Investment tip: Stocks which are one of a kind are risky
Shares of companies which are the only ones in their sectors to be
listed often get a good response from investors. One reason for this is
scarcity. That is why most such stocks clock huge listing gains, though a
few fizzle out after some time.
Uniqueness is much sought-after in today's competitive world. But does this apply to investments as well?
Shares of companies which are the only ones in their sectors to be listed often get a good response from investors. One reason for this is scarcity. That is why most such stocks clock huge listing gains, though a few fizzle out after some time.
However, the complexity of valuing such companies makes it more likely that you might end up buying a wrong stock .
IMPORTED VALUATION
Valuation is difficult due to absence of listed peers and track record. So, analysts value such companies by comparing them with similar companies listed abroad.
"If there is no other listed stock from the sector, you have to look at similar companies listed abroad. Take the case of MCX. The only listed Indian exchange was valued in line with commodity exchanges listed abroad," says Gaurav Dua, head of research at brokerage Sharekhan.
One way to do this is comparing price-to-earning, or PE, ratios. Consider this: In early March, MCX launched an initial public offer, or IPO, which got a good response. The exchange was valued at 15-18 times 2011-12 earnings. On the basis of this, the IPO price band was fixed at Rs 860-1,032. The company got a premium of 18 times earnings at the upper limit of the band, that is, Rs 1,032. Listed international exchanges such as CME, ICE, CBOE, Nasdaq and OMX were trading at 16-17 times 2011-12 earnings when the valuation was done.
PE ratio measures the price paid for a stock relative to its earning per share. It shows how much investors are willing to pay per rupee of earning. A PE of 20 means investors are willing to pay Rs 20 for Re 1 current earning.
BEING SINGLE MATTERS
It is assumed that many people will want to have unique stocks in their investment basket because of lack of any listed competitor. The number of unlisted players in such sectors, too, is usually small.
"There is some scarcity premium attached with such stocks," says Dua of Sharekhan.
This is because those wanting to invest in the sector to which the company belongs will have no choice but to buy its stock.
For example, MCX is the only listed commodity exchange in India. If someone wants to take exposure to a commodity exchange in India, he will have no option but to buy MCX shares.
However, industry experts are divided on whether solo stocks make good investment sense.
"I don't think uniqueness per se matters to institutional investors. Businesses with premium valuations are those that have superior profitability. I can think of a number of unique companies which do not command premium valuations because their delivery of numbers is sub-par," says Saurabh Mukherjea, head of equities, Ambit Capital.
"If prospects of the company with no listed peer are good, it can give good returns, but such stocks are more risky. If you buy a wrong company, you will suffer heavy losses," says Sandeep Singhal, co-head of institutional equities at Emkay Global Financial Services.
Other than the valuation-which is done on the basis of companies listed abroad-the basic parameters of stock selection such as profitability, corporate governance and growth potential will apply to unique stocks as much as they will to other stocks.
TO PICK OR NOT TO PICK
In view of the hype, one should be careful in stock selection. "Whatever you watch in a normal stock, you have to watch here. It is about earnings, growth, cash generation, corporate governance, efficient use of resources, etc," says Dua of Sharekhan.
Hype ensures that such stocks give good returns on the listing day but in the long run a company's efforts to maintain profitability rules.
Experts say while institutional interest does play a role in a stock's performance, one should see that the number of institutions that have invested in the company is large.
If this is not the case, the stock will fall sharply if any institution sells out, says Singhal of Emkay.
"Incidentally, IPOs of many solo companies were valued cheaply. Many also attracted anchor investors. After listing, one or two influential investors lapped up the remaining shares and so volumes were thin," says Singhal.
CONTRASTING FORTUNES
Let's look at some unique companies that have hogged the limelight in the recent past. Two of the most well-known, Jubilant Foodworks and SKS Microfinance, have given contrasting returns.
Jubilant, which runs the Domino's pizza chain in India, was listed in February 2010. It launched its IPO in the price band of Rs 135-145. The stock is trading around Rs 1,170, which implies an absolute return of eight times in two years.
"Jubilant worked because of growth. Plus it's a high-margin business," says Singhal of Emkay Global.
On the flip side, investors in SKS Microfinance lost most of their capital. The IPO of India's only listed microfinance company got a great response. The shares were issued at the upper end of price band of Rs 850-985. The stock was listed in mid-August 2010 and rose 17 per cent on the first day itself. The company lends to the poor in rural areas and was viewed as a promising investment.
However, a few months later, it faced a crisis due to loose regulatory environment in which entry into the business was easy. Then, the whole industry was hit when Andhra Pradesh, which accounted for a huge chunk of microfinance loans, clamped down after a spate of suicides by borrowers.
The state government passed a law that restricted lending and recovery by microfinance institutions. This encouraged farmers to default, following which recovery of loans came to a trickle. SKS, whose business was concentrated in the state, had to write off huge debts. The stock was around Rs 56 on 6 June, almost 94 per cent down from the IPO price.
