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Saturday, May 2, 2015

Ten Questions Every Investor Should Ask Before Buying A Stock

Courtesy : Fortune Mgazine

According to studies conducted during the stock market boom of the late 1990s, the average investor devoted far more time to researching his next vacation than to investigating the stocks he was buying. Sounds foolhardy, right? And also a bit familiar. In truth, the thought of thumbing through guidebooks to compare beachfront hotels in Antigua is a lot less daunting to most of us than trying to come to a meaningful understanding of something as complicated as a public company. We'd rather just roll the dice.
But here's the really crazy part: Anyone can take a lot of the luck out of investing by applying a relatively small amount of time and effort. To demonstrate, we put together a checklist of ten basic questions every investor should ask before plunking his or her hard-earned money down on any stock. Inspired by the ideas of corporate consultants like Ram Charan, the approach doesn't require exhaustive financial-securities analysis. In fact, some of the questions may sound almost elementary. But we can guarantee this: If you take the time to answer them before buying, you can make a wager that is firmly grounded in the long-term prospects of a business rather than merely hope for a hot hand. 

( 1 ) HOW DOES THE COMPANY MAKE MONEY? 

If you don't know what you're buying, you're hardly in a position to know what you should be paying for it. So before you buy a stock, you need to get a handle on how the company earns its dough. As basic as that sounds, the answer is not always so obvious. General Motors, for instance, sells millions of vehicles every year--unfortunately, it's barely making any money on them. In fact, almost 100% of GM's earnings these days derive from loans the company makes to consumers through its financing arm, General Motors Acceptance Corp. And about half of those profits aren't coming from car loans, as you might assume. They're coming from residential mortgage loans that GM makes to homeowners through subsidiaries like ditech.com (yes, the same outfit in those ubiquitous television commercials). That doesn't necessarily make GM's stock a bad investment. But clearly, it gives you a better understanding of the company's risks and potential profits.
Leaf through the filings of FORTUNE 500 companies, and you'll find dozens of similar examples. That's why a company's most recent annual report is required reading for any stock investor. There you'll find a detailed description of a company's business units and a breakdown of the sales and earnings figures that come from each. You'll also find the answer to another crucial question: Are those earnings likely to be converted into cash for investors? While "net income" and "earnings per share" results may dominate the headlines in the business press, those figures are merely accounting concepts. It's cold, hard cash that counts the most for shareholders--either in the form of dividends or reinvestment in the company's operations that should lift the stock price. Turn to the statement of cash flow in the annual report and see if "Cash flow from operating activities" is positive or negative and whether it has been growing or declining. And check for this red flag: Are net earnings (as reported on the income statement) increasing while cash flow is declining? That could signal the use of creative accounting practices designed to goose paper profits that are of no benefit to shareholders.
(2) ARE SALES REAL? 

Speaking of cash, it's important to realize that, thanks to accounting rules, a company can book sales revenue long before the cash actually comes in the door. (In the worst-case scenario, the cash never comes in the door.) And that can drastically affect the price you should be paying for the stock today. How can you tell if it's the case? Often it's clearly spelled out in the company filings. Take, for example, the case of tech company RSA Security. In the footnotes to its 2001 first-quarter financials, the company revealed that it had switched to an aggressive (but allowable) accounting method that permitted RSA to book sales revenue as soon as its software was shipped to distributors--why wait until an end user actually purchased it?
Sometimes the warning signs of revenue manipulation are more subtle. For instance, be alert to companies whose sales are increasing at a far faster clip than those of its competitors. "If you can't nail it down to something specific, like the company having a product they can't keep on the shelves, you have a right to be suspicious," says Jack Ciesielski, a forensic accountant and publisher of the highly regarded Analyst's Accounting Observer. Be wary also of companies whose sole source of sales growth appears to come from gobbling up other companies. If a firm is averaging more than a couple of acquisitions a year, the motive is likely to be management's desire to satisfy Wall Street's short-term expectations. Over the longer haul, integrating a bunch of disparate companies into one can get messy and costly. 

