X

Sign up for Equitymaster's free daily newsletter, The 5 Minute WrapUp and get access to our latest Multibagger guide (2017 Edition) on picking money-making stocks.

This is an entirely free service. No payments are to be made.


Download Now Subscribe to our free daily e-letter, The 5 Minute WrapUp and get this complimentary report.
We hate spam as much as you do. Check out our Privacy Policy and Terms Of Use.
Leveraged investing: The pitfalls - Views on News from Equitymaster
 
 
  • PRINT
  • E-MAIL
  • FEEDBACK
  • A  A  A
  • Feb 9, 2004

    Leveraged investing: The pitfalls

    The current stock market rally began in April 2003 last year. However, it was post July 9, 2003, that the primary market (for equities) saw much activity. The market we are talking about here is the IPO segment (primary market). The stock, which listed on the bourses that day, was that of Maruti Udyog, India's largest passenger carmaker. After listing at almost a 50% premium to the allotment price, the stock continued to gain ground and outperform the benchmark indices by a considerable margin. Just to put things in perspective, while the BSE-Sensex has gained 58% since July 9, 2004, the Maruti stock has surged 280%!

    Company Date of
    listing
    Allotment
    Price (Rs)
    Price as
    on Feb. 5, 2004
    % Gain High/Low
    Maruti Udyog July 9, 2003 115 437 280% 454 / 156
    UCO Bank October 9, 2003 12 23 88% 26 / 17
    Indraprastha Gas December 26, 2003 48 92 91% 165 / 89
    TV Today January 16, 2004 95 138 45% 225 / 132

    Note: Maruti and TV Today are Rs 5/- face value

    The IPO market has benefited immensely from the sentiments prevailing in the secondary market, which is vindicated by the fact that a slew of IPO offerings are slated to hit the markets in the next 3-6 months. According to reports, as many as 30 offer documents are awaiting Securities and Exchange Board of India (SEBI)'s approval, which plan to raise capital to the tune of Rs 160 bn over the next 3-6 months. One big factor prompting companies to come out with IPO's has been the strong acceptance and appetite seen for the IPO offers both, from the institutional as well as the retail segments. This is also evident from the fact that all the IPO's (since mid-2003) were oversubscribed several times and are currently trading at significantly higher prices as compared to their issue price (see table above).

    In this backdrop, we conducted a poll on our website wherein we asked our readers about their source of financing for these IPO's. It was encouraging to know that over 2/3rd of those who took the poll put in personal funds to finance their IPO investments, while the percentage of those who either borrowed funds or liquidated their (current) holdings was a much lesser 18% and 13% respectively.

    While all of the above sources of investments would have some positives and negatives, the riskiest amongst these would be, but of course, financing from borrowed funds. It must be noted that in this article, we are not limiting ourselves to investing in IPO's but rather investments in equities as a whole.

    In today's times, where practically every second bank is providing loans to invest into the secondary markets and moreso, into the primary markets, it makes much sense to look at the possible pitfalls of investing through borrowed funds, also known as leveraged investing. For the advantage of the 18% readers who voted for borrowed funds and also for those who are planning to opt for this style of financing their investment needs, here is why borrowing to invest could be hazardous.

    Firstly it must be understood that leveraged investing is a high-risk proposition, especially if one fails to consider the risk-return profile. This form of investing undoubtedly increases your profits but at the same time, it significantly enlarges the quantum of losses that the investor might have to bear, just in case the markets decide to go into reverse gear. Here, if the investor has failed to assess his 'bearable' risk, then it could lead to some serious consequences.

    This is because, though the banks/institutions would have readily sanctioned the loan, in a falling market they would be forced to call for additional margins (in case of margin trading) or further collaterals, in order to make good their losses in the market value of the portfolio of the investor. If the investor fails to provide either of the above two, the probability of he losing his pledged collaterals as security is very high, which would permanently terminate all his possibilities of recouping his losses, even if the markets bounce back.

    This is one big advantage in case of the other two types of investments. Since investments (primary/secondary) are made from either personal funds (assuming that the investor is not going overboard by stretching his personal financial situation) or by liquidating current holdings, the investor has the option to hold on to his investments despite sharp movements in stocks (especially on the downside). It must be noted that volatility has been the order of the day for sometime in the case of Indian stock markets, where 150-200 points intra-day index movements has the potential of unnerving even the most savvy of investors. However, if investments are made through borrowed funds, and the markets correct, even if temporarily, the investor might have to let go off his holdings (probably at a loss).

