Jet is plunging. Should you board?

On March 25, Jet Airways shares soared 17.77% in intra-day trade on BSE when its founder and chairman Naresh Goyal and his wife Anita Goyal stepped down from the Board. Less than a month later, April 16 saw the stock plunging nearly 19% amid reports that the company was likely to temporarily shut down its operations. Two days later, the stock crashed over 30% to hit a 52-week low as the reports emerged true.

And yet on April 23, ending a three-day losing streak, shares surged nearly 10% on value-buying.

Investors may be tempted to put money into the companies that are in deep crisis in the hope of making super-normal profits if the fortunes of such firms reverse. However, experts are unanimous in advising caution while betting on such stocks, pointing out that such windfalls are an exception, not the rule.

“Equity investments are all about risk and consequential reward,” says Kishor Ostwal, MD, CNI Research Ltd. Thus, wherever the reward is high, the risk could be equally great.

V K Vijay Kumar- chief investment analyst, Geojit Financial Services, says, “Buy (stocks) on bad news is a good investment strategy.” However, this strategy can be extremely risky, and therefore, has to be used with a lot of discretion.

Ostwal and Kumar were speaking on whether retail investors should consider buying shares of beleaguered firms such as Jet Airways. 

Remember the fraud-hit Satyam Computers? Investors who brought dirt-cheap Satyam shares at that point in time made a killing. A similar story played out with SpiceJet's revival. However, many of those who invested in firms like Gitanjali Gems and Kingfisher Airlines lost their proverbial shirts.

So how does the retail investor distinguish the gems from the lemons?

Firstly, retail investors should probably stay away from such chimeras.

“I feel that an investor should preferably keep away from such risky stocks and stick to buying good quality stocks that are fundamentally strong,” advices Pradeep Gupta, co-founder and vice-chairman, Anand Rathi. Investors should look at important parameters such as growth in business, profitability, cashflow and management quality. “Companies with low ROE (return on equity), liquidity issues, solvency should be stayed away from,” notes Gupta.

But what should an investor do if the lure of such firms is too strong? 

“Before taking such a risky bet, take into account various factors such as the net residual value of the assets of company after such a crisis,” says Ostwal. If the net residual value is much higher (than the financial overhang), then the chances of seeing the successful turnaround could be possible. “Only in that scenario your risky investment could yield good returns like we saw in Satyam or SpiceJet,” Ostwal says.

“While investing in such stocks, always stay updated with every single news and information along with the actions being taken by the Board or the management of such companies,” says Gupta. The investor should also be vigilant and analyse all updates related to corporate actions. The behaviour and the pricing of the stock are also important guidelines.

And retail investors, due to lack of deep pockets, are always more vulnerable as compared to the institutional investors and high-networth individuals.

All information regarding a company may not be always available in the public domain. “For instance, last year the stocks of some companies crashed due to auditor exits,” says Kumar of Geojit. Here also, retail investors bought into these stocks when their prices crashed. “Institutional investors were continuously selling these stocks,” he says.

A very important point to analyse while investing into companies facing the threat of a collapse is whether the crisis is temporary or structural.

For example, Maruti Suzuki's stock crashed in 2012 amid panic following the temporary closure of its Manesar plant due to the violent strike that resulted in the unfortunate killing of a company executive. This was a temporary problem faced by a strong company, and therefore, it was a great buying opportunity. Investors who bought the stock then reaped a fortune when the share price rose several fold in the next few years.

On the other hand, if a stock is crashing due to structural issues, stay away even if it is 'very cheap'. Structural issues being faced by a company can result in bankruptcy and huge losses to investors. Those who bought into stocks like Reliance Communications, JP Associates, Reliance Power, Unitech and other such firms incurred huge losses. “Retail investors have lost heavily committing this mistake,” says Kumar.

Unfortunately, the number of companies in distress may increase going forward and head to the National Company Law Tribunal under the new Insolvency and Bankruptcy Code, 2016.

And for new promoters, bidding for such stressed companies is usually cheaper than setting a greenfield (new) project. “Only in such cases will there be some hope of investors making money provided they invest and give sufficient time to the new promoters to turnaround such companies,” notes Ostwal.       

Here, it is the (new) management that counts along with its expertise and resources. “Investors should see the track record of the management in running such a company in that particular sector previously, their ability of raising funds for meeting new challenges and turning the company around operationally,” advices Ostwal.

In the past the (new) promoters of SpiceJet turned the company around operationally, and thus, the market has rewarded the shares. The takeover of Satyam by a strong promoter with great track record and ability resulted in the company's change of fortunes. (Incidentally, the erstwhile Satyam Computers was merged into Tech Mahindra).

Ostwal says if an investor feels the urge to invest in troubled companies, no more than 1-2% of their overall portfolio should be allotted to such risky investments. “Bhushan Steel seems the only company as of date which could have the potential upside since they were taken over by Tata Steel,” says Ostwal.

However, the track record of number of companies that have been taken over eventually is not encouraging. Experts point out the case of Ranbaxy, whose investors lost even after it was merged with Sun Pharma.

Also, investors need to note that their returns from a turnaround come after a very long time. While Satyam exploded in 2009, investors had to wait almost half a decade before they could see returns. “This is a very long term investment. The investor can get similar returns from other investments,” says Ostwal.

“Tech Mahindra and SpiceJet are the exceptions rather than the rule. It is better for retail investors to err on the side of caution,” cautions Kumar.

“I would not recommend investing in stocks which have been through a crisis situation,” stresses Anand Rathi's Gupta. “Please look at companies which have a strong growth potential with able management and sustainable earnings.” 

BALANCED RISK

• The behaviour and the pricing of the stock are also important guidelines
   
• Risky bets should not be more than 1-2% of the overall portfolio