Off-late a lot of skeletons are falling out of the closet. In the last few months, we have had stocks of several high growth companies falling off the cliff with investors not getting an opportunity to exit. With the use of technology, while it has become easy to spot companies with high growth and other parameters, it has become all the more important to find how the growth is being funded and whether the reported growth is real or fake.
While there are no sure shot signs and there are always exceptions, we like to avoid companies which exhibit following traits:
Frequent fund raising/equity dilution – Normally, we avoid companies which keep on raising funds by diluting equity. Yes, while it’s not a sure shot sign of trouble brewing in the company, it does tell us the fact that either the company is trying to be too aggressive or the business isn’t self-sufficient enough to generate funds for expansion.
It also tells us that promoters themselves don’t value their equity much in the company and a lot of times such promoters have even siphoned out funds from the company.
Too many acquisitions – It’s well known that no matter how much the promoters talk about the synergies from acquisition, most of the times the acquisitions turn out bad or the price paid turns out to be too high with subsequent write-off.
An occasional acquisition of a company and that too of a manageable size (with respect to the acquiring company) is understandable; however frequent acquisitions are most definitely a red flag for us.
Consistently increasing debt – Well there are several examples like Bhushan Steel, Amtek Auto, Kwality Ltd, etc of the companies where the debt on the balance sheet increased with every passing year. The common pattern that we have found is that sales, profits for such companies also grow every year just like their debt and suddenly one year they report huge loss and become bankrupt.
While debt is lifeline for capital intensive businesses; however if the company isn’t taking breather and consistently expanding by taking on huge debt then some day or the other it will find itself in trouble.
Formation of too many subsidiaries – It’s been observed that companies that form too many subsidiaries are generally up to something. A lot of times, such subsidiaries are formed for the purpose of siphoning off funds.
Basically, the modus operandi is that parent company offers loans to such subsidiaries, which then are unable to perform up to the mark or report losses and finally the loans and advances are written off. While there could be genuine cases as well, but a lot of times promoters take out money through such subsidiaries.
Disclosure: I don’t have any investment in the stocks mentioned above, nor have traded in them in the last 30 days.
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