Markets are constantly rising day by day, in anticipation of so many things in India and across the globe, you must have been bombarded with many brokers and TV channels with so many recommendations of stocks to invest with fancy targets.
I have seen many young investors are making a very basic mistake of investing in penny stocks
- Without even knowing their business type and revenue they generate over time,
- They simply go by the stock price movement, few people will invest when the stock price is crashed to very low levels, hoping it comes back to old higher levels soon,
- And a few others will invest when the stock price is zooming high hoping it will grow further high.
Choosing stocks to invest should never be on such stock price movement, you may succeed few times, but will fail most of the time.
Ticking Time Bombs!!
There are many indicators that will show up the poor quality of earnings, high Debt, corporate governance problems etc etc..
Based on some of the famous case studies, I have listed a few “Failed companies ” with the following problems.
- Some are reluctant to review changes required.
- No Innovation; No improvement in Quality of products over time;
- Failed to adapt to market volatility.
- Their market share crashed by new and more innovative companies.
- High Debt companies
- Companies often take Loan to expand their business, however, when they fail to generate profits, it will lead to big losses on account of repayment of interest costs and Principle.
- Companies Debt should be within limits, in other words, Debt to Equity ratio must not exceed 2
- Hindustan Motors: Maker of the famous Model Ambassador those days.HM was a monopoly car maker in India and was having more than 70% market share for almost 30 years around 1970 to 2000 period. But when Maruti entered Market, Hindusthan Motors realized the importance of changes. they never bothered to change their models, It failed to keep their Brand live, their revenues were constantly dropping from Rs. 1250Cr in 1990 to almost Rs. 200Cr in 2014. in 2014 they finally stopped making Ambasidor Brand cars.
- Hindustan Machine Tools (HMT): HMT started in the 1970s along with a Japanese partner Citizen watches. HMT had very good technology and produced the best quality watches. it was having a huge market share of over 90% . But when it lacked style and variety in its watches.
- Then entered Titan from the Tata Group, it took over the watch market from HMT.
- Titan offered a variety of models and styles which HMT was lacking earlier.
- HMT realized that watches were not only meant for just keeping the time but also has become a stylish ornament.
- KINGFISHER AIRLINES: Kingfisher had been a loss-making company from the beginning since 2006. Yet the company took on more debt, taking its debt-to-equity ratio to over two. As losses mounted, debt kept on accumulating. The business couldn’t be revived. Their promotors kept on waiting for good times which have never happened, instead of changing the business strategy or they never even attempted to do so. I have seen many people buying this stock even after it’s declared bankrupt seeing the low price, which is very bad.
- SATYAM: Satyam’s promoter and CEO, B Ramalinga Raju, was convicted for accounting fraud. Under him, the company inflated its revenues and profits through fake invoices. It also faked its cash reserves by inflating them by around `Rs. 5000Cr. The news of the scam broke in January 2009. One forewarning was that Raju had been constantly selling his stake in the company. He held a 22% stake in Satyam in 2002. He brought this down to just 2% in December 2008.
- VIDEOCON INDUSTRIES: Videocon was mainly into consumer electronics and
then it diversified into highly unrelated businesses like power and oil etc.. The management says it wants to be an oil and energy company in the coming
times. To fulfill this ambition, the company has also raised huge debt of around Rs. 50,000Cr. But then the company defaulted on its loan due to a slump in the oil sector.
- Many more in this list like NOKIA Mobile business, MTNL, KINETIC MOTOR etc. are very good examples.
In general, avoid companies which are highly exposed to Debt and are failing to generate profits to cover at least to pay their EMIs ( Interest and Principle) and companies with poor Management.
You may like to read How to earn Rs. 1 Cr by investing just Rs. 1300 Per Month?
Learn How not to invest in stocks with these bad qualities.
While it is very easy to point out the failed companies when analyzing the present companies it may be a difficult task to find failures in stock which are live in your portfolio.
- Avoid companies which are not changing with time:
- Most of the companies who failed earlier were mainly due to no introduction of new products
- Could not make the required improvements to suit the newer Generation.
- Their Sales & profits were declining quarter on quarter, but they could not make any effort to set them right with the latest technologies.
- Their balance sheet will indicate failures much earlier, In spite of having required facilities, if a company did not incur any large expansion cost for very long time, there could be a possibility of a big failure in the expansion.
- Lack of Quality management & Promotors.
- Consider Eicher Motors, the maker Royal Enfield Bike
- Eicher has kept its Royal Enfield brand live with the introduction of so many models, variants, and many good features to suit the young generation, in spite of having higher market share in that segment.
- Look for Companies with creative Ideas
- Consider watchmaking company Titan, Their main line of business was watchmaking. it overtook market share of HMT much earlier.
- It has also sensed that watch segment may mature in early 2000 and hence it started addressing the jewelry market by its brand “Tanishq”
- It didn’t end there, later it started youth attractive brand Fasttrack! in early 2000 and made huge money, being a monopoly in the segment.
- It is now testing a sarees business.
- Such innovative companies will sustain in the market.
- Consider Eicher Motors, the maker Royal Enfield Bike
Few companies you should never choose to Invest
- Hindustan Construction Company: HCC operates in the engineering and construction Field. when the market was booming and prospects were high in the future, the company has taken huge debt for its projects. But business losses and delays in some of its major projects hit its revenues and profits. It has been a loss-making company for a long time. Even before the 2008 crisis, when business sentiment was quite bullish, the company had a poor return on its investment. Presently Debt to Equity ratio is around 9( very high) and Return on investment is around – 23%- A Big No
- RELIANCE COMMUNICATIONS: Reliance Communication, an Anil Dhirubhai Ambani group company, is the latest entrant to the loan defaulters’ club.
Its debt-to-equity ratio, which is below 1.5, doesn’t look too bad. But its Returns on capital, which is around 4% in the past five years, is too low to service debt for a long time. The business has taken a hit due to the heavy competition in the telecom sector and due to Reliance Jio- Stay away from such companies.
- SUZLON ENERGY: Suzlon Energy is in the business of wind-power generation and it also manufactures and installs equipment for that. Suzlon was ahead of its time. Looking at the bright future for renewable energy, the company aggressively acquired many companies abroad. It raised debt in the process. But the acquisitions did not work. Suzlon’s debt has soared year on year, Its return on capital has largely remained negative or insufficient to cover debt repayments. You must be vigilant about companies Debt over Equity always.
Conclusion: These are some of the basic parameters to look when choosing stocks to invest. One must always have a check on basic parameters from time to time.
Always remember Thumb Rules in Investing Equity stocks and Mutual funds
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