(3) HOW IS THE COMPANY DOING RELATIVE TO ITS COMPETITORS? 

Before buying a stock, it's vital to know how it stacks up against the competition. The first readily accessible place to start your analysis is with sales figures. "The best clue as to whether a company is beating its competitors is to simply watch year-over-year revenues," says mutual fund manager Ron Muhlenkamp, whose eponymous fund has handily beaten the S&P 500 index over the past decade. If the company is competing in a high-growth industry (like videogames), are its sales growing as fast as those of its competitors? If it's operating in a mature industry (like grocery retailing), have sales been holding their own over the past few years? Pay close attention as well to the sales inroads made by new competitors, especially in those industries that aren't growing. "Wal-Mart going into groceries has upset the whole industry," notes Muhlenkamp. "Based on the past, Kroger and Safeway may look cheap, but in the past they weren't competing with Wal-Mart."
And don't forget the cost side of the equation when comparing a company with its rivals. Automakers GM and Ford, for example, are saddled with huge costs related to pension and health-care plans for their retirees--costs that put them at a severe competitive disadvantage to foreign competitors like Toyota and Honda. 


(4) HOW DOES THE BROADER ECONOMY AFFECT THINGS? 


Some stocks are highly cyclical--in other words, the company's performance is heavily dependent on the state of the economy. And cyclical stocks aren't always the bargain they appear to be. For example, when the economy is on a downswing, the stocks of paper companies may begin to look incredibly cheap. But there's a good reason for that: In tough economic times many businesses cut back on their advertising, newspapers and magazines get thinner, and paper companies therefore sell less paper. Of course, the opposite effect usually occurs coming out of a recession.
Investors should also pay close attention to trends in interest rates, since rate moves can have a dramatic effect on many industries.Perhaps one of the most important factors to consider before buying a stock is the degree of price competition that exists within the industry. Price wars may be great for consumers, but they can quickly kill a company's profits. According to an analysis of FORTUNE 1,000 companies conducted by consulting firm McKinsey & Co., for each 5% decrease in its selling price, a company would need to increase the number of units it sells by 18% to break even. "For most industries that just is never going to happen," warns Craig Zawada, a McKinsey partner and pricing specialist. In most cases a company fighting a price war must have a big cost advantage over its competitors if it hopes to remain profitable. Just witness the havoc the so-called "burger wars" have continually wreaked on the bottom lines of McDonald's and Burger King.

(5)  WHAT COULD REALLY HURT--OR EVEN KILL--THE COMPANY OVER THE NEXT FEW YEARS? 


Before you invest in a company, you must give some thought to the worst-case scenarios it may face in the years ahead. For instance, a business that's dependent on one customer for a huge chunk of its sales could collapse if it lost that customer. You can get an idea of these risks by reading a copy of the initial offering prospectus (if the company has just gone public) or the most recent 10-K--the annual report a company files with the Securities and Exchange Commission. (You can download both documents at the SEC's website, www.freeedgar.com.) Take fiber-optic maker Sycamore Networks, which went public in late 1999. Anyone who had read the offering prospectus would have discovered that the company had only one customer, Williams Communications. Two and a half years later Williams went bankrupt; today the stock of Sycamore (which managed to pick up a few more customers along the way) has plunged by about 97% from its 2000 high.
Some businesses are just inherently more risky than others. Consider the many profitless biotech companies whose shares have soared only to come crashing down after their wonder drug got shot down by the FDA. Which brings us to another important point: If the performance of a company is heavily dependent on the actions and reputation of one person, then be aware that the risk attached to the stock will automatically be several notches above the norm. Indeed, the stock of Martha Stewart Living Omnimedia is down some 50% since its namesake's current legal woes began in June 2002. 

(6) IS MANAGEMENT SWEEPING EXPENSES UNDER THE CARPET? 

