Hunting for the 10 bagger
(Jun 9, 2015)
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In this issue:
» Should banks act like Asset Management Companies?
» Why is India Inc not interested in reducing its debt?
» An important labour reform could be around the corner
» ...and more!
I and my team members are often asked which of our recommended stocks are going to become 10 baggers. Wish we could wake up every morning with the aim to find a 10 bagger stock. And check it off our to-do list by the end of the day! Unfortunately neither the hunt for nor the realization of profits from such game changing stocks can be timed.
As is the practice, for prudence sake, we prefer to meet and track a company well before we recommend them. I remember meeting VST Industries, eClerx and Page Industries well before we recommended them. And apart from the fact that these were solid well managed companies, there was hardly much that distinguished them from the other high potential mid and small caps.
That these stocks sport 3 to 4 digit returns is not just a function of good and timely selection. But also the fact that we keeping hunting for and stalking potential 10 baggers based on their rationale for investment.
Now, what do I mean by 'hunting a 10 bagger'?
Well, the term was introduced to us by none other than the legendary Peter Lynch. And he did complete justice to it by giving fellow investors enough hints about the factors where investors err the most in bagging a 10 bagger. The hints are on how to distinguish a good company from a great one and the best time and reason to sell the multibagger.
Now, before you get to that, as an investor you need to identify the kind of company that you are stalking. And only then can you on to figure out if the stock can continue to multiply or is it time to exit. Mind you here we are referring to the stocks that would have already performed beyond expectations and would have offered you a healthy return. The purpose of stalking the outperforming stock is to know whether you have enough reasons to hold on to it or sell it.
So let's start with discussing the criteria for booking profits in stocks that Peter Lynch called 'Stalwarts'. These are the best of bluechips with the largest market share and possibly the best fundamentals in the sector. So here are the signals that should set the alarm when you are stalking such Stalwart multibaggers.
The bluechip company that comes to my mind when thinking of most, if not all these signals, is Titan Industries. Mind you we have loved the company and its management and had recommended the stock for the first time in 2002. The manner in which the company stood out as a retailing giant with high margins at a time when other retailers were bleeding was very comforting for investors. However, the subsequent reliance on jewelry retailing, stiff competition and vulnerability to economic and regulatory risks, falling margins and exposure to leverage made us wary. To top that it seems very unlikely that a company of Titan's size will be able to grow fast enough to justify the nearly 40 times multiple that the stock is trading at!
- The company has lost market share in recent months and no new products are being developed. The new products launched in the past few years have solicited poor response.
- Spending on R&D is being curtailed and the company is resting on its past laurels.
- A major division contributing to more than 25% of revenues is vulnerable to economic slump.
- While growth has been slowing down, the company has been sustaining profits only by cost cutting.
- The company has paid so much for acquisitions that the balance sheet has gone from being one with zero debt to one with some debt.
- Recent expansion or acquisitions of unrelated business look like attempts at diworsification.
- The stock has PE multiple of 35 when its earnings growth is unlikely to exceed 15% per annum in the foreseeable future.
- Even at a lower stock price the stock's dividend yield will not lure investors.
Later this week, I will tell you about the alarm signals that you need to look out for in fast growing, turnaround and asset rich multibaggers. Stay tuned.
Which other stocks comes to your mind when you think of the alarm signals for Stalwart multibaggers? Let us know your comments or share your views in the Equitymaster Club.
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Speaking of alarms, the consistent slippage in asset quality is an alarm that has been ringing loud and clear for PSU banks since the past year. But it seems that the RBI has found a remedial measure. The business papers are calling it the 'new ammunition' for banks! But we beg to disagree! And this is one decision of the RBI that for a change we are not terribly excited about. First let us tell you what it is all about.
The RBI's new norms on Strategic Debt Conversion (SDR) give banks the right to convert their non performing outstanding loans into a majority equity stake in the companies. This is if the borrower fails to meet conditions stipulated under the restructuring package. Also allowing loan conversion will now be a precondition for all debt restructuring deals. Since the banks will now be eligible to pick up 51% stake in the companies it will relieve them of the worries of not recovering the NPA post restructuring. However, given the attitude of PSU banks in controlling asset quality, we would rather not want to see them as asset management companies. By relying on the equity conversion clause these banks are likely to get even more callous about the restructuring pipeline. And holding over 50% stake in scores of companies is not going to make the banks any healthier! Neither do these entities have the skill sets to turn around companies nor will they be able to recover their dues well to cover all the losses. And such remedial measures may in fact act as a deterrent in banks tightening their credit appraisal processes.
The motivation behind the RBI's move on debt restructuring can be seen from today's chart. Think of a company that has a huge debt burden. Sales are slowing down. The interest burden is rising. The profits, if any, are falling rapidly. What should the promoter do? The answer is simple. He should pay down some of the debt. If the company doesn't have the cash to do so, raising funds from equity markets is an option. If the markets are in a bullish phase, this should not be too difficult. However, in the case of India's most indebted firms, this has not happened in FY15.
The perils of Debt Restructuring
As per an article in Livemint, the top 100 such firms reduced their debt by a mere 4% YoY. Why is this so? A big reason is the lack of pressure from banks. As per the article, the Indian banking system has restructured a mind boggling amount of loans totaling over Rs 4.5 trillion in the last three years! With such leniency being shown to promoters, why would they want to repay quickly? This is something that the latest move by the RBI may not be able to address we believe.
The Modi government's desire to improve India's ease of doing business ranking is well known. The government has made some moves on this front. Steps have been taken in terms of online business approvals, factory inspections, environmental clearances and a few labour issues as well. However, these were not seen to be enough. Mining, infrastructure and construction firms in particular were facing serious problems related to temporary labour. Their fear was that these workers might have to become permanent employees once projects are completed.
Now though a potentially big labour reform could be around the corner. The government is set to introduce a separate category of temporary workers called 'fixed-term' labour. The draft changes in Industrial Employment Act, if approved, could pave the way for this to become a reality. Under this proposal, companies will be able to hire project-specific labour for a 'fixed-term'. This will enable a large number of workers to be hired on a temporary basis. However, this will not be without challenges. Trade unions are already up in arms. We will certainly watch this space closely for further developments.
Meanwhile, after a dull start, the Indian stock markets are trading in the green at the time of writing. The BSE-Sensex was trading higher by 50 points (+0.19%). Sectoral indices were trading mixed. Metal stocks were leading the gainers while pharma stocks were leading the losers. Asian markets closed mostly in the red. European markets have also opened on a negative note.
"Behind every stock is a company. Find out what it is doing." - Peter Lynch
|| Today's investing mantra
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|This edition of The 5 Minute WrapUp is authored by Tanushree Banerjee (Research Analyst).
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