Should you invest based on 'debt repayment' theme? - The 5 Minute WrapUp by Equitymaster
Investing in India - 5 Minute WrapUp by Equitymaster

Should you invest based on 'debt repayment' theme? 

A  A  A
In this issue:
» Funds from QIPs have soared
» Are safety nets more important than fundamentals?
» Americans looking to prolong auto debt tenure
» Will India's coal sector get privatised
» ...and more!

Ever since Narendra Modi has come into power and set the development ball rolling, stock markets have been zooming. With all the hype, it is hardly surprising that 'theme based' investing ideas are doing the rounds. One theme that has caught on is infrastructure and so most companies in the infrastructure space have seen their stock prices soar.

Now we have come across another theme as per an article in the Economic Times. This article has listed a few stocks that have generated returns of anywhere between 30% and 85% in 2014 so far. The common thread running among these stocks is that the companies were highly leveraged with most reporting debt to equity of around 1-2 times. But they were making attempts to reduce this debt. So the surge in these stocks was probably due to investors wanting to cash in on the prospect of higher returns once this debt gets repaid. And the steep rise in stock prices has inflated valuations as well.

We believe that it is always a dicey affair to invest in companies with too much debt on their books. Indeed, the problem becomes all the pronounced when there is a slowdown in the business because interest costs will still need to be paid and this exerts considerable pressure on profits. In severe cases, there have been companies which have had to entirely restructure, sell off assets so that the cash can be used to pay off debt.

There is nothing wrong with leveraged companies looking to tone down their balance sheets. But investing in them on the possibility that the debt burden is likely to reduce in the future is fraught with risks we believe. There has to be some evidence that this debt indeed is coming down. Basically, we will be more comfortable when this debt actually reduces to acceptable levels and then evaluate if they are potential investment candidates.

The other aspect is valuations. Most of these theme based stocks run up so much that the valuations begin to look quite expensive. We believe that valuations cannot be ignored and there has to be that margin of safety while buying into a stock. So even if a debt free company has seen a run up in its stock price as a result of which the valuations are expensive, investors should refrain from investing in it.

When investing in stocks, how much importance do you give to theme based investing? Let us know in the Equitymaster Club or share your comments below.

--- Advertisement ---
Small companies, big ambitions and even bigger profits (for you)...

Today, We want to tell you about a popular Watch company...

This company was once very small. Struggling to make a place for itself in the Indian Watch segment.

But that did not stop the company from dreaming big. It made its plans, and followed them to the tee.

As a result, it is now one of the biggest watch brands in India. And it has made the people who invested money in it during its early days extremely rich!

We are talking about Titan.

And there are some select small companies like it with great potential even today. Companies that could make you very rich in the long run.

But how do you find all such companies? Just click here for full details...

01:46  Chart of the day
With euphoria returning to markets the fund raising exercise has also gathered momentum. Take the case of money raised via qualified institutional placement (QIP) for example. In this calendar year, corporates have raised Rs 114.5 bn in the first five months itself via the QIP route. This is about 30% more than what they raised in entire previous calendar year! Renewed investor confidence amidst change of power at the Centre has given a new lease life to the QIP markets as witnessed in today's chart. Expectations that the new government will improve business environment has led corporates to expand their balance sheets. And for now QIP seems to be the preferred mode.

But it may not be long before the IPO market too witnesses the same kind of momentum. Corporates that were eagerly waiting on the sidelines to raise money from primary markets will jump in the fray soon. However, this is the time when investors need to be more cautious. It should be remembered that corporates raise money when they can do so rather than when they actually need it! And the current market conditions are perfect for them to raise money. As such, investors need to be extremely vigilant while applying to any new IPO issue. They should focus on fundamentals and valuations and must not get carried away by the current hysteria.

Funds raised through QIPs have soared
*So far in 2014

Save for the last couple of months, retail investors have hardly benefitted from the upside in stock markets. The fear of losing money in stocks has always been on top of the mind for small investors. And despite several fiscal benefits, getting retail savings into stock markets has been an effort in vain. Both the government and the capital market regulator (SEBI) have tried and failed at several attempts. The SEBI for instance, has over the past few years, implemented several measures to protect the interest of retail investors. This included a quote for retail investors in the case of offer for sale. Further, there is a safety net for retail investors subscribing to IPOs. Now while these measures certainly help in building confidence amongst retail investors, it could also make them callous. As pointed out by Economic Times, the fact that the retail portion of the IPO of Wonderla Holidays got oversubscribed 7 times is rare. And it could be worrying if the investors are relying solely on the safety net promise rather than the fundamentals of the company they are investing in. Thus while SEBI should encourage retail investors to participate in stock markets, the same should come with some riders. So the due diligence required for buying a stock cannot be compromised on the premise of safety net.

If you wish to buy a car, but cannot afford to pay the monthly installment, what's the way out? Extending the loan period seems like one solution. This is what seems to be happening in the US right now. As per Moneynews, a growing number of Americans are looking to extend their loan terms for buying vehicles to as many as 11 to 12 years! As reported by Wall Street Cheat Sheet, one-fourth of new vehicle loans ranged from 73 to 84 months, up 27.6 % from a year earlier. In any way you look at this, it seems like a cause of concern and one that could lead to being a bubble situation. Especially considering that such buyers would end up paying a lot more in the form of interest payment; and could possibly face issues when it comes to trading their vehicles for a new model! Not to mention, this route is mainly being taken by people who don't have the best of credit records.

