their credibility and start defaulting. There certainly would be complete chaos in financial markets across the world. Not to forget the enormous damage to the American economy by way of reduced economic growth and increased unemployment. If you have been thinking all along that all this is a figment of someone's imagination, let us tell you that you could be wrong here. A default by the US Government on its debt is well within the realms of possibility. This is exactly the kind of possibility that US Treasury Secretary Tim Geithner seems to have raised. He has warned that if the US debt ceiling is not raised, there could well be catastrophic consequences. It should be noted that the spending by the US Government has been exceeding its earnings by quite a distance, with the gap being filled up by borrowings. Thus, after months of living beyond means, things have come to such a pass that the US Government is about to hit its US$ 14.3 trillion debt limit. And if the same is not raised soon, be prepared for some extreme volatility in global financial markets.

The hike in petrol prices is here once again. After a gap of four months, the petrol prices have been increased by Rs 5 a litre. We all know that fuel prices in India are ridiculously subsidized. A price hike is inevitable for state run OMCs (Oil marketing companies) to survive. Interestingly, the recent hike is just 50% of what is required to trim losses on petrol to nil. The Government wants to take the credit for a 'moderate' increase keeping in mind consumers' concern. But wouldn't that have been best served by cutting the excise duty on crude oil? The Government let that opportunity slip in Budget announcement for the fiscal. Had that been done, it would have cut losses both for OMCs and the public.

Now that the State elections are over, the Indian consumers should be ready to face higher fuel prices. The decision whether to decontrol prices of diesel will be taken this week. Currently, sale of diesel is making a loss of Rs 17 a litre and constitutes four times the demand of petrol. All we can say is that hike in petrol prices is just a trailer and the worst is yet to hit the general public.

Borrowers may be getting mad at the RBI for raising interest rates indiscriminately. Consumers are still trying to figure out why petrol prices had to be raised by Rs 5 a litre. Complaints over rise in food prices have got lost in the noise over interest rates and fuel prices. But the government has been completely inept at addressing the common man's woes. Or at least making way for better pricing and adequate supplies going ahead.

Agreed that stopping the US from printing cheap money and pumping that into India is not in the Indian government's hands. Also, that the rise in crude oil prices is not something that the government can contain. But what it can certainly do is to ensure that food products available in plenty are evenly distributed. This can at least keep the prices of some products under check.

But as per chairman of Commission for Agricultural Costs and Prices, the government is doing little to ensure stable prices. While wheat exports have been disallowed, the farmers are selling the produce below the minim support prices (MSP). They are in fact forced to do so as the government is not buying the surplus produce. At the same time high taxes in states like Punjab make the export of what unviable. Thus there are several anomalies that need to be corrected. Unless the government wakes up on time, both the producers and consumers of the grain will be severely hit. And that is something the economy can ill afford at this point.

With its meteoric rise and now drastic fall, silver seems to be a very volatile asset class. So should you as a retail investor look at owning this white metal.

Well, if you are looking at investing for long term returns, then the answer is a resounding 'yes'. Gold has risen by more than 62% since 2008, while silver prices have run up by more than 220% during the same period. And if one were to take a look at the results over the past ten years, silver has risen by more than 668% since 2001. Gold and the Sensex on the other hand, have seen an increase of about 385% and 368% over the period. Silver's has definitely hit the ball out of the park.

But, there are some caveats. With such dynamic returns, the metal is a favourite play for traders trying to make a quick buck. Thus returns over the short term are quite volatile, as seen by its recent 30% fall, which left investors spooked. As for gold, the shiny metal has for years maintained its status as a store of value, due to its scarcity. Since, silver is much more easily available in nature, it cannot replace its richer cousin as a store of value. All in all, you may have to bear short term pains, for long term gains from this asset.

In the meanwhile, the Indian stock market continues to trade weak due to selling pressure in heavyweights. At the time of writing, the benchmark BSE Sensex was trading down 106 points. Mahindra & Mahindra and ONGC were seen losing the most amongst blue chips. All major Asian stock indices closed in the red today. Europe too has opened on a negative note.

 Today's investing mantra
"Wide diversification is only required when investors do not understand what they are doing." - Warren Buffett

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5 Responses to "Should you invest in loss-making companies?"


May 18, 2011

With respect to the hike in Petrol Prices looks it was inevitable but why the govt don't reduce the excise duty and VAT on it. It is a better option rather than by paying the duties and taxes that help this politician to make easy money. Finally, their is no fiscal deficit actually it is the deficit of the white money circulation. All the money in the scam done by this politician be it Telecom, Asian Games should be brought back to Government Account. Nodoubt it's difficult to bring the money from Swiss but atleast Governemt oh no not the Governemnt but the General public should so sthing to force this guy to give the money to the Public Account


Asish Banerjee

May 16, 2011

Recently I have been deeply thinking over investing in silver. But after going through the prudent analysis, I understand, it will be wise to look carefully into the volatility of the market to invest in. Thanks to The 5 minute wrapUp.


Balan Bhaskaran

May 16, 2011

I personally feel that an investor with long term plan should continue to build the shares during high volatility to average holding prices as long as the selected company has strong fundamentals and forward looking management


Jyothi Kumar

May 16, 2011

Not only in Punjab for wheat produce the issue is same with rice producers in AP...the farmers also loose out because the day wage has gone up from Rs 120-150 5 yrs back to Rs 400 in the peak season currently without concomitant increase in the price of the output...serious reforms are necessary to ensure that the rural fabric remains intact.



May 16, 2011

This certainly has a individual context to it:
1) how much you are invested in equity currently ratio to net worth in equity, cash and equivalents)
2) less than 20% of companies in your stock portfolio performing to market/ above market expectations
3) Your fair goals cannot be met (with a date)
4) Company performance (net profit growth is -ve) compared to 2008, 2009,2010 (See if in future it is not aligned to reach its goal- data extrapolation)
5) If all above true PLUS in current interest rate scenarios check for the above companies high debt/E, negative earnings going hand in hand with negative sales (ex: Gujrat Alkalies), any large structural changes, if any. YOU MAY WANT TO EXIT THE STOCK.
If you are comfortable placed with the first four points and have the company history numbers digested with some gut feeling then you may wait for your evaluated price to enter-in say equally divided no of shares for 10 to 20 trading days. OR do determine a SIP and act on it.


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