The biggest destroyers of investor wealth - The 5 Minute WrapUp by Equitymaster
Investing in India - 5 Minute WrapUp by Equitymaster

The biggest destroyers of investor wealth 

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In this issue:
» Are retail NBFC losing steam?
» India must reboot its manufacturing sector
» American debt explosion - What it means
» China folds on reforms
» ....and more!

00:00  Chart of the day
Retail investors were active participants in the Indian stock markets 10 years back, both in primary and secondary segments. However, that was in the past. Things have changed hugely since then. Even though Indian stock markets have hit new highs, retail investors have been net sellers. So what is the reason for declining retail participation in stock markets?

One could attribute this to the massive loss of shareholder wealth. According to an article in Business Standard, as many as 77 of the 155 BSE-200 companies (excluding banking and financial ones) have reported a decline in their market value since March 2008. This means that nearly half of the top Indian companies have destroyed shareholders wealth since 2008. The chart shows the top Indian companies which have destroyed maximum shareholder wealth.

Top wealth destroyers since FY08

But what is more interesting is that despite the fall in market value of these companies, their balance sheet size has expanded. This is because companies took on more debt to achieve higher growth. Companies that used easy and cheap money to fund aggressive growth are now struggling with interest liabilities as they are unable to service their debt in the current sub-5% GDP growth economic scenario.

The economic slowdown, rising interest rates, tight liquidity, declining investments and depreciating rupee have taken a toll on India Inc's balance sheet. And now for most of the companies, debt has accumulated so much that it exceeds their market value. This seriously hurts the long term prospects of the company.

Companies that are unable to service their debt with their yearly profits are likely to borrow more money to make interest payments. While this would help them make the payouts in the short-term, their burden is compounded over the longer term unless they are able to significantly boost revenues and profits to repay new loans. The only way out for many of these financially-stressed companies is to shrink balance sheets through divestments and asset sales. This will help them reduce debt and increase market value.

Hence investors should invest in companies with little or no debt on the books. Debt free companies will be in a position to post reasonably strong bottomline numbers even during economic downturns. Also, being debt free brings with it another advantage. These companies can choose to re-invest the surplus cash flow back into their business and gain a competitive advantage over their peers who might be struggling to make interest payments. Over time, such firms can significantly outperform other companies in its industry.

Do you think India Inc will be able to restore investor confidence? Let us know your comments or share your views in the Equitymaster Club.

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The companies in the sector made a killing in 2013. This was even as players several times their size in the banking space struggled to grow their loan book. But the golden run for retail non banking finance companies (NBFCs) seems to have come to a premature halt. As per an article in Business Standard, retail NBFCs are very unlikely to repeat their performance seen in 2013. Ones in the auto financing, truck financing, gold loan and personal loan space saw valuations go through the roof last year. For despite having lending margins that are nearly double that of banks, most of these entities saw a healthy loan growth.

Moreover even the asset quality, in most cases was not a worry. But investors forgot that even a temporary slowdown in economic growth can lead to lumpy NPAs for these companies. And hence once the NPAs started showing, investor appetite for these stocks started falling. Given the pressure of provisions on profits, it is likely that the profit growth for these entities will also be subdued in the near term. However, we believe that for investors who are willing to bet on the long term value creation nature of their businesses, there could be some attractive bets.

Several causes have been highlighted for the slowdown that the Indian economy is going through currently. But one of the main reasons is the sorry state of India's manufacturing sector. Indeed, industrial output has been sluggish for quite some time now. The Finance Minister in his recent Interim Budget 2014 announced some excise duty cuts for few industries to kickstart growth. But is that really going to achieve much? India's problem when it comes to manufacturing is more structural.

And these structural issues are preventing it from toppling China as the world's manufacturing powerhouse. It is not that the potential is not there. China's labour is beginning to get expensive. Given that labour in India is still vast and cheap, this should be reason enough for it to become an industrial force to reckon with. But there are plenty of other problems too, all of which are well known. Corruption and red tapism. Problems acquiring land. Rigid labour laws. Frequent power cuts. Poor road infrastructure. The list is endless. Urgent reforms are needed when it comes to land and labour laws and creating a simpler tax structure. If these issues are resolved, there is no reason why India's manufacturing sector will not grow by leaps and bounds. Especially when it has the advantage of a favourable demographic dividend. All eyes will now be on the outcome of the general elections and what the new government chooses to do in this regard.

Is the debt mania back in the land of Uncle Sam? Well, it does look like it. At least this is what the famous magazine Fortune proclaims in one of its articles. Apparently, the Americans have taken on US$ 241 bn in new debt during the fourth quarter in 2013. To put things in perspective, this is the largest quarterly increase since 2007. So, is this a bad thing? May be not if the consumers have taken new loans after repairing their balance sheets. If this is indeed the case then it's a good sign and the new debt will likely help the economy grow. However, there's a bad and an ugly side also to the rise in US consumer debt. The bad side being that the less credit worthy borrowers are finding it difficult to avail of any loans. This would mean the low and middle class America is not seeing a sufficient rise in income.

And then there is the ugly side where the largest percentage increase in debt has happened in the student loan category and that too in the group with the lowest credit score. Now, if these students would spend the money sensibly and invest in their own education where returns could accrue few years down the road then there's nothing wrong about it. But this does not seem to be happening as delinquency in student loans has been on a rise. Therefore, if the rise in consumer loans in the US is going more towards this kind of lending, then it's not so good for the future of the US economy we reckon.

Chinese economy has been in news for quite some time now, for all the wrong reasons. A recent one suggests the rise of shadow banking that may engulf the banking industry in China and topple the economy. As per an article on Zero Hedge, overcapacity coupled with a slowdown in the demand had led borrowers turning to shadow banking for credit. Even by conservative estimates, the shadow banking sector is expected to account for around 20%-30% of GDP. Now that is really a matter of concern. This is because shadow banking sector relies on inter-banking loans for short term liquidity. And it's not just about reduced liquidity. The fact that borrowers are cross guaranteeing each others' debt could lead to a chain of defaults. May be full blown banking crisis in China.

In the meanwhile, Indian stock markets were buoyant. At the time of writing, the benchmark BSE Sensex was up by 44 points (0.2%). Consumer durable and pharma stocks were the biggest gainers. Most of the Asian stock markets were trading higher led by China and Singapore. However, the Japanese market languished in the red.

04:55  Today's investing mantra
"The best stock to buy may be the one you already own"- Peter Lynch
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4 Responses to "The biggest destroyers of investor wealth"


Feb 27, 2014

It is said "Business with borrowed money makes good business better and bad business worse"

In fact most of the corporate giants have built up their empires on borrowed money, the debt to equity ratio being generally more than 2:1.


Rajesh Cherayil

Feb 20, 2014

Are RIL and NTPC being cited as companies that are stressed in terms of debt servicing? While both of them deploy leverage, neither one of them has any issues in terms of meeting debt obligations

Like (1)


Feb 19, 2014

hope dies a pretty old investor i have seen number of cyclical moves in free market this is certain to happen. but current economic situation leverage is not likely to be in tune with rejuvenation in industrial activities. economic and political situations having been completely out of gear because of colossal corruption and radar less policy ( rather a state of policy paralysis ) and in spite of insurmountable CAD theFM`s conviction to increase subsidies (to buy votes) against any ethics will bring more i feel this phase will change with change with men in the helm and silver line will sparkle in the horizon.

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vijay hinduja

Feb 19, 2014

Good article sir, indeed very informative and providing a true picture.


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