Throughout the course of a company's history, write-downs and restructuring charges are often unavoidable. But alarm bells should go off if a company has a habit of taking those "one-time" charges year after year: It becomes practically impossible for investors to figure out just how profitable the company really is. For instance, in the years leading up to its bankruptcy in 2002, retailer Kmart repeatedly took one-time charges for everything from closing its ailing stores to writing down its obsolete inventory to "redefining" its Internet business. "That was just classic," says Michelle Clayman, chief investment officer at New York investment management firm New Amsterdam Partners, who has studied the phenomenon of serial chargers. "They kept having all these charges that their competitors weren't having."
Clayman advises that if you see one-time charges appearing in at least three of the past five years of income statements, you should be wary of the stock. In fact, her research has shown that about 70% of the time, the stocks of companies falling into this category consistently underperform the S&P 500 index. Check the notes to the financial statements for an explanation of the one-time charge; sometimes it will relate to a move that has actually benefited the company, such as the early retirement of debt refinanced at a lower rate. But all too often the charges spell bad news for potential investors. 

(7) IS THE COMPANY LIVING WITHIN ITS MEANS? 

Even if a company's profits look rosy today, those good times simply won't last if it has racked up a gargantuan pile of long-term liabilities. Before you buy any stock, check out the amount of debt on the balance sheet--too much debt is risky, since a slowdown in sales or a hike in interest rates could threaten a company's ability to make interest payments. And it greatly decreases a business's margin for error. "When you have debt picking away at you, you not only need to be right, you've got to know when to be right, or else you're dead," says Bob Olstein, founder of the Financial Alert fund. What's more, debt holders come first in the pecking order: A company must pay interest on its debt but is under no obligation to pay dividends to shareholders. To determine whether a company is overloaded, divide long-term debt by total capital (debt plus shareholder's equity--both numbers are on the balance sheet). If the result tops 50%, there's a strong chance the company is borrowing beyond its means.
But debt isn't the only way a company can get in over its head. Stock options--that great boon to executive compensation--come at a steep price to shareholders. In the footnotes to a company's annual report, it must disclose what earnings would have been had options been factored into the equation. Make this footnote required reading: Options can quickly turn reported earnings into losses, as would have been the case in 2002 for Apple Computer, Applied Materials, and Charles Schwab had they expensed their options. 

(8) WHO IS RUNNING THE SHOW? 

Assessing the quality of a company's leadership team is not always a straightforward exercise for the average outsider. Still, experts say there are some classic indicators that investors should consider before buying a stock. Mike Mayo, the straight-shooting Prudential Financial bank analyst, recommends that investors read several years' worth of the letters that CEOs write to shareholders in their annual reports. Has the management team been consistent in its message, or is it constantly changing strategy or blaming outside forces for poor performance? If the latter, steer clear of the stock.
Even a company's headquarters can say a lot about where the management team has placed its priorities. "If I see a big, spanking-new headquarters, the stock's a sell," says Donald Sull, an assistant professor at Harvard Business School who studies CEOs and organizational behavior. "There's just too much shareholder cash sloshing around." Sull cautions that investors should steer clear of companies possessing any of the following in their new headquarters: an architectural award for design, a waterfall in the lobby, or a heliport on the roof. As lighthearted as this warning may sound, Sull insists he's dead serious. "Management is saying, 'We've declared victory, and now we're building a huge monument to our victory,' " notes Sull. "But they're not thinking, 'Hold on a minute: Maybe the thing that got us here in the past isn't the thing that's going to be best going forward.'" 

(9) WHAT IS THE COMPANY REALLY WORTH? 

