Thousands of scams are happening across the globe. Sadly, India has become a hub for scams. The list goes on, be it ICICI- Videocon scam, Zee scam, ABG Shipyard fraud, PNB fraud, SBI, etc. The black cloud of scams, frauds & financial crises doesn’t seem to fade away.
These scams adversely affect the shareholders. To ensure you remain protected from such scams, we will look at a few ways to spot these mischiefs. So, let’s get started!
Though debt might come as an essential need for growth, avoiding high-debt companies can be a prudent strategy while investing. Investing in companies burdened with excessive debt in the stock market could be much riskier. The company’s profits should be able to square off its debt for the FY, with profits remaining.
Companies with high debt levels must allocate significant earnings to service their debt through interest payments. While this allocation reduces the funds available for growth, dividends, or reinvestment, hindering the company’s ability to generate shareholder value, it ensures that it doesn’t fall into a debt trap.
The fact is highly leveraged companies are more sensitive to economic downturns. The subprime crisis of 2008 made a lot of investors wary of companies with high debt levels. This uneasiness was because the uncertain future made it difficult for investors to ascertain whether such companies could service their debts.
One such example is Suzlon Energy. When Lehman Brothers collapsed, order flow from two of the world’s biggest energy markets – Europe and the US- stopped utterly. The Suzlon share price started declining as credit flow almost stopped. This slide led to the shutting down of its blade-making factory in Pipestone, Minnesota.
Moreover, the main downfall to Suzlon was the non-availability of debts due to the fall of the Lehman Brothers, as they were the highest investors in turbine services and manufacturing. The company’s net profit fell drastically the following year despite achieving 100% topline growth (Y-O-Y).
It even registered a loss for six straight years, from FY10 to FY15. Servicing its debt became a significant problem for the company.
Stock market paid course online can be a valuable resource for investors to learn more about identifying companies with high debt levels and understanding their potential risks.
Generally, a good debt-to-equity ratio is somewhere lower than 0.5 times. A ratio of 2.0 or higher is often considered risky. However, specific high-capital industries, such as power and telecom, have high debt-to-equity ratios. Thus, ensure the debt-to-equity ratio doesn’t exceed 1.5 times for such companies.
If the debt-to-equity ratio is negative, it implies that the company has more liabilities than assets. Such a company would be considered extremely risky.
Long Working capital cycle
The long working capital cycle could be a red flag for a company, as it may indicate potential financial and operational challenges. The working capital cycle can be described as the time a company takes to convert its raw materials into finished goods, sell them, and collect cash from customers. It measures the efficiency with which a company manages its short-term assets and liabilities.
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A prolonged working capital cycle means the company’s cash is tied up in inventory, accounts receivable, and other current assets for an extended period. Such cycles can lead to cash flow constraints, making it difficult for the company to meet its short-term obligations or invest in growth opportunities.
The following table tells us the figures of “Cox and King”, which has got bankrupt in 2020. If you look at the working capital days, it’s ridiculously high more than 1000 days, approximately three years. You can often compare it with your peers to understand it more clearly.
If we compare itself with its peers Thomas Cook, then the working capital cycle is very lean in Thomas Cook.
Thus, comparing the working capital cycle with its peers would be best to get a clearer picture. However, it’s also essential for professionals in the financial industry to keep learning and stay updated with the latest trends and techniques. Enrolling in “Online Stock Market Courses in India” can be a smart move for anyone seeking to advance their career in this field.
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Promoter pledging is an essential analytical parameter. When promoters pledge shares, they keep shares as collateral with financial institutions, like banks, to raise money. It’s just like mortgaging something for money. Pledging is sometimes good. Many times, promoters pledge their stake for sound business reasons and release their pledged shares soon after. But pledging takes an ugly turn when the pledged stake is high, and the promoter cannot pay back the dues. This issue might push the financing institutions to sell the pledged stake, which can result in a sudden fall in stock price and the dilution of the promoter stake in the company. A high pledged stake also indicates terrible management. Investors should stay away from companies that have high levels of pledging. Retail investors should avoid these stocks, especially where the promoter pledge is more than 3%.
