Quality of Promoters and Impact on Share price in Investing

Quality of Promoters and Impact on Share Price in Investing 

Introduction

A promoter is an individual or an entity who does the preliminary work incidental to the formation of a company, including its promotion, incorporation and flotation and solicits people to invest money in the company, which is being formed. The entire lot of people and other companies that control a company in this way is called its promoter group. Their combined shareholding is called promoter holding. Higher the promoter holding in a company,greater is the promoters control over it. Promoters exercise their control by taking key decisions of the company and appointing people in various positions of its management and board. They also provide the visions for the existence of the company. It is, therefore necessary that the promoters continue to hold a dominant shareholding position in the company. A large promoter group also provides stability to a company. Generally, promoters are in a fiduciary relationship with the company and its investors and shareholders, and must avoid conflicts of interests and exercise reasonable care in performing their duties. They must refrain from self-dealing or other types of abuse to take advantage of their position as a promoter. 

When money is invested in shares of a company, Quality of Promoters is the most important aspect. It is because promoters are the people who are going to be involved with the day to day activities of business and is at the foundation of success of entire business. If promoters carry out their duty with integrity and efficiency then every stakeholder of the business including shareholders can flourish and wealth maximization takes place.

In India a lot of companies which had corporate-governance issues have been the biggest wealth destroyer from shareholders perspective. In many cases it was not possible to identify the symptoms until it was very late for shareholders to exit. However, if few aspects are kept in mind while analyzing a company, shareholders can save their capital.All the mechanisms put in place by a company to protect stakeholder rights, in particular shareholders rights, is referred to as its corporate governance structure. It consists of policies, procedures and regulations that define how the management must deal with its stakeholders, and the remedies available to them in case of a violation. 

Important Points in Respect of Quality of Promoters from Investment Perspective :

• Educational qualification, age, experience in the sector or elsewhere, role assigned etc. are the important points to be checked to determine quality of promoters while investing in a company

• Shareholding of promoters group greater than 51% in the business shows the interest of promoters as well as it helps in proper implementation of business decisions due to majority ownership. Knowingly and willingly promoters are unlikely to take decisions which are not in the interest of the company in which majority of their personal wealth is invested

• Regularity of reporting to regulatory authorities and stock exchanges is very important. Failure in timely reporting of financial statements and necessary disclosures as required by stock exchanges can be considered as a red-flag on the part of promoters. Eg. If a company does not report it's quarterly results within time limit set by regulations it is a red-flag

• Avoid companies where promoters have pledged substantial part of their stake to raise funds. In case promoter makes a default, then banks/financial institution which has given loan will sell the pledged shares in open-market to recover it's loan which can lead to meltdown in share prices

• Integrity on the part of promoters is very important. Promoters remuneration for the time and energy they contribute to the business must be analysed thoroughly by investor to determine whether it is reasonable or not.

• Personal transactions of promoters or relative of promoter or any related entity  with the company shall be on fair terms. Investor has to ensure that related party transactions are not of such nature which exploit resources of company for personal gains

• Concept of "Independent director" was introduced by SEBI some 17-18 years back to ensure that board of directors also have people who are outsider (unbiased) and take decisions in the interest of stakeholders at large. Listed companies are compulsorily required to have one-third composition of board to comprise of Independent directors as per regulations. Investors have to ensure that independent directors are appointed and removed as per the policy and also check whether they are really independent or related to promoters

• Necessary information related to promoters remuneration, related party transactions and independent directors etc is available in the annual report of the company which is available on the website of the company as well as on the stock exchange website

• Violation of rules of stock exchanges, companies act, taxation act etc can be considered as a red-flag from investor perspective. Violation of internal policies,guidelines and procedures established by the company is also a red-flag from investor perspective

Sarveshwar Foods Ltd : Emerging Value Play in FMCG

                            Sarveshwar Foods Ltd : Emerging Value Play in FMCG

CMP : 39

ISIN: INE324X01018

Market Cap : 96 Crore

LISTED ON : NSE SME Emerge Platform

Lot Size : 1600

Time Frame : 18-24 Months 

History of the Company :

Sarveshwar Foods Ltd was incorporated in 2004 and is primarily engaged in the business of processing and marketing various types of Basmati and non-Basmati rice in the domestic and international markets. The operations are based out of the Jammu Region in the State of Jammu and Kashmir. 

The latest venture of the Company has been into organic farming where the Company does contract farming for rice, dry fruits, cereals, pulses in addition to a variety of superfoods and has 22,000 acres of certified organic farming land with the company.

The Company has presence in export markets such as the USA, Europe, Middle East, Australia etc. Company was listed on the NSE Emerge platform in March, 2018.

Company owns 2 USFDA and BRC approved manufacturing facilities in Jammu and Kashmir for the processing of rice that have recently also got requisite approvals from Chinese authorities

Well-known clients and distributors of the company include names like walmart, Ebro, Big Bazaar, Costco, Nifol, Veetee, Vaishnav Devi Shrine Board Etc.