The greatest company in the world can make for the lousiest investment in your portfolio if you pay too much for the stock. By the same token, a company with average fundamentals can be your star performer if you buy it at a cheap enough price. Still, as Warren Buffett pointed out in FORTUNE's 2001 Investing Guide, investors will jump at the chance to buy just about anything at a discount--except stocks. Indeed, all too often investors prefer to wait until the price of a stock has gone up before buying in.
Don't fall into this trap. If the stock you're thinking about buying has been on a rip-roaring tear of late, hitting its 52-week high, find out why: The fact that it's "hot" isn't enough reason for you dive in. "Individuals tend to herd into certain stocks," says John Nofsinger, a finance professor at Washington State University and author of Investment Madness: How Psychology Affects Your Investing. "But if you're going to buy a stock because everyone else has bought the stock, then aren't you the last one in? Wouldn't you rather buy a stock before everyone else buys it?"
Here, the stock's price/earnings ratio (the stock price divided by earnings per share) is still one of the best and quickest ways to value a company. As a general rule, most value-oriented portfolio managers won't touch a stock with a P/E ratio above 30, even if it operates in a growing industry. (And why would they? Compared with the overall market's valuation, that means the company's returns would have to be roughly 50% better for investors to profit.) Remember, if you're using "next year's" or 2005's projected earnings to calculate your ratio, you're guessing--not evaluating. The next critical step is to review the cash flow statement, checking for positive (and hopefully growing) cash flow from operations. If a company has never managed to generate positive cash flow, any rise in stock price will be much more a reflection of wishful thinking than economic reality. 

(10) DO I REALLY NEED TO OWN THIS STOCK? 

With about 15,000 publicly traded stocks available for sale on U.S. exchanges alone, there's no one "must have" investment. But all too often, we allow ourselves to become convinced that we'd be missing the boat if we didn't own the likes of WorldCom or eToys. "Too much of the time we invest in a story, and that usually works out badly," says Nofsinger. So make a pact with yourself here and now that you'll hold off on your purchase at least until you've answered questions 1 through 9. If you invest on this basis, you'll have the conviction to hold on to your stock throughout the broader market's zigs and zags. You'll also have the comfort of knowing that you have invested in, not gambled with, your long-term financial future.

Saturday, April 25, 2015

IL&FS ENGINEERING AND CONSTRUCTION COMPANY LTD. - UPDATE


 


 
IL &FS Engineering and Construction is one stock I suggested as a BUY @ Rs.98 which is currently trading 15 % below the suggested price. Yesterday company announced the receipt of an order worth Rs. 326.99 Crores from  Bangalore Metro Rail Corporation Limited. ( Link HERE) .Currently company's total order book is around  Ten Thousand Crore  which giving very good visibility for future. Recently one visual media interpreted the revision of project cost  of one of their projects as a 'Scam' and I received lot of queries from my readers to express my opinion about the company post this event. To my understanding , this is one project originally awarded to a consortium of Maytas infra and Gayatri Projects .( Later  Maytas changed its name to  IL&FS Engg when the control of company fully transferred to the hands of IL&FS  .( IL &FS is promoted by Housing Development Finance Corporation Limited (HDFC) ,Central Bank of India (CBI), Unit Trust of India (UTI),  State Bank of India, Life Insurance Corporation of India, ORIX Corporation - Japan and Abu Dhabi Investment Authority). Due to time overrun for the completion of the said project , as per terms and conditions , company succeeded in re-negotiating the project cost  and this is interpreted as a 'Scam' by a media . I believe , such project cost revisions are  not unusual and there is nothing wrong in it if the terms and conditions are framed in a manner with a provision to do that . Unfortunately , to give the colour of  a 'scam' to this incident ,visuals of Raju( Satyam) shown repeatedly in the said news even though this company is not even owned by him at present but owned by reputed PSU banks and institutions .
                                                                             As you are aware , IL&FS Engineering is currently working on many prestigious projects including India's First smart City (Gujarat International Finance Tec-City (GIFT) .Still this is my first choice from this sector and reiterating a BUY at CMP Rs.84 with a long term view.

