Who knew that the liquidity crunch which began in September 2018 would kick start one of the most sweeping clean-ups in Indian corporate history? Slowly, all cockroaches are coming out one after the other. Fraudulent business, over-leveraged or fragile, the sudden drying up of liquidity has now exposed them all. Stocks of these businesses have crashed as much as 70-80 percent in the last year and this fall has surely shaken investor confidence.
Many new investors are learning the same old lessons. Unfortunately, many are still committing the same old mistake of averaging costs when stocks are falling heavily. Some think that these stocks have fallen 80 percent from their 52-week high, and so, how much more can they fall? They do not realize that these shares could fall another 100 percent from here before they become zero in value. When you realize you are in a hole, the first thing to do is to stop digging further. So, the idea of recovering losses by averaging down the very same stocks may not be wise.
One sensible question which many individual investors are now raising is whether it’s possible to identify such fraudulent or fragile companies? If yes, what are the factors to consider?
Here, we share some key factors using which even a layman can weed out 90 percent of such fraudulent and fragile companies and minimize the chance of permanent loss of capital by filtering out such businesses while investing.
The single biggest reason for corporate bankruptcy is borrowed money. Nobody can force you into bankruptcy if you don’t owe them any money. Unnecessary capex or an ill-timed acquisition can still be managed if funded with internal accruals. However, the effect of that wrong decision gets magnified if it’s funded with debt. Look at all the troubled companies and most of them would have one thing in common – debt. This applies not only at the company level but also at the parent company and promoter levels. The recent Zee Entertainment & Dish TV fiasco is a classic example; though these companies hardly have any debt, the Essel group (promoter) is over-leveraged and has pledged its shares in Zee & Dish. The stock prices of the two companies crashed.