Most retail investors think that stock markets are highly risky and prospects of the company underlying the shares are uncertain. Nothing can be further from the truth.
Normally, in a business, there is certainty about the volumes that it can generate provided its products are well-known and it has a moat to protect against competition. The problem for an investor is the stock price of such a company is normally always fully priced. This does not leave much scope for price appreciation unless the profit to earnings ratio expands due to general buoyancy in the markets.
However, under certain circumstances, even stable companies stumble — resulting in the stock price plummeting and becoming available for highly tempting valuations.
In 2013, the manufacturers of India’s largest plastic water tanks, Sintex Industries, was in trouble because it had borrowed in U.S. dollars to buy two companies in Europe. The crash in the value of Indian Rupee meant that the principal amount to be repaid went up significantly.
The Sintex stock price dropped to ₹17. The book value of Sintex Industries was ₹88. The company was still making profits and declaring a dividend of 70% on a stock with a face value of ₹1. The markets had over reacted in pricing the uncertainty. The fact that the brand was well known and had a high customer recall meant that consumers were still buying its windows, doors and tanks.
After restructuring and issuing more equity to promoters and Foreign Institutional Investors, the company was able to substantially reduce debt. Existing shareholders were rewarded with a deeply discounted rights issue. The company has since split into the original textile business which is vested in Sintex Industries Limited; and Sintex Plastics Limited.
The former is now trading at about ₹37. The plastics company listed at ₹136.50. The total money realised would have been ₹171.50. The net profit would have been ₹154.50. The investor would have received a further ₹2.8 as dividend. The returns generated are more than 50% CAGR over three years and 10 months.
The 2008 crash gave investors a chance to buy companies with great moats at very reasonable prices for which the downside was limited and the upside, unlimited. In less than a decade, these investments have grown several times in value. TCS, whose share price rose from ₹222.9 in 2008 to ₹2,494 in the last traded session is an example. So too are M&M (₹251 to ₹1346.35) and Kotak Mahindra Bank (₹116 to ₹991.1).
The moral is that, over time, the business of large companies is stable and will show moderate growth. However, investors, in anxiety and panic, will drive down stocks such that the valuation becomes attractive and is available at minimum risk.
(The writer is an author and a consultant)