NEW DEHI: Hunting value bets among penny stocks is not everyone’s cup of tea. Ones who have done it and made money also learnt hard lessons – stuff that makes one a seasoned hand in the market place.
Ashish Chugh has over time come to be known as a leading penny stock picker in India. This Delhi-based trader has burnt his fingers many a time, but the few bets on which he got it right have made him more money than what he lost in half-a-dozen others.
“It is easy to buy such stocks. But you would have problems exiting them,” Chugh told an audience at a market conclave in Delhi over the weekend. The wisdom he shared reflected his personal experience in treading the minefield that penny stocks are.
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Hunting ‘multibaggers’ is almost an obsession among new generation Indian stock traders, majority of whom have entered the market after recent gains made Dalal Street stand out globally and projections for world-beating growth in the economy have raised hopes of quick wealth creation in stocks, drawing in a generation desperate for quick riches.
Patience is very important, insists Chugh, Director at the Delhi-based Hidden Gems Advisory.
While smallcap and microcap stocks lure retail investors, it’s not a safe place for them, he adds. “Investing in microcaps is very risky. If you dare to go out there and take some risk, make sure you chase growth.”
Growth vs value
Earnings growth is the common factor among the microcap and smallcap stocks that have turned out to be multibaggers. “Value remains value unless there is growth. Look for stocks where there is potential for growth,” said the market veteran.
Growth stocks often come at higher prices.
Growth itself can have layers, as there could be a huge variance between potential and actual growth. “A company with potential to grow but where actual growth has not come could prove a goldmine. Chances are, it is facing temporary setbacks, in which case you might get the stock at a reasonable valuation, thanks to the uncertainty surrounding the business,” says Chugh.
Where are these stocks?
Currently, the Indian market is crowded with stocks that show value but are down in the dumps because of massive debt loads accumulated over time, company-specific issues and sectoral headwinds – both external and internal.
Short-term negatives are an opportunity, says Chugh. Stocks and sectors that have fallen out of favour with investors because of temporary setbacks often end up delivering big gains to investors who stay put through the bad patch.
Chugh, who took to investing seriously in the early 1990s, says he looks for stocks with ‘curable’ negatives. “Make sure, you get this bit right. It is possible that you may believe a certain negative to be curable, but it ends up becoming a permanent damage. One has to keep tracking such stocks carefully,” he said.
The market veteran chuckles at the opportunity that the Indian market presents currently. There are stocks where enterprise values have fallen to equal 2-3 years of cash flow from the business, he exclaims!
How to identify price multipliers
Successful investors know how to distinguish between a company doing ordinary work and the one investing on future.
A quality company reporting good numbers and having healthy financial ratios and good management may still find its stock stuck in a trading range. Indian company managements, most of which are family promoted, are often not very forthcoming, which causes their stocks to trade below par.
When promoters are not interested in talking to analysts or investors, a stock may be evading radars of brokers and investors. When a company doing extraordinary work grows and reaches a certain size, the price multiple gets rerated. Then it sees multiplier effect. That’s the time when the company gets talked about and big money flows in. If you manage to spot that business before it begins to buzz, wealth is all yours, says Chugh.
Special situations such as merger, demerger and share buyback can also throw up opportunity to make big money. Institutional investors, focused on a core business or following thematic allocation, often do not show much interest in demerged entities, leaving them quoting at battered valuations.
Chugh recalls the Marico demerger. Most institutional investors were interested only in the FMCG business, which was the core. When Kaya was delisted, Marico’s m-cap was Rs 7,000-8,000 crore and Marico Kaya’s about Rs 200-250 crore at listing. An investor holding 4-5 per cent in Marico Kaya as part of Marico’s Rs 200-300 crore business may not be interested in a tick size of Rs 2-3 crore. Marico Kaya Enterprises was later merged with Kaya, another group demerged entity.
On Monday morning, Kaya had a market-cap of Rs 1,159 crore, a six-fold expansion. Marico, on the other hand, saw its market-cap swell five times to Rs 40,000 crore.
Most institutional investors also ignored Arvind Infra (Arvind SmartSpaces) when it got demerged from Arvind. It now has a market-cap of Rs 400-odd crore.
How you judge management quality
Good management is a key criteria for all kinds of stock investment, be it penny stocks or largecaps. India’s IT bellwether Infosys recently took a major tumble over management transparency issues even when there was a share buyback offer at a 20 per cent premium.
Chugh says while management quality is key, it is a subject often not easily understood. In most cases, the quality of the management is nothing more than a perception, which changes as stock prices move up, he says.
When a stock quotes at Rs 20 with PE multiples of 4 or 5, one tends to believe there is some problem with the management. Once a big investor enters the stock at Rs 200, the management issues go away from the mind of investors.
“What I would look for is well-managed businesses, where there has not been much equity dilution by the management over time, where growth is coming through internal accruals and sales and profitability are rising over the years,” Chugh said.