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Time to Invest in These Smaller, Lesser-Known Companies?

Nov 25, 2015

In this issue:

» Why has rural demand remained weak?
» Infra companies looking to issue masala bonds
» ...and more!
00:00
Radhika Nabar, Managing Editor of ValuePro

We came across a recent article in the Economic Times on how open offers are flooding the Indian stock markets. Is this just another fad - always a notorious feature of the markets - or is there some meat to it?

For that, let us understand open offers first. An open offer is a part of the takeover code as defined by the Securities and Exchange Board of India (SEBI). When a company acquires a certain percentage in another listed entity, the open offer is triggered.

In the past, the announcement of open offers always saw the stock price of the acquired company shoot up. This is because there were expectations that the acquiring company will acquire stake at a premium. So investors made a beeline for the stock on hopes of cashing in on gains during that window.

The last time open offers were tempting investors was when MNC parents announced their intention to increase the stakes in their respective Indian subsidiaries. And stocks of companies such as Hindustan Unilever and GSK Pharma saw their prices rise.

The lure of open offers seems to be making the rounds once again. The Economic Times article highlighted how 94 companies have announced open offers so far this year compared to 53 the whole of last year. And unlike the MNCs above, these are essentially smaller, lesser-known companies.

What's more, while some open offers are triggered over the takeover regulations, many are voluntary. What this probably means is that promoters are looking to buy stakes in lesser known companies in an attempt to drive up the stock prices.

Therefore, investors need to be wary of such offers. First, we do not believe that one should invest in stocks based on the prospects of an open offer. These are ultimately short-term gains and do nothing to build shareholder wealth.

Second, the quality of the business has to be good. Do these smaller, lesser-known companies boast proven business models with healthy growth prospects? Are the balance sheets, cash flows, and return ratios strong? If not, investors should stay clear.

And of course, valuations can't be ignored.

If a business is bad, investing in its stock - at any price - is a bad idea, even for strong, established companies such as Hindustan Unilever and GSK Pharma. This is true even if the parent companies are buying stakes in the companies at a premium.

Fads and themes will always be a feature of the Indian stock markets, and circumstances will determine which fad dominates headlines. But prudent investors, sceptical of fads, will stick to their investment discipline.

For us at Equitymaster, the process of investing in small, lesser known companies calls for much heavier due diligence than for the better known ones. That is the reason why the Hidden Treasure and The India Letter teams meet scores of companies and travel thousands of kilometers to visit companies and meet managements in person. Without such effort, investing in any small company, at any point of time, based on any offer, is akin to putting your capital to excessive risk.

Do you invest in companies based on the prospect of open offers? Let us know your comments or share your views in the Equitymaster Club.


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03:03 Chart of the day

Demand in rural India remains far from recovery. Monsoons were 14% short on a long term average basis after a 12% shortfall witnessed last year. And to add to its woes, the rainfall deficiency has been in states that are not adequately irrigated. The penetration of irrigation facilities remains low in states such as Uttar Pradesh, Bihar, Maharashtra, Karnataka and Andhra Pradesh, making their agrarian economies dependant on the rain gods. Therefore poor rainfall in these states has impacted the Kharif crop.

Also the global meltdown in commodity prices has adversely affected realizations, pulling down farm income. Moreover, the government has not hiked wages under the government sponsored employment schemes for rural India. Therefore, rural income and demand continue to remain weak. This demand downturn has hit companies such as Hindustan Unilever, ITC, Mahindra Finance and Shriram Transport Finance. These companies derive a large part of their sales from rural India.

However, things are likely to improve in future on expectations of a better winter crop. Higher infrastructure spending outlined by the government is also likely to kick-start projects and translate into higher rural wages going ahead.

Why rural demand remains weak?
04:01

From weak monsoon, let us come to a graver problem hurting the Indian economy. And the problem that we are referring to is that of rising incidence of loan defaults by troubled, debt ridden sectors such as infrastructure and iron & steel. With banks wary of lending further to these sectors, the investment climate in the country has come to a standstill. But the advent of masala bonds is likely to break the logjam affecting the economy.

Masala bonds being offshore bonds denominated in rupee offer an added advantage of low currency risk for the issuer. Moreover, the government has also clarified on the tax incentives for masala bonds. There will be a 5% withholding tax rate on interest payable on the bonds whereas the capital gains arising in case of rupee appreciation between the date of issue and the date of redemption will be exempted.

Infrastructure firms are increasingly looking to tap cheap funds from overseas markets through masala bonds. These funds can be used by them to refinance existing loans or fund new projects. Companies such as NTPC and the JSW Group are already exploring this route to raise funds. The success of these bonds is likely to come to the rescue of infrastructure firms stuck in a debt trap and this in turn will provide the much needed leg-up to investments in the country.

4:45

Indian markets were closed today on account of Gurunanak Jayanti. As far as Asian indices are concerned, while China was up 1%, Japan and Hong Kong were trading lower.

4:55 Today's investment mantra

"Speculation is most dangerous when it looks easiest." - Warren Buffett

This edition of The 5 Minute WrapUp is authored by Radhika Pandit (Research Analyst) and Madhu Gupta (Research Analyst).

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