 Link - India’s first smart city takes shape in GIFT
 

Monday, April 20, 2015

MIC ELECTRONICS - UPDATE

MIC ELECTRONICS  is one stock suggested here @ Rs.5 about six months back ( Link HERE)  which is currently trading around Rs.11.Today company informed exchanges that ,company led consortium emerged as the lowest bidder for Design, Manufacture, Supply, Testing, Installation and commissioning of 1,81,398 LED Street Lights for four districts of Andhra Pradesh(Guntur, Krishna, East Godavari, West Godavari.) .Thy also emerged as the second lowest bidder for another 31,221 LED Street Lights for Prakasam Dt of AP .This project is executed under Energy Efficiency Services Limit which is a joint venture of PSUs of Ministry of Power, Govt. of India. I hope , MIC will win  this order at their home turf  . Though the amount of project not disclosed ( Earlier Nashik Municipality's similar order for replacing  69500 street lights awarded for Rs.202 Cr)  , I believe it will be a turning point in the second innings of company and will act as a catalyst in its efforts for a come back.

Last month promoters converted 1.64 Cr warrants into equity shares out of  7.4 Cr warrants issued at the end of 2014 . On full conversion , promoter stake in MIC will increase from close to  10 % to above 45% .

Suggesting to HOLD it

Link to latest Announcement HERE

Saturday, April 18, 2015

BASICS FOR BEGINNERS .....

 BOOK BUILDING AND REVERSE BOOK BUILDING

  Courtesy :www.goodreturns.in



Often we must have come across the term book building in financial dailies, magazines or television when companies air the advertisement for their likely IPOs, FPOs or rights issue. The book building is nothing but the price discovery mechanism for the issued shares when a company plans to raise capital. Listed companies raise capital either through follow on public offer (FPO) or right issue but unlisted do so through an Initial Public Offer (IPO). And during the process, shares can be allotted to investors at a fixed price or investors can be provided a price band for making their bids. And based on the demand and supply for the shares in the market, cut-off price or the issue price for the floated shares is determined. This process involving the provision of a price band for the investor class for issuance of securities is referred as book building.
Company Issuing securities and Lead Manager complete book building process
The company raising fund capital to effect the book-building process appoint lead manager and an investment bank for making the issue public. Size of the issue or the maximum capital that will be raised through the issue as well as the price band is determined by the lead manager and the issuing company. Following, based on the bids from the investor for the issued securities as well as the demand-supply market forces for the securities in the market, cut-off price or the price at which the securities would be issued to the public is decided and finally securities are issued to investors. Accordingly, letters of allotment or refund are send across to the investors.
Further, as the bidding for shares of the company in the book building process is done within the provided price band; the lowest price referred as the floor price and the maximum price as the cap price, the demand for the securities is known on a daily basis unlike in case when the securities are issued at a fixed price.
Book-building vs Reverse Book building
Book building seems to be a much known term in contrast to reverse book building. So how the two process are different? While book-building as well as reverse book building process both facilitate price discovery, book-building methodology is adopted when a company plans to raise capital and the other is applied when the company voluntarily engaged in delisting of shares. Similar to the book building process, for buying back the shares, shareholders of the company can make bids a either the floor price or at a higher price. Maximum bids at a particular price then determines the discovered price I.e the price at which the company buys back shares from the public.
SEBI in a move to simplify the delisting process for companies is making plans on examining the complete structure of delisting that includes the number of shares to be bought back from public shareholders and price discovery to effect the delisting process among others.

Saturday, April 11, 2015

PIONEER EMBROIDERIES LTD - REVIVAL TIME ....



