Friday, July 10, 2015

How to Find Great Companies and IPOs to Invest Into?

Chinese market has risen for a second day today, strengthening the rebound that followed Chinese government’s extraordinary interventions. And Greece has formally submitted its next bailout request to Europe within the deadline, signalling that global cues are turning green once again. However, so far, Indian market has failed to follow suit, probably due to its already overbought situation from recent weeks. Stocks of highly-leveraged or low-growth Indian companies have taken a beating. At the same time, stocks of better performing Indian companies have resisted the pressure to fall significantly. India is also all set to enter a major round of initial public offers, after a long time, with around 30 IPOs getting readied to be launched. The days of easy money are over in India, and the relevant question once again has become how to find great companies and IPOs to invest into.

Indian market is once again at crossroads. While the euphoria driven by a new majority government led by Narendra Modi is getting over, adding to the woes are the not so rosy situations emerging from China, Europe, and the imminent US tightening of interest rates.

However, on the upside has come a better than expected monsoon, and the falling Chinese stock market, which is correcting from a steep 100%+ rally within a year. Huge institutional money coming out from China has to find a safe place to hide, and India’s 20 P/E market is a lot safer than China’s overheated 60+ P/E world.

India fully can’t accommodate the Chinese market outflow as there is still no comparison between the sizes of the two markets. However, India is likely to accommodate a bit more than earlier due to a peculiar development.

Many large-sized unlisted Indian companies are readying their IPOs, sensing this opportunity. Examples include IndiGo, Café Coffee Day Holdings, DTDC, RBL Bank, GVK Airport Developers, Syngene, Catholic Syrian Bank etc. Some estimates put the number of major upcoming IPOs at over 30.

Add to this the government disinvestment program, which has been lagging its targets, and the Chinese outbound money could find space to park in the emerging world itself.

While screening the IPOs, retail investors could do themselves a favour by going beyond the usual headline ratings given out by the rating agencies. Needless to say, most of these IPOs will be offered at the maximum-possible valuations, if not the sky-high type.

The quality of the sales and earnings growth remain the most crucial metrics to watch out for. The multiples at which the public offer will be coming will obviously be pegged to these crucial growth numbers.

But it is often seen that unlisted companies go for their IPOs at the height of their growth and the resultant buzz, but often starts underperforming by way of earnings growth soon after the IPO and listing.

Even if this is not the case, retail investors could do well to remember that most companies would eventually fail to grow at their best pace, sooner or later. What then shields the investor from massive loss on investments?

Only one metric can shield the investors in such a scenario, and that remains the company’s dividend policy. There are numerous examples in the Indian market, where the company is not growing anymore at its historical best rate any more, but is compensating for it by continuing generous dividends.

There is a public sector bank that has been challenged like all its peers due to the NPA crisis. It is not growing its earnings as fast as it once used to grow, but it is still a profit-making bank. For an investor who had invested Rs. 1 lakh in this bank in 2002, it recently gave an annual dividend of Rs. 48,000 for FY’15. Not bad, right? Welcome to Union Bank of India. That was dividends alone, while the investment of 1 lakh has become 12 lakhs now.

Another bank, this one from the private sector, is not a so-called new generation bank or a large private bank. Like all its peers, it is also facing increased competition, and therefore reduced growth rates than earlier. But it is still profit making, and for an investor who had invested Rs. 1 lakh in it in 2000, it recently gave an annual dividend of Rs. 80,000 for FY‘15. Pretty good, right? Welcome to South Indian Bank. That was again dividends alone, while the investment of 1 lakh has become 22 lakhs now.

Another one, this one from the NBFC sector, used to grow at a blistering fast rate sometime back. But ever since some regulatory controls came in to force in its sector, it is growing at only a much slower clip. But it is still profit-making, and for an investor who had invested Rs. 1 lakh in it in 2005, it gave out Rs. 3.68 lakhs as annual dividend for FY‘15. Mind blowing, you would agree. That is Manappuram Finance for you. Again, that is dividends alone, while the investment of 1 lakh has become 80 lakhs now.

Of course, for such magic to happen, entering a company while it is still young is also important.

IPOs provide that opportunity to enter into a company when it is relatively young. Any possible deep correction after an IPO provide the opportunity to enter into a relatively young company at a more safer level.

But the thing to look out for is really the company’s dividend policy. Whether the company is willing to share real cash - your rightful share of the profits - with you on a regular basis.

In fact, some of the best multibaggers in recent years like Page Industries were identified by discerning investors from their dividend policy. When it became clear that the Jockey maker has implemented a policy of giving out 30-to-60 percentage of its profits as dividends, with the rest going in for expanding the business, the stock just rallied like crazy, and still goes up to crazier valuations. Of course, matching the dividend policy is one of the best CAGR growth rates in both sales and profits.

Coal India is another company that is starting to surprise the markets with its dividend yield that stands at a high 7% at current stock prices. At its IPO price of Rs. 287.75, Coal India’s dividend yield stands at a robust 10.07% that beats fixed-income instruments, and at its all-time post-IPO low of Rs. 238.35, the dividend yield stands at a surprisingly high 12.17%.

SEBI is planning to enforce a dividend policy for all listed companies, that will force each company to pay out at least a fixed percentage of its profits as dividends, but until that comes, you are on your own to pick dividend paying companies and shun non-dividend payers.

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