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Savings account? Go to the stock markets...

Jul 13, 2004

Usually, the equity markets carry a bad omen of being a gambler's haven, with high returns equally complementing high risks. This to a large extent drives away an average risk averse investor, who prefers safe returns on investments and stays away from equity markets. This article is targeted towards drawing these investors to the so-called risky stock markets. A typical risk averse investor would prefer to invest a chunk of his money in risk free government bonds, fixed deposits and other statutory investments such as PPF, etc, thereby earning sub-optimal returns. Now, how about you investing in the stock market in securities that promise the same security and at the same time super normal returns? Sounds utopian, read on...

Let us now take an example that you invest in a stock with the worst-case scenario purpose. The fact that you invest in the stock is proof enough that you believe the stock prices to move further up with positive growth indicators for the industry in general and the company in particular.

Now, suppose you had purchased shares of Gas Authority of India (GAIL) at Rs 75 as on 31st March 2003. At this price, as a risk averse investor, your primary concern is the safety of your investment. Therefore, let us now analyze the main aspects, viz., the worst-case scenario and as to how much do you stand to lose if the company goes into liquidation.

If the company goes into liquidation, it would have to pay off its creditors who have a first right on the fixed assets as a collateral (security) and then to the preference shareholders following which the residual amount shall be paid off to the equity shareholders. It is therefore important to calculate this residual amount that shall be paid to you. Let us have a snapshot of the main contents of the balance sheet of the company:

Assets Liabilities
(Rs m)FY03(Rs m)FY03
Current assets46,437 Current Liabilities19,933
Investments6,879 Prov.7,828
Fixed assets69,502 Total Debt20,471
Total122,818 Total48,232

From the above table, it is clear that the company would be left with around Rs 74.6 bn after paying off all the debts including current liabilities and provisions. Now the total market cap at Rs 75 per share stands at Rs 63.4 bn as on 31st March 2003. The difference between the amount that the company has been left with and the market cap is a healthy Rs 11.2 bn.

At a residual balance of Rs 74.6 bn (excluding reserves), the price that shall be paid back to the investor would be approximately Rs 88 per share. Remember, the amount you had invested was only Rs 75. The above example may be a rare scenario where your money enjoys safety and gives you decent returns. So could we say that you missed the bus!!! Well not necessarily, as there is always next time in the stock markets.

CompaniesP/BV (x)RONW (%) (FY05E)
Escorts0.5 7.5%
Indo-Gulf Fert.0.8 15.1%
VSNL0.8 6.1%
MTNL0.9 7.4%
Essel Propack0.9 11.4%
Tata Power1.0 9.9%
NIIT1.0 2.3%
Kochi Refineries1.2 21.6%
Indian Rayon1.2 12.5%
Arvind Mills1.2 12.5%
HPCL1.3 17.7%
* From our research-reports

The below mentioned chart gives you a perspective as to how much you would have made had you invested Rs 100 in GAIL as against the amount invested in the BSE Sensex as on 31st March 2003.

The main idea is not to spell out the stocks with such rare opportunities but to highlight the fact that investors need to study the target company first with the main focus being on the how much do you stand to lose in the event of the company shutting shop. Many investors invest based on so-called hot tips but what makes an investor reap rich benefits are the fundamentals of the company.

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