   
Pioneer Embroideries is a stock need no introduction to veteran investors .It was a hot one till 2007-08 which recorded its lifetime high @ Rs.345 during January 2008. Company is in the business of manufacturing embroidered fabrics, laces and dope dyed yarn and its brand “Hakoba” is still the undisputed leader in embroidered clothing category.In the ‘Laces’ segment company is the second largest producer in the world
                                                                             Company operating six manufacturing facilities across India with facilities to produce Embroidery (4248 million stitches), Bobbin Lace (25,200,000 mtrs), spun yarn (1,788 MT) and dope dyed yarn (10,500 MT). Due to leveraged and untimely expansion ( mainly in retail segment)  and  unexpected downturn in overseas markets due to recession ..etc  company went into big trouble .From a net profit of Rs.15 Cr reported in 2007 , its bottom line crashed to a loss of Rs.33 Cr in 2013 ( Out of this Rs.33 Cr , more than Rs.15 Cr were interest payment) . Sensing the big trouble, management initiated efforts to revive the company . Efforts to settle bank loans through CDR mechanism failed due to disagreement of few banks in the lender consortium . Because of this reason company initiated talks with each banks separately for one time settlement ( OTS) .Through this route company already settled its due to ICICI Bank and it is expected to complete the payment  to  State Bank of Patiala which already negotiated and reached amicable agreement .Meanwhile during last  year , company re-paid its entire FCCB obligation on a modified repayment terms .Now  its efforts to reach settlement with other banks are at various stages and management expressing their confidence to reach an amicable settlement with remaining lenders within not so distant future. In a recent development, Edelweiss ARC Limited ( EARC) , an asset reconstruction company sponsored by  Mr. Rashesh Shah led  Edelweiss Group took over the debt of Pioneer with EXIM Bank. I believe , Compared with banks ,Private asset management companies are more flexible and time and formalities needed to deal with them is less compared with PSU banks . Now EARC agreed to accept re-payment of interest outstanding on this loan in the  form of equity . As part of this agreement company now allotting  Eight Lakhs Fifty Thousand shares to EARC at a price of Rs.35 each. I don’t think ,any private ARC will convert  even a part of their assignment to equity if they feel the underlying business is not viable . 


 
 
Company’s retail venture – Hakoba Lifestyle-  is running through its subsidiary ( Currently four stores are operational ) and it also selling products like ready to stitch salwar kameez and dupatta sets, sarees ..etc through e-commerce sites like Flipkart..etc. Amid its not so good financial situation and working capital crunch , for the last five years pioneer reported substantial and steady improvement in its top line ( See below Table)  .





This clearly indicating,demand of product is  not the major issue of the company but mainly  the debt related issues eating its bottom line. Major fabric manufacturers in India and overseas are company's customers and the increase in export income was robust in last years which jumped from Rs.17 Cr to Rs.41 Cr. Its operating cash flow turned positive  in 2011  and it is about Rs.61 Cr in last FY. Now promoters are trying their level best to find a solution for debt related issues  and considering the recent developments ,I believe the possibility for a success in this effort is quite high. If the success of of their efforts continue in this same tempo , Pioneer may emerge as a dark horse in the years to come . Due to cash crunch company could not modernize some of its machineries in recent times. Once they are in a position to do that it will surely improve their efficiency and margins.   After the news of allotting shares to EARC @ Rs.35 , stock price appreciated in past few days . Average risk takers can wait for a correction ( if any )  for an entry and high risk takers may buy part now and add further in any dip ( if it happens) . This is not a stock suitable for those looking for quick bucks by investing only for one or two quarters. Earlier also I   indicated my positive stand on this company around Rs 20-25 level ( through replies to reader queries) which was before the arrangement with  EARC .  Stock listed in both exchanges and currently trading around Rs. 30 .





Link to Company Website HERE

Disc: It is safe to assume that I have vested interest in this stock.

Monday, April 6, 2015

SML ISUZU / CAPLIN POINT LABOROTORIES / SMS PHARMA - UPDATES

SML ISUZU LTD - Recommended @ Rs.335 hits its life time high today @ Rs.1415 . Today company  reported  33% year on year growth in vehicles sales at 1,772 units for the month of  March 2015. Those with some risk appetite can still HOLD it

Recommendation Link HERE



CAPLIN POINT LABORATORIES LTD  - Recommended @ Rs.86  hits its life time high today @ Rs.1176 .Company now  informed the exchange that a license and distribution agreement has been made and entered by and between Caplin Point Laboratories Limited, India and Fresenius Kabi USA, . Under this agreement, Caplin Point shall be responsible for developing and manufacturing identified parenteral products whereas Fresenius Kabi USA shall be holding these ANDAs and commercialize the same in USA. 
Earlier suggested to book part profit to recover your cost . One can still hold the remaining quantity . 


 Recommendation Link HERE

SMS PHARMA LTD Recommended @ Rs.240 hits its life time high today @ Rs.650 .  Those with some risk appetite can still HOLD it .