Main Business Activities : 

• Food Processing/ Presence across entire Rice Value Chain

Financials of the Company : 

• Profit After Tax (PAT) for the year ended on 31st March,2019 has been reported  at Rs 18 Crore and turnover at Rs 566 Crore. (Consolidated Basis)
• As per the numbers as on 31st March,2019 the company has generated Return on Equity of approx. 16% , Return on Capital Employed of 15% and Return on Assets of 6%
• Debt to Equity ratio is below 2 and is reasonable in nature

Investment Rationale : Why to Invest in this Stock ??

• Shareholding of the promoters in the company is 74% indicating strong interest of promoters in the business as on 31st March,2019
• Market Cap to Sales Ratio : 0.20  is very attractive
• Book Value of Stock at present is 56 Rs per Share, which is 30% discount to current market price of the stock. Such a discount to book value provides a margin of safety to investors making investment in the company at current market price
• Technically on chart the stock appears to have completed the process of bottom formation
• At current price of 39 Rs per share and EPS of 7 Rs on trailing basis, the stock is presently trading at an attractive P/E ratio of 6
• At a forward reasonable P/E of 15 and EPS of 10.00, we expect the stock price to soar higher atleast to 150 and higher levels in coming time.

Attaching Investor presentation for more detailed analysis which is shared by the company in the investors section on it's website : CLICK HERE --> INVESTOR PRESENTATION 2018

Disclaimer Note: The above is not a research report but information as available on public domain and it should not be treated as a research report. Registration status with SEBI: I am not registered with SEBI under the (Research Analyst) regulations 2014 and as per clarifications provided by SEBI: “Any person who makes recommendation or offers an opinion concerning securities or public offers only through public media is not required to obtain registration as research analyst under RA Regulations.

Disclosure: It is safe to assume that I might have Sarveshwar Foods Ltd  in my portfolio and hence my point of view can be biased. Readers should perform own due diligence before investing. We do not assume any responsibility or liability resulting from the use of information , judgments and opinions for Trading or Investment purposes on the Blog.

Operating profit margins and its importance in investing in shares

Operating profit margins and its importance in investing in shares

Introduction 

Operating profit margin (OPM) is derived when direct expenses are reduced from total sales. OPM in excess of 10-12% is considered to be good. Higher the OPM the better. In business environment lot of factors keep on changing in real-time which affects the margin of the business. If a company has higher OPM it will be able to withstand and sustain adversity due to change in business environment. Regulatory changes, demand-supply changes , currency fluctuations, commodity cycles, change in rate of interest etc. are some of the changes that can affect a business.

Business with very low operating margins shall be altogether avoided. Because even a slight change in business environment can hamper the growth of business negatively impacting shareholders value. To improve operating profit margin companies can focus on cost reduction steps or increase sales of products which have high margins by changing the sales-mix of products.

Operating Margin (%) = Operating Profit / Net Sales

Operating Margin Important points : 

• Businesses which are having high competition or which are approaching end of life cycle are likely to have lower operating profits and should be avoided. Eg. Wires Business or Computer hardware business

• Businesses which have monopoly or very high market share in a sector or some form of competitive advantage which cannot be easily replicated will normally have higher operating margins and shall be good for investment objective Eg. Alcohol industry due to barriers on entry of new players or Any Government enterprise having monopoly in a sector

• Operating margins of a sector can be altered substantially due to change in business environment which can make a new investment advisable or an old investment obsolete. Eg. Demand for Automobiles is slowing down due to rise of cab industry and is likely to go down further in future. So investment in auto sector may not likely be advisable.

• While evaluating an investment in shares, one has to ensure whether there is consistency in operating profit margins for a certain period of time to say like 3 or 5 years. Companies which have very volatile operating margins can have wild share price fluctuations regularly is unlikely to delivery good returns to shareholders

• To improve operating profit margins, company can eliminate or outsource products with low profit margins. Increasing proportion of products with higher margins or introducing newer products with higher margins can also help

• Cost-reduction program can be undertaken to improve operating profit margins. Reduction of cost can be done in various domains like packaging, transportation, raw material procurement, automation to replace costly labor etc.

• Operating profit margin of companies with similar size and similar business model can be compared to identify which one is efficient

Debt/Borrowing and it's Impact on Share Price in Investing

Debt/Borrowing and it's Impact on Share Price in Investing

Introduction

Debt or borrowed fund is used by companies for various purposes. It can be used either for expansion of business or repayment of higher rate debt or for working capital needs. Debt comes at a certain terms and condition and has implications on the business. It makes sense to borrow funds when company is capable to generate higher rate of return then the rate at which fund is borrowed. Eg. If Company generates return of 18% in it's business then it makes sense to borrow funds at rate lower than 18% and deploy it in business. Debt creates leverage which fuels growth of the business. Debt if used properly in business can help it grow multi-fold. However, if a company has excess debt then it can affect the cash flow as well as profitability of the company. Many instances have been observed where companies have gone into liquidation/insolvency due to excessive debt.