    Thus, to conclude, while leveraging one's investments is not entirely the incorrect option, we feel it should definitely not be the favoured one. Further, before investing into equities (either through personal or borrowed funds), certain key issues like assessing one's own risk bearing profile, the investment time horizon and investing in fundamentally sound companies must be adhered to.

     

     

    Equitymaster requests your view! Post a comment on "Leveraged investing: The pitfalls". Click here!

      
     

    More Views on News

    How to Ride Alongside India's Best Fund Managers (The 5 Minute Wrapup)

    Jun 10, 2017

    Forty Indian investing gurus, as worthy of imitation as the legendary Peter Lynch, can help you get rich in the stock market.

    How To Read Your Mutual Fund Account Statement Correctly (Outside View)

    Aug 17, 2017

    PersonalFN simplifies the mutual fund account statement for you.

    This Small Cap Can Drive Chinese Players Out of India (and Make a Fortune in the Process) (The 5 Minute Wrapup)

    Aug 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.

    Which Gods Will Bring Down the US Empire? (Vivek Kaul's Diary)

    Aug 17, 2017

    Mr Trump is in the White House and the gods are in their heavens; what's not to like?

    Will They Haul Off Trump's Statue, Too? (Vivek Kaul's Diary)

    Aug 16, 2017

    All across the country, the old gods become devils. New, gluten-free gods take their places...

    More Views on News

    Most Popular

    Demonetisation Barely Made Any Difference to Tax Collections(Vivek Kaul's Diary)

    Aug 7, 2017

    The data tells us quite a different story from the one the government is trying to project.

    Proxy Plays: A Smart Way to Bet on 'Off Limits' Companies(The 5 Minute Wrapup)

    Aug 4, 2017

    The small-cap space is full of small players that are clear proxies to great growth stories and Indian megatrends.

    Should You Invest In Bharat-22 ETF? Know Here...(Outside View)

    Aug 8, 2017

    Bharat-22 is one of the most diverse ETFs offered so far by the Government. Know here if you should invest...

    Signs of Life in the India VIX(Daily Profit Hunter)

    Aug 12, 2017

    The India VIX is up 36% in the last week. Fear has gone up but is still low by historical standards.

    7 Financial Gifts For Your Sister This Raksha Bandhan(Outside View)

    Aug 7, 2017

    Raksha Bandhan signifies the brother-sister bond. Here are 7 thoughtful financial gifts for sisters...

    More
    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.

    LEGAL DISCLAIMER: Equitymaster Agora Research Private Limited (hereinafter referred as 'Equitymaster') is an independent equity research Company. Equitymaster is not an Investment Adviser. Information herein should be regarded as a resource only and should be used at one's own risk. This is not an offer to sell or solicitation to buy any securities and Equitymaster will not be liable for any losses incurred or investment(s) made or decisions taken/or not taken based on the information provided herein. Information contained herein does not constitute investment advice or a personal recommendation or take into account the particular investment objectives, financial situations, or needs of individual subscribers. Before acting on any recommendation, subscribers should consider whether it is suitable for their particular circumstances and, if necessary, seek an independent professional advice. This is not directed for access or use by anyone in a country, especially, USA or Canada, where such use or access is unlawful or which may subject Equitymaster or its affiliates to any registration or licensing requirement. All content and information is provided on an 'As Is' basis by Equitymaster. Information herein is believed to be reliable but Equitymaster does not warrant its completeness or accuracy and expressly disclaims all warranties and conditions of any kind, whether express or implied. Equitymaster may hold shares in the company/ies discussed herein. 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: info@equitymaster.com. Website: www.equitymaster.com. CIN:U74999MH2007PTC175407
     

    Become A Smarter Investor In
    Just 5 Minutes

    Multibagger Stocks Guide 2017
    Get our special report, Multibagger Stocks Guide (2017 Edition) Now!
    We will never sell or rent your email id.
    Please read our Terms

    S&P BSE SENSEX


    Aug 17, 2017 (Close)

    MARKET STATS