 Recommendation Link HERE



Caplin Point Laboratories Ltd has informed the exchange that a license and distribution agreement has been made and entered by and between Caplin Point Laboratories Limited, India and Fresenius Kabi USA, LLC, a Delaware Limited Liability Company.
- See more at: http://www.indiainfoline.com/article/news-top-story/caplin-point-lab-enters-into-agreement-with-fresenius-kabi-usa-115040600017_1.html#sthash.TTi824vn.dpuf
Caplin Point Laboratories Ltd has informed the exchange that a license and distribution agreement has been made and entered by and between Caplin Point Laboratories Limited, India and Fresenius Kabi USA, LLC, a Delaware Limited Liability Company.
- See more at: http://www.indiainfoline.com/article/news-top-story/caplin-point-lab-enters-into-agreement-with-fresenius-kabi-usa-115040600017_1.html#sthash.TTi824vn.dpuf

Saturday, March 28, 2015

BASICS FOR BEGINNERS .....



Multibagger stocks: Manage risks and reap rewards

Courtesy : Economic Times
Multibagger stocks: Manage risks and reap rewards



Stock investing is inherently risky. Little wonder that it's not recommended for those who usually want to play it safe. Still there's no dearth of brave hearts who, in a bid to maximize gains, are always willing to take that 'extra' or even 'unlimited' risk.

After all, as the saying goes, there's no gain without pain. And there are stocks available for this breed of people as well. The 'only' catch is that if they can make one a millionaire, they can make one bankrupt too! But not everyone is scared, at least not the risk seekers. Even with all the risks and drawbacks involved in such stocks, many investors simply find the potential windfalls well worth it.
If you too are unable to resist the lure of big money, you can also take a chance. However, it is better to know the tricks as well as the risks involved before putting your hard-earned money into high-risk stocks.

Things You Should Know

The first question before venturing into high-risk stocks should be directed at yourself. Do you have the knowledge, temperament and resources to let you start investing in such stocks without seriously damaging your financial future? And exactly how familiar are you with these stocks and the way this market works? .The golden rule of investing is never invest in anything you don't understand. So, if you don't understand high-risk stocks at deeper layers, never take the chance.You also need to figure out the amount of money you are willing to risk investing in such stocks. In fact, you should limit yourself to that amount, and not a single rupee more. That way, even if the worst happens, you may be poorer, but you won't be destitute.


Get a Fair Idea of High-Risk Stocks

If you still consider them worth the risk, you should have some idea about these stocks, which include penny stocks, turnaround stocks and concept stocks.

Penny Stocks are of a company whose business failed and which does not have a revival plan to make it economically viable again. Because of the continuous erosion of shareholders' wealth, these stocks trade at low prices -- typically, between Rs 1 and Rs 10. However, since their levels are quite low, they sometimes represent great money-making opportunities with limited risk.

Turnaround Stocks are of companies which are not performing well for various reasons, including adverse industry fortunes, higher debt and higher interest burdens, accumulated losses, inefficient management or uneconomical size. However, when these companies go through restructuring or they see a management change, they can offer turnaround possibilities.

Concept Stocks are of companies that are likely to create significant value for investors in the future. Usually concept stocks trade at very high multiples because there are great expectations built into the future prospects of these companies. Organized retail, branded jewellery, wind power energy, security and surveillance systems, logistics, outsourcing and oil drilling are all concepts that are likely to have great demand going ahead.

Risks Involved with Penny Stocks

Liquidity Risk: Usually the major ownership of penny stocks rests in the hands of a few people like promoters of the company. If these people decide to unload a significant number of the stocks, the price drops steeply. Also, since most of the trades are speculative and not really backed by fundamentals, the moment there is a market correction everyone wants to get rid of these stocks, resulting in huge price corrections.

Trick Trades: Going by the past experience, penny stocks' prices are sometimes rigged and artificially inflated. Investors get sucked in looking at the price movement only to suffer later as prices drop when the traders offload large quantities of shares.