The new government seems to be taking some baby steps towards some crucial reforms. There is some good news regarding the coal sector. The sector may be opened to private players with conditions attached. The government is considering a proposal to auction mining leases to private bidders. This would include the leases to those areas that Coal India is unable to mine. The Coal ministry is also developing a long term plan to reform Coal India by 2030. This would be in line with the new governments view to reform PSUs instead of privatizing them.

While these steps will certainly help, we believe that if the government were to go in for reforms in any sector, it should be decisive. Coal India is a cash rich PSU that enjoys a monopoly. The government should consider ending its monopoly. Participation of private companies with a proven track record into the coal mining sector should be allowed. This will lead to an increase in the supply of this important commodity in the local market. Indian power companies will then not need to import a commodity that it has in abundance.

The Indian stock markets were trading weak. At the time of writing, the benchmark BSE-Sensex was down by 106 points (down 0.4 %). Barring IT and pharma, all sectoral indices were trading in the red. Realty and oil & gas stocks were the biggest losers on the bourses today. Majority of the Asian stock markets were trading in the green led by China and Hong Kong. European markets have also opened the day on a strong note.

04:56  Today's investing mantra
"I have pledged - to you, the rating agencies and myself - to always run Berkshire with more than ample cash. We never want to count on the kindness of strangers in order to meet tomorrow's obligations. When forced to choose, I will not trade even a night's sleep for the chance of extra profits" - Warren Buffet
Today's Premium Edition
Stocks to watch out for after Modi's win
Which stocks/sectors will benefit the most out of the new economic agenda rolled out by government?
Read On...Get Access
Recent Articles:
This Small Cap Can Drive Chinese Players Out of India (and Make a Fortune in the Process)
August 17, 2017
A small-cap Indian company with high-return potential and blue-chip-like stability is set to supplant the Chinese players in this niche segment.
This Company Beat the Business World's 'Three Killer Cs'
August 16, 2017
And what it has in common with beating the stock market too.
Let's Hope This Correction Continues
August 14, 2017
Last week's correction is making a number of Super Investor stocks look a lot more attractive...
Insider at It Again. This Time Stealing from Buffett and Berkshire
August 12, 2017
What is Equitymaster Insider Ankit Shah stealing from Berkshire's success?

Equitymaster requests your view! Post a comment on "Should you invest based on 'debt repayment' theme?". Click here!



Copyright © Equitymaster Agora Research Private Limited. All rights reserved.

Any act of copying, reproducing or distributing this newsletter whether wholly or in part, for any purpose without the permission of Equitymaster is strictly prohibited and shall be deemed to be copyright infringement

Disclosure & Disclaimer: Equitymaster Agora Research Private Limited (hereinafter referred as 'Equitymaster') is an independent equity research Company. The Author does not hold any shares in the company/ies discussed in this document. Equitymaster may hold shares in the company/ies discussed in this document under any of its other services.

This document is confidential and is supplied to you for information purposes only. It should not (directly or indirectly) be reproduced, further distributed to any person or published, in whole or in part, for any purpose whatsoever, without the consent of Equitymaster.

This document is not directed to, or intended for display, downloading, printing, reproducing or for distribution to or use by, any person or entity, who is a citizen or resident or located in any locality, state, country or other jurisdiction, where such distribution, publication, reproduction, availability or use would be contrary to law or regulation or what would subject Equitymaster or its affiliates to any registration or licensing requirement within such jurisdiction. If this document is sent or has reached any individual in such country, especially, USA, the same may be ignored.

This document does not constitute a personal recommendation or take into account the particular investment objectives, financial situations, or needs of individual subscribers. Our research recommendations are general in nature and available electronically to all kind of subscribers irrespective of subscribers' investment objectives and financial situation/risk profile. Before acting on any recommendation in this document, subscribers should consider whether it is suitable for their particular circumstances and, if necessary, seek professional advice. The price and value of the securities referred to in this material and the income from them may go down as well as up, and subscribers may realize losses on any investments. Past performance is not a guide for future performance, future returns are not guaranteed and a loss of original capital may occur. Information herein is believed to be reliable but Equitymaster and its affiliates do not warrant its completeness or accuracy. The views/opinions expressed are our current opinions as of the date appearing in the material and may be subject to change from time to time without notice. This document should not be construed as an offer to sell or solicitation of an offer to buy any security or asset in any jurisdiction. Equitymaster and its affiliates, its directors, analyst and employees will not be responsible for any loss or liability incurred to any person as a consequence of his or any other person on his behalf taking any decisions based on this document.

As a condition to accessing Equitymaster content and website, you agree to our Terms and Conditions of Use, available here. The performance data quoted represents past performance and does not guarantee future results.

SEBI (Research Analysts) Regulations 2014, Registration No. INH000000537.

Equitymaster Agora Research Private Limited. 103, Regent Chambers, Above Status Restaurant, Nariman Point, Mumbai - 400 021. India.
Telephone: +91-22-61434055. Fax: +91-22-22028550. Email: Website: CIN:U74999MH2007PTC175407