To catch a falling knife’ is a popular market saying and is thrown about when one wants to buy into a stock that has plummeted. The underlying belief being that it will bottom out and reverse trend soon. In the current scenario, there are a lot of stocks that have lost 30-50% of their market cap and seem attractive when compared to their glory days. The table Bottom-less is representative of the truism that low price does not necessarily equate value.
Nilesh Shah, CEO, Envision Capital Management explains. “Price is just a reference point. It says nothing about the intrinsic value of a business or how much a business is worth. So, a low price does not mean a business has huge value. When a stock falls, one needs to figure out if the fall is temporary or due to a permanent impairment in the business,” he says.
Take, for instance, REI Agro, which was once the world’s largest rice processing company. The promoters held 47% while FIIs held in excess of over 40% in 2013, when the stock was quoting at Rs.10. While that might have seemed low-priced, the stock has continued its slide and now trades at Rs.0.50 after a fraud allegation against the promoters. Lanco Infratech is another example. It traded at Rs.75 in 2011 and had a market cap of over Rs.20,000 crore on an equity of Rs.4,600 crore. However, losses incurred due to high interest cost have knocked its price down to an all-time low of Rs.4.
In debt we trust
Investors often hope to find diamonds in the dust, but a happy ending is never guaranteed. If one looks at Unitech, its equity is over Rs.10,000 crore and debt around Rs.5,200 crore, but its market cap is Rs.1,200 crore. In FY16, the company was not able to cover its interest cost of Rs.347 crore and hence, incurred a loss of close to Rs.1,000 crore. Though the developer has close to Rs.4,000 crore worth of inventory, including land that is currently valued at Rs.3,500 crore, the market is skeptical about the optimum utility of the inventory owing to hurdles in terms of approvals and execution of projects. Besides, its con