Corporate Governance: Most of the penny/small stocks are poorly managed and governed. Some of them don't even send their annual reports to investors!


Risks Involved With Turnaround Stocks

For these stocks, the turnaround may not sustain, leading to losses.
"The risk in turnaround stocks arises when a restructuring plan has yet to take shape, and only ideas are floating around. Normally, only one of 10 such companies will be successfully restructured, while the rest will be liquidated. Additionally, such companies carry a very low net worth on their books, and provide little cushion to equity investors," Dinesh Thakkar, CMD at Angel Broking, said.


Investors' Profile

Usually, retail investors/day traders invest in penny stocks are.

"These investors are risk seekers as they want usually high returns and, hence, are attracted to penny stocks. Sometimes greed and ignorance are the only explanation for some of these investments," T Srikanth Bhagavat, Managing Director at Hexagon Capital Advisors Pvt Ltd, said.Like penny stocks, turnaround stocks also bring in multiple returns, but investors in these stocks are convinced about the future profitability and are looking for high returns accompanied by some risks.


The conceptual style of investing is good in any market circumstance. However, benefits become more obvious over a longer time cycle.Therefore, relatively long-term investors looking for extraordinary returns are interested in concept stocks. Once these stocks come into the limelight, they generate healthy returns," Ashish Kapur, CEO at Invest Shoppe, said.

Precautions while Investing in Penny Stocks

Anyone new to investing in penny stocks should first be made aware of the differences between these stocks and the more conventional bluechips and midcaps.

"Unlike buying shares in a large, stable company like Reliance and SBI, you are dealing with speculative investments. Penny stocks and junk scripts look attractive to the investor when the indices are rising since the price of these shares usually rise faster than  the rise in prices of other shares. However, when the market falls, the investor is left with junk, which has no value," Kapur warned.

As a matter of principle, you should invest in only those penny stocks whose fundamentals are known to you. Also be prepared to hold on to these stocks till the market discovers the hidden value in them. You also need to diversify and never put all you money into a single stock, no matter how sure you are.

Precautions in Turnaround/ Concept Stocks

Often turnaround players report bumper profits after a "sad" track record. It is pertinent to understand the driving factors behind the profits. A savvy investor typically chooses companies that have started making profit at an operational level due to operational efficiencies and changing business fortunes. The company is in the first stage of turning around, though it is still in losses at the net level. There is a high possibility that it would make it to the net earnings level soon.

"As far as concept stocks are concerned, investors need to be educated about the conceptual style investing, as it requires commitment for a longer time from the investors. Also you need to have the ability to spot emerging trends in the social and industrial environment," Kapur said.

Identifying Multibaggers

Identification of these stocks is also far more difficult than large, reliable stocks. Picking these stocks, therefore, requires detailed understanding of their business and a vision to anticipate the future for the companies' business. It may also require an eye to discover the hidden assets in a deeply-undervalued company.

For instance, turnaround stories can be identified by closely keeping a watch on the concerned company, following its policies, results and other business activities. A close interaction with management and understanding of their decision making is also necessary. But these stocks come into light only after some of the turnaround has already happened and there are some signs of changes. Also, in such cases, the net worth of the company is generally eroded, and, therefore, one should look at the replacement value of the company. "This can be done by studying the company's EV to sales and comparing it with the industry average," Thakkar said.


Have Patience/ Conviction

Invest in these stocks only if you are fully aware of the risks involved and also know the market well. Whatever be the case, investing in theme/concept stocks requires patience and conviction.

"Patience because the sector/company which has tremendous value may take time to be noticed by the market, and conviction because without thorough knowledge of underlying value in the stock you will not be able to hold the stock for the period long enough for full appreciation to be realized," Kapur said.


Conclusion

Sure, these big prizes also mean the investor needs to be resourceful, have an upper hand on the information flow connected with the stock, and that means investing some serious time as well. An upside is that there are professional services available nowadays that can help big players with these investments. They may be in the form of private equity investment vehicles or hedge funds, etc..

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