A few cinemas put off the air conditions just about 20-30 minutes before the climax of the movie starts, to save on the cost and improve the return on capital employed. Unfortunately, a very few viewers realize this as most get engrossed in anticipating the climax.
The domestic market in the last few weeks gave us a few good lessons to learn. A consumer product stock price fell about 37% in a matter of just 5 trading days. A highly leveraged midcap company could crash 38% within 9 trading days. This proves the point that the risk of losing substantial capital in the stocks that already are mutli-baggers and also over-valued, remains quite high.
A stock which has moved up four fold within a year and trades over 50-70 times the current earnings always carries potential risk of cracking in a big way when the overall market comes under pressure or the specific stock has a temporary setback. Possible correction in such stocks is huge as the early investors with multi-bagger opportunity would be the first ones to reap the benefits by aggressively selling them.
Similarly, a stock with a huge debt, which exceeds sales by a big margin, has the least capacity when it goes through any tests. Such stocks should be evaluated carefully – at best, one can enter such stocks at bargain prices with limited exposure. If a company has a turnover and debt of Rs. 1,000 crore each, then it has to post a minimum 10% operating margin for servicing the debt alone (assuming 10% interest costs).
If a company has a debt, which is 150% of sales and makes 15% operating margin, then such a company would be able to service only the interest costs (I), but would not be able to make any return to take care of depreciation (D) or to pay the government any Tax (T) or pay any reward in the forms of dividends to the shareholders. Those companies have to make consistently anywhere around 30% or 40% operating margins to take care of D and T in PBDIT (Profit Before Depreciation, Interest and Tax) and also to finally reward the stake holders. However, such consistency is quite difficult in the medium to long term.
The history shows that the stocks of highly leveraged and the ones which have already become multi-baggers quite frequently crack on the markets in a big way. The retail investors would be better off, if they learn from shrewdness of such cinemas to maximize the return from the equities and chase tomorrow's multi-baggers instead of getting engrossed in today's multi-baggers like inside the cinema halls for the climax!