Investors who have undergone a stock market paid course would have a better understanding of identifying warning signs like high promoter pledging, enabling them to make prudent investment choices.
You will also see that the company with a high pledged holding would not have created wealth for shareholders, e.g., Vedanta. If you look at Vedanta, 100% of the promoter holding is pledged in Vedanta.
Vedanta is trading at the same price as it used to trade in 2009.
Another example is Suzlon. If you look at Suzlon, 80% of the promoter holding is pledged in Vedanta.
As you can see in the chart, the company’s share price has tanked by 95%.
CFO/EBITDA higher, the better
As per a famous quote in the market, “Topline is vanity, the bottom line is sanity, and cash is the ultimate reality.” Many companies have higher profits and return ratios. But are these profits being converted to cash? This conversion is a big question for investors. Let’s understand it with an example.
This company is making an EBITDA of Rs. 65 at a scale of 100, taking an EBITDA margin of 65%. Looks so great and seems like an exciting business model, but here is the catch, let’s say the cash flow from operation for this company is Rs. 20.
Now things look disconnected to an investor. How can a company which makes profits of Rs. 60 have cash of Rs. 20? That is why you should always check CFO (Cash Flow from Operating Activities)/EBITDA conversions, which should be at least 70% for B2C business and 60% for B2B.
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Yes, now one can come up with some exceptional years, so you can do this analysis on a cumulative basis by taking cumulative CFO/cumulative EBITDA, or you can look at five years on a singular basis.
Here is an example of Data patterns where the CFO to EBITDA is less than 50% and has become negative. These are signals for being cautious as an investor.
Communication and transparency are the most critical factors while analyzing a company’s management. Management’s integrity is the key to the company’s growth. As a responsible management, it must give ‘fair’ quarterly and annual results to its shareholders.
Just as the management announces the company’s good results proudly, in a similar fashion, the management should come in front when results are bad to explain the reasons behind it to its shareholders. Good management always maintains the transparency of its organization. Let’s take an example!
The morning context report published on 13 March reported that Adani Group does not own ACC and Ambuja. Vinod Adani controls ACC and Ambuja. The group used a special purpose vehicle (SPV) called Endeavour Trade and Investment Ltd to buy the two cement companies from Holcim Group. Vinod Adani owns this Mauritius-based entity.
Adani’s Spokesperson said, “Endeavour Trade and Investment Limited (controlled by Mr Vinod Adani), the Acquirer of ACC Limited and Ambuja Cements Limited, belongs to Adani Group. This fact was disclosed in our public offer document dated 19 August 2022.”
“This means neither Adani Enterprises nor any of the Adani group’s other listed companies in India or their subsidiaries acquired Ambuja Cements/ACC. Even though group chairman Gautam Adani projected to the world and shareholders that the Adani group acquired the cement companies.
This announcement shows that there is a severe lack of transparency and lack of clear communication.
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Fluctuation in promoter Holding
Fluctuations in promoter holding can be a red flag when evaluating an investment company. Promoters are individuals or groups that hold a significant stake in a company and are responsible for its management and strategic decisions. When the promoter holding fluctuates significantly, it can indicate several underlying issues.
Promoters are clued into everything that happens behind closed doors. Promoters’ activity on their stock can give a much better idea of how they perceive things to change. Several instances of insider trading and stock manipulation have made the promoters rich at the cost of unsuspecting investors. Investors need to be wary of pump-and-dump stocks.
One such example is Brightcom Group. In Mar 2016, the promoter holding was 34.37%, which fell to 7.24% in Mar 2021 and increased to 18.48% in March 2023.
It is better to stay away from the companies where the promoter himself is trading in the stock.
Currently, if you see, the share price is down by more than 70% from its all-time high.
The companies mentioned here are not fraud companies. These companies need to be more fundamentally sound current due to some parameters. As an informed investor, look for these signs before you invest in any stock, or simply look for any stock market paid course