Is investing in PSUs risky? - The 5 Minute WrapUp by Equitymaster
Investing in India - 5 Minute WrapUp by Equitymaster

Is investing in PSUs risky? 

A  A  A
In this issue:
» Time for revision in insurance cover for bank deposits?
» Do not ignore subsidiaries of the parent company
» Will the Walmart controversy affect FDI in retail?
» Hasn't the FM seen how disastrous big banks can be?
» ...and more!

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Typically, researching a prospective stock involves some important steps such as studying the company's business model, industry prospects, financial performance and valuations. But all your hard work could go waste if you ignored the people who run the business. Some very important questions that an investor must be able to answer are these- Is the management of the company focussed on maximizing shareholder returns? Does the promoter care about the interests of minority shareholders? If the answer to this is not positive, then you could be riding an ostrich. You never know when you'll be thrown off.

This brings us to the topic under discussion today. A leading financial daily reports that Finance Minister Mr P Chidambaram has urged CEOs of public sector banks to not be fixated with high margins but rather cut down interest rates to attract borrowers. The FM is said to have stated, "An NIM of 3% is good for the economy. When a businessman is borrowing, he always looks at the rate of interest to decide on the viability of the project."

Of course, Mr Chidambaram's suggestions haven't really pleased bankers. Whether they go ahead with the interest rate cut remains to be seen. But that's not the point. Let's think about the FM's remarks in the context of the questions that we posed at the beginning. Does the FM, as a representative promoter of public sector banks, inspire confidence in minority shareholders? We don't think so.

The government in its role as a promoter is not solely focussed on maximizing shareholder returns. Given its larger role in the economy, it has to cater to the needs of the various stakeholders in the economy. This creates a direct conflict of interest. As such, the government will always aim at doing what is 'good for the economy'. And this may not always bode well for shareholders.

This makes investing in PSUs inherently risky. A sudden diktat from the government can put all your estimates and valuations for a toss. Very recently, the FM had warned several PSUs to either stick to their investment targets, or be prepared to pay off the excess cash on their balance sheets as special dividends. Following this, several PSUs announced their investment plans. The list of such instances is long. It just goes on to show that PSUs have to often give up their best economic interests and succumb to government pressures.

In your view, are PSUs successful at protecting the interests of minority shareholders? Share your comments with us or post your views on our Facebook page / Google+ page

01:25  Chart of the day
In India, there are different layers of safety net for protecting depositor's interest and constantly reinforcing their trust and confidence in the banking system. The deposits of investors are insured by Deposit Insurance and Credit Guarantee Corporation (DICGC), the second oldest deposit insurer of the world, quietly taking care of the interest of depositors, particularly small depositors. It is a wholly owned subsidiary of the Reserve Bank of India (RBI). Data suggests that as of September 2011, bank deposits worth Rs 38 trillion which account for about 67% of the total deposits do not have cover from the DICGC. Today's chart of the day shows the percentage of the total deposits that are insured by the various bank groups. Bank depositors enjoy insurance cover on deposits up to Rs 1 lakh. This means that if a bank goes bust, each account will still recover up to Rs 1 lakh from the Corporation. What is the reason for the falling insurance cover? The answer is increasing proportion of high value deposits. Does this call for a revision in the insurance cover? It must be noted that the insurance limit of Rs 1 lakh was set back in 1993. If we take the high inflation into account, which has averaged about 6.5% during the period, Rs 1 lakh deposit then would equal Rs 3.3 lakh at current price levels.

Data source: The Hindu Business Line
*As of September 2011

What do you think is the major difference between some of the conventional jobs and investing? We believe it has to do with the level of activity. In conventional jobs, the more active you are and greater the number of projects you are working on, the higher perhaps would be your income. However, investment professionals don't get paid for being active. They get paid for being right. Thus, it makes little sense for them to break their head trying to analyse a company that has a large number of subsidiaries or a complex business model.

They would be better off analysing large number of simple businesses that are easy to understand and evaluate. After all, who would want to spend hours and hours poring over financial numbers? And then finding at the end of it all that the holding company they are evaluating has several loss making subsidiaries and not worth investing into. For a successful consolidated entity is not the one where only standalone numbers look good. All its subsidiaries too should possess good economics. Otherwise the subsidiaries could end up eroding the overall performance. And give analysts one more reason to ignore the company.

FDI in retail continues to remain a touchy topic. Just when the government is battling fierce opposition from political parties, the Walmart issue could add fuel to the fire. In the latest such development, the Indian joint venture of Wal-Mart Stores has suspended its chief financial officer and other employees. This is as it investigates alleged violations of US anti-bribery laws.

Walmart has been at the focus of investigations into bribery not just in India but also in Brazil and China. As a result, its operations in India will most likely slow down till such time the investigation is completed. It is too soon to say that this is reason enough why FDI in retail will fail in the country. Indeed, if the allegations are true, it only points to a much deeper malaise. And that is namely corruption that has been at the root of India's many problems for quite some time now.

