Hard lessons to learn from five stocks that crumbled in 2018

Over the last year, while the Nifty was mildly positive, the real correction was in the mid-caps and the large caps

The Nifty may not have been substantially impacted in the last 1 year and may have actually given positive returns. However, the pain has been a lot more pronounced in the mid caps and small caps. Over the last one year, while the Nifty was mildly positive, the real correction was in the mid caps and the large caps. While reasons touted ranged from the tax on LTCG to the mutual fund reclassification to the additional special margins, the actual reason was a return to reality. Here are five stocks that saw a return to reality and the lessons underlying the same.

Five stocks that crumbled in 2018

Chart Source: Bloomberg

The stocks that crumbled were from diverse sectors. From software to housing finance to jewellery to banking; the story was largely about corporate governance and lack of transparency. Yes Bank may look relatively better off with a 30% correction but this conceals the fact that the stock has bounced sharply from lower levels. On a point-to-point basis, it was a lot worse.
 

Vakrangee: The stock tanked over 80% in 2018 and the fall started when SEBI initiated investigation into price manipulation by group companies. There were also doubts raised by auditors about the number of Vakrangee facilitation centres, which was supposed to be far less than the 35,000 claimed by the company. The result was a severe run on the stock.

PC Jewellers: The Company took a sentimental hit after the Nirav Modi episode but some of its investments came under scrutiny as well as some of the promoter actions being largely contrary to the interests of minority shareholders.
 

Infibeam Avenues: For quite some time the company was on Cloud Nine. It had acquired one of India’s oldest payment gateways, CCAVENUE last year. Soon it became apparent that the company had made some opaque intergroup transactions. It has been falling since.

Dewan Housing: For a long time, this stock was preferred by retail and institutional investors alike. When IL&FS crisis broke out, it became apparent that DHFL was applying long term funds to short term loans. Ratings were downgraded and it has been down since then.

Yes Bank: This was a slightly more complicated story. Apart from NPA issues, the bank also had problems with management shift. The stock has bounced with the change in management, but the overhang of asset quality still remains.

Key takeaways from the five stock crash list

If we were to summarize the lessons of these five stocks (these are just a sampler, and there are many more), there are 3 lessons that we can glean from the same.

• The big lesson is corporate governance. In fact, the common thread running through the above five stocks is about poor corporate governance standards. In the last few years, the markets have been extremely severe on companies where the interests of the shareholders were not aligned with the actions of the management. In the case of Infibeam, the company did not disclose the inter group transactions. There were cases like Manpasand Beverages where auditors had resigned on technical grounds. In the case of Dewan Housing, the markets were worried that all funding and asset allocation decisions were not in the interests of shareholder value. That is likely to be an enduring theme in the current year too.

• Vulnerability of the core business is another issue. In many cases, this may not be immediately visible. As investors, this is a key question that they need to ask. Take the case of Dewan Housing. On paper, the stock was looking great. But the model had risks on both sides. On the supply side, it was sourcing short term CP funding and on the demand side it was financing the realtors. When the IL&FS fiasco created a liquidity crunch it hit DHFL in terms of funding costs as well as client defaults. Businesses may be vulnerable but that may not always be obvious.

• Be cautious when valuations run way ahead of the visible business model. In the above case, most of the stocks had serious issues of valuations. There were too much expectations built into the price and therefore the P/E compression was as rapid as the P/E expansion. Just as an aside, a P/E of 100 means that the company has the potential to double its revenues and profits each year; obviously a scenario that is not tenable. When valuations are entirely out of line with the industry average it is time for investors to tread with caution.

Of course, these are not the only five stocks but these are perhaps the 5 prominent stocks that corrected sharply in 2018. Interestingly, the hard lessons are likely to endure in this year too!

Disclaimer: The above opinion is that of Mr. Amarjeet Maurya (AVP – Mid Caps - Angel Broking) & is for reference only.