Major Uses of Debt :

1. Expansion of Business ( Capital Investment )
2. Working Capital Needs (Funding Debtors +Inventory )
3. Repayment of Existing Debt which has a High rate of Interest

Important Points related to Debt from Investment Perspective :

• Investors must check credit rating performed by various rating agencies in respect of the debt of the company. For listed companies it is available online. It can give investor an idea in respect of credit profile of the company. If credit rating of the company is good it can borrow fund at lower rate of interest. Companies with bad credit rating should be avoided for investment because its cost of borrowing will be higher and also possibility of default is higher so shareholder risk is increased in such case

• Debt to equity ratio upto 2 is considered to be safe for investing in a company. Many infrastructure companies in India borrow excess funds and when project gets halted due to any reason and there is cash-flow crunch it results in default and many other problems which ultimately and unfortunately erode share holder value

• Purpose for which a company borrows fund is very important to understand from investor stand point. When fund is borrowed for expansion of business then for initial period when the new unit is being setup only costs are recorded and so profit goes down initially. Once the plant is ready and starts generating sales then higher profits become visible and share prices are likely to go up

• When a company borrows fund for working capital one has to ensure that it does not have unusual high value of inventory(stock) or high debtor days than industry average. If it is so, it may indicate that inventory(stock) is not real and is being used to cover up some loss which is not being reported. Similarly high debtor days may indicate that some of debtors have turned bad debt but not being reported

• If a company borrows fund regularly to repay the old debt it is not a sign of healthy company. It may indicate that company is not able to generate enough cash-flow from the business in the longer run to make the repayment of principal value of debt

• Default in debt repayment is not a sign of healthy company. Due to extra-ordinary  circumstances or one time event if such thing happens then it can be ignored. But if proper justification is not available then investor must exercise caution while investing in such companies and should be avoided to the extent possible

• Investors must avoid companies with excessive debt. Companies which have debt to equity ratio in excess of 2 shall be totally avoided

• In case debt is raised from outside the country, then investor must check the annual report to ensure that proper hedging has been done for the same so that currency fluctuation does not have impact on the profitability of the company

Sector selection and Stock Selection for superior returns in Investing

Sector selection and Stock Selection for superior returns in Investing

Introduction 

Outcomes from the past if analysed thoroughly can help one arrive at various observations which can be used for better decision making in future. Sector selection is an important aspect in stock selection process for investing. Have you ever found any power company in the past that has provided extra-ordinary or superior returns to shareholder ? The answer from your end would be a NO in 99% cases for power companies. Similarly a lot of FMCG companies have provided multi-bagger returns in the past has been observed. So what is the fundamental difference ? Businesses which have natural demand, monopoly or some form of competitive advantage normally provide superior returns to shareholders in the longer run. Businesses like food products, alcohol, condoms, paint, pharma etc. fall in the above categories. Capital intensive businesses like energy, telecom, defense, steel, mining etc. generate relatively lower returns in their business and so shareholders value increases at a slower rate in such business. If one can understand these fundamental points than success rate in investing can be enhanced substantially.

"EFFICIENCY" is the driving Factor :

Stock selection process in investing is more or less revolving around Efficiency. Whether we are looking at returns or valuation or debt or any other factor. All we are looking for is to invest in an efficient business which can generate superior return with lesser capital and lesser risk.

Top-Down Approach : In this approach one identifies first the sector in which one wishes to invest and then looks for the best available companies in the sector.

Bottom-up Approach: In this approach one identifies first the stock in which one wishes to invest and then performs sector study to arrive at conclusion whether it is fit to invest.

Both the approaches are equally valid and effective. However, one point is to be kept in mind that investor must go across and understand primary information for all the sectors so that they can chose the best sectors and best stocks.

Sector Selection Important points : 

• Investing in sectors which have asset-light business model normally provides superior returns to Investor in the long-run. Eg. FMCG, service industry etc.

• Sectors which have natural demand for the products or services are attractive for investor. Eg. Pharma, consumer products etc.

• Sectors which are capital-intensive shall be avoided because larger capital is required for growth in such businesses and so the return on capital is lower for such stocks. Also as the technology keeps changing up gradations have to be made continuously on large scale basis so growth happens at a slower pace.

• Sectors which are highly regulated shall be analysed carefully before investing because change in government regulation can impact the returns in the stock. Eg. Insurance, real estate etc.

• Sectors which are unique or have some competitive advantage in the listed space can have potential for superior returns. Eg. Listed Art company or listed company manufacturing gas valves etc.

• Sectors which have a huge present and potential market size are good from investment perspective. Because as the market size is huge, the margins of such business is less likely to decline in future.