The debate for consolidation in Indian banks has gone on for a while now. And the same was revived at a recent conference with the Finance Minister stating that consolidation in the sector was inevitable. Naturally, Mr. Chidambaram is pro-consolidation. The FM believes that India requires two or three world-sized banks and that the same must be done if the country wants to be the third largest economy by 2017. The FM did however state that these banks would be required to be different from each other - as opposed to being clones - and assured that the government would not try to impose uniformity.

Taking a broader perspective, we cannot help but be concerned about a probable outcome of this idea. That is of the Indian banks gradually becoming 'too big to fail' - a term that describes how failure of large financial institutions being widely held to be disastrous to an economy, leading to no option but to be supported by the government in times of difficulties. As you would know, it was such banks and financial institutions of the US that have been blamed for the financial crisis. As JP Morgan's CEO recently stated, these financial behemoths literally brought the country down to its knees. And, in the process, walked away with millions of dollars at the end of it!

In Hong Kong, an interesting trend has been noticed. The trend is not just economic in nature but is likely to impact long term demographic patterns. As per a recent industry report, the declining housing affordability in the wake of slow economic growth and rising real estate prices in Hong Kong could be the reason for a reverse baby boom. The city is witnessing over 5% YoY decline in the birth rates. Quite an unusual trend when the marriages are up by around 5% YoY.

Generally, a high population growth is believed to be a precursor to increase in house prices. But a slowdown in the Hong Kong economy coupled with stubborn house price seems to be driving things the other way round. Housing being one of the prime components of cost determines the standard of living and has a major influence on social attitudes. While people are struggling with housing affordability, they seem to be in no mood to compromise on the quality of life and appear to be dealing with it by limiting the family size.

In the meanwhile, Indian equity markets are trading above the dotted line. At the time of writing, the benchmark BSE-Sensex was up by 41 points (0.2%). Consumer Durable and Metal stocks were trading strong while Banking stocks were trading weak. Asian stock markets were trading mixed with Taiwan and Singapore trading firm, while markets in China and Malaysia were trading in the red.

04:50  Today's Investing Mantra
"Fortunately, the investment business is one where knowledge accumulates and builds into a knowledge base that's useful. There's a lot to absorb over time." - Warren Buffett

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    Equitymaster requests your view! Post a comment on "Is investing in PSUs risky?". Click here!

    6 Responses to "Is investing in PSUs risky?"

    meenakshi pai

    Nov 28, 2012

    I cannot agree more than as has been stated,totally endorse that any moment any as per whims & fancy of Minister or Government PSU heads will be forced to succumb and our experience says Government is bothered only about their problem not people-problems,definite NO to such Ostrich Rides.Present Finance Minister is more worried about Stock-market than real development plans for progress of nation.
    I sometime get amused the way FM comments as if spokesperson of Corporate India,poor PSU people got no option than to listen to Govt,any scam they are the scapegoats,Ministers will be no where.We the people are ultimate sufferers will continue to do so.



    Nov 28, 2012

    Yes, I think investing in PSUs is not just risky,but dangerous.



    Nov 27, 2012

    yes, it is very risky in investing in PSU. The present government spoiling the PSUs in all possible manner. And it is nothing wrong to call the FM as Tuglak. There is no growth in PSUs. I have a lot of investment in Public sectors, duly waiting how to get out. Lost confidence.



    Nov 27, 2012

    I have a golden rule when it comes to investing --- stay the hell away from PSU stocks ---- Personally I have experienced enough suffering from investing in PSU stocks to evolve the rule and NOTHING will change my rule..Take stocks like BHEL, HindZInc, SBI and other PSU Banks, the biggest example of the scam the Govt.plays in the stock market is the Oil PSU's..How much value Govt. has destroyed of small investors.. The size of Govt. scam on small investors in the stock market due to value destroying decisions imposed on these companies will exceed in value all the market scams ever happened in stock market.

    Like (1)

    ajit potnis

    Nov 26, 2012

    I think ministers r behaving like specialist doctors in a poly clinic, each one just worried about his part of the problem. The govt is heading towards multiple organ failure (if not already there). FM worried about deficit, PM worried about growth rate and both pushing reluctant ministries who dont want do anything which would reduce their positions of power. Meanwhile the patient, the nation, can go to hell, and it will sooner than later

    Like (1)

    R Verma

    Nov 26, 2012

    It is indeed risky -as has been explained in very lucid terms in the "wrap up". As a share-holder of ONGC I have learnt this the hard way. The Government decides the subsidy which ONGC has to pay to the Oil Marketing Companies and it is this which determines the dividend and, therefore, the price of the ONGC shares. Minority share-holders have no say in the amount of the subsidy!

    Like (1)
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