"It depends from case to case. The microfinance story looked promising but changes in the regulatory environment caused a crisis," says Singhal.
Shares of companies which are the only ones in their sectors to be listed often get a good response from investors. One reason for this is scarcity. That is why most such stocks clock huge listing gains, though a few fizzle out after some time.
However, the complexity of valuing such companies makes it more likely that you might end up buying a wrong stock .
IMPORTED VALUATION
Valuation is difficult due to absence of listed peers and track record. So, analysts value such companies by comparing them with similar companies listed abroad.
"If there is no other listed stock from the sector, you have to look at similar companies listed abroad. Take the case of MCX. The only listed Indian exchange was valued in line with commodity exchanges listed abroad," says Gaurav Dua, head of research at brokerage Sharekhan.
One way to do this is comparing price-to-earning, or PE, ratios. Consider this: In early March, MCX launched an initial public offer, or IPO, which got a good response. The exchange was valued at 15-18 times 2011-12 earnings. On the basis of this, the IPO price band was fixed at Rs 860-1,032. The company got a premium of 18 times earnings at the upper limit of the band, that is, Rs 1,032. Listed international exchanges such as CME, ICE, CBOE, Nasdaq and OMX were trading at 16-17 times 2011-12 earnings when the valuation was done.
PE ratio measures the price paid for a stock relative to its earning per share. It shows how much investors are willing to pay per rupee of earning. A PE of 20 means investors are willing to pay Rs 20 for Re 1 current earning.
BEING SINGLE MATTERS
It is assumed that many people will want to have unique stocks in their investment basket because of lack of any listed competitor. The number of unlisted players in such sectors, too, is usually small.
"There is some scarcity premium attached with such stocks," says Dua of Sharekhan.
This is because those wanting to invest in the sector to which the company belongs will have no choice but to buy its stock.
If there is no other listed stock from the sector, you have to look at similar companies listed abroad for valuation.
Gaurav Dua
Head of Research, Sharekhan
However, industry experts are divided on whether solo stocks make good investment sense.
"I don't think uniqueness per se matters to institutional investors. Businesses with premium valuations are those that have superior profitability. I can think of a number of unique companies which do not command premium valuations because their delivery of numbers is sub-par," says Saurabh Mukherjea, head of equities, Ambit Capital.
"If prospects of the company with no listed peer are good, it can give good returns, but such stocks are more risky. If you buy a wrong company, you will suffer heavy losses," says Sandeep Singhal, co-head of institutional equities at Emkay Global Financial Services.
Other than the valuation-which is done on the basis of companies listed abroad-the basic parameters of stock selection such as profitability, corporate governance and growth potential will apply to unique stocks as much as they will to other stocks.
TO PICK OR NOT TO PICK
In view of the hype, one should be careful in stock selection. "Whatever you watch in a normal stock, you have to watch here. It is about earnings, growth, cash generation, corporate governance, efficient use of resources, etc," says Dua of Sharekhan.
Hype ensures that such stocks give good returns on the listing day but in the long run a company's efforts to maintain profitability rules.
Experts say while institutional interest does play a role in a stock's performance, one should see that the number of institutions that have invested in the company is large.
If this is not the case, the stock will fall sharply if any institution sells out, says Singhal of Emkay.
"Incidentally, IPOs of many solo companies were valued cheaply. Many also attracted anchor investors. After listing, one or two influential investors lapped up the remaining shares and so volumes were thin," says Singhal.
CONTRASTING FORTUNES
Let's look at some unique companies that have hogged the limelight in the recent past. Two of the most well-known, Jubilant Foodworks and SKS Microfinance, have given contrasting returns.
Jubilant, which runs the Domino's pizza chain in India, was listed in February 2010. It launched its IPO in the price band of Rs 135-145. The stock is trading around Rs 1,170, which implies an absolute return of eight times in two years.
"Jubilant worked because of growth. Plus it's a high-margin business," says Singhal of Emkay Global.
If prospects of the company with no listed peer are good, it can give good returns, but such stocks are more risky.
Sandeep Singhal
Co-head, Institutional Equities, Emkay Global Financial
However, a few months later, it faced a crisis due to loose regulatory environment in which entry into the business was easy. Then, the whole industry was hit when Andhra Pradesh, which accounted for a huge chunk of microfinance loans, clamped down after a spate of suicides by borrowers.
The state government passed a law that restricted lending and recovery by microfinance institutions. This encouraged farmers to default, following which recovery of loans came to a trickle. SKS, whose business was concentrated in the state, had to write off huge debts. The stock was around Rs 56 on 6 June, almost 94 per cent down from the IPO price.
"It depends from case to case. The microfinance story looked promising but changes in the regulatory environment caused a crisis," says Singhal.
