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While there are some stocks with unique businesses and sound fundamentals that can be considered for long-term investment, there are others which are highly risky.
There is a new set of stocks that is attracting investor attention — those listed on the brand-new SME (small and medium enterprises) platforms of the Bombay Stock Exchange and the National Stock Exchange.
There are 25 stocks listed on the BSE SME platform and three on the NSE SME platform . Most of these are small companies doing Rs 50-100 crore in the topline and do not have a comparable peer in the listed space.
To keep away small investors from these stocks the securities market watchdog has kept the minimum investment in these stocks at Rs 1 lakh. Market lots in these stocks are fixed at the time of IPO (based on the issue price). Both at the time of IPO and in the secondary market, these stocks can be bought or sold only in the standardised lots.
However, investors are intrigued by the fact that of the 16 SMEs that have made public offers this calendar year, 13 are trading above their offer price. Even as the BSE IPO index declined 24 per cent since December last year, the BSE SME IPO index has rallied 131 per cent.
Many of these stocks have given hefty gains to investors on listing. GCM Securities, which was priced at Rs 20, listed on the BSE’s SME platform at Rs 68, giving a three-fold return. It is trading at Rs 131 now.
Ashapura Intimates Fashion made a 25 per cent gain on listing day and is currently over 80 per cent up from the issue price of Rs 40. So, should investors consider investing in these stocks? A close look at the companies reveals that investors need to be extra cautious in dealing in these stocks. While there are some stocks with unique businesses and sound fundamentals that could be considered for long-term investment, there are many which can be highly risky, too. Here are three factors you should check before taking the plunge.
INSTITUTIONAL HOLDING
One way of selecting SME stocks would be to look at the institutional holding since a higher holding by large institutions would mean better governance and higher accountability. In most of these companies, promoters hold almost 40-60 per cent of the stake.
Institutional holding is very small at around 1.5-2 per cent in some and absent in many companies. The three stocks listed on the NSE’s SME bourse, however, have institutional holding of 11-16 per cent. In Thejo Engineering, for instance, Indian Overseas Bank, SIDBI Venture Capital and CanBank Venture have stakes.
The merchant banker to the issue would also give clues about the company. In an SME issue, the merchant banker has a key role to play with responsibilities of underwriting the issue (100 per cent), market making and undertaking the pre-issue due diligence.
Of the 13 issues on the BSE’s SME platform this year, seven have been handled by little-known Guiness Corporate Advisors, a Kolkata-based investment banking company. On the NSE’s EMERGE, the issue of Thejo Engineering was handled by Prabhudas Lilladher.
BUSINESS MODEL
Now, are all the SME stocks that have given multi-fold returns good fundamental picks? Not necessarily.
Take, for instance, GCM Securities. This company is engaged in the business of equity broking. Till FY11 GCM Securities was making only marginal profits. But all of a sudden, in FY12, the company made a bumper profit and recorded a PAT margin of 30 per cent as against a loss margin of 0.8 per cent in the previous year. How the company achieved this feat is not clear. In FY13, the company reported a per share earnings of just 14 paise.
The case of Sunstar Realty Development (return of 50 per cent from the offer price) is also not convincing. Revenue for FY12 fell 85 per cent compared with FY11 due to lack of projects.
The company does not have expertise in real estate development and as its projects are currently in West Bengal and Gujarat, which are not among the prime real estate markets in the country. Risks are high in the business .
Esteem Bio Organic Food Processing (return of 165 per cent from the offer price) which is in the business of organic farming and raised Rs 11.3 crore from the capital market has recorded lacklustre numbers for FY13 with profits falling 13 per cent. It has already used up Rs 5.2 crore of the IPO money.
The company has ambitious plans to enter dairy farming, logistics parks for food, floriculture and horticulture. None of these can be accomplished with an investment of Rs 10-11 crore. So, this again is not a stock to keep in the portfolio. HPC Biosciences, E Dynamics and Ashapura Intimates Fashion too, do not look tempting.
Interestingly, all three stocks on the NSE SME platform seem to have a more convincing business model and financial performance.
Thejo Engineering, a company that provides repair and maintenance services for conveyors in the mining, steeland cement sectors, is actually a good bet with a business model less dependent on capex spends of clients. In the last three years, the company’s revenues have grown at a compounded annual growth rate (CAGR) of 24 per cent and adjusted profits at a CAGR 72 per cent.
Another stock, Opal Luxury Time Products, also looks a good pick. The company manufactures and sells clocks, both in the premium and economy categories. It is an established brand with a good distribution network across India. Opal’s revenues grew at an annual average rate of around 40 per cent between FY09 and FY13, while profits grew at an annual average rate of 52.5 per cent in the same period.
The stock of Veto Switchgears and Cables which is in the business of making and selling cables, switches and electric fans, is also attractive. Between FY09 and FY12 the company has grown revenues at an annualised rate of 18 per cent by increasing penetration in the northern markets. In FY12, the company’s profits grew 47 per cent and margins were around 9 per cent — on the higher side of the industry’s average.
VALUATION
Most stocks that listed at a hefty premium have rallied further in the secondary market and are trading at crazy valuations. Sunstar Realty Development, for instance, is trading at 200 times its per share earnings of FY13.
E-Dynamics (which is in the business of online retailing of groceries and electronics) is trading at 900 times its FY13 EPS. Esteem Biosciences and Samruddhi Realty are at 26-27 times. GCM Securities, which trades at Rs 130 per share, actually made an EPS of just 14 paise last year. Given that the BSE Small-Cap index, where the stocks are of much larger market capitalisation, is itself trading at only 32 times (trailing twelve months), the valuations here are really steep.
Some stocks where the valuations are still attractive are Thejo Engineering, which trades at 5.5 times its trailing per share earnings of last one year, Veto Switchgears, which trades at around 10 times, and Opal Luxury Time Products, which discounts its trailing EPS by seven times.
LIQUIDITY
Investors need to be aware that transacting on an SME platform is a different ballgame compared with the normal platform. Liquidity here is extremely low. Monthly turnover in any SME stock on the BSE is around just Rs 50-90 lakh.
In NSE’s EMERGE too, volumes are around the same levels. The stock of Veto Switchgears and Cables saw a turnover of Rs 72 lakh in June. The turnover in Thejo Engineering in the same month was Rs 29.15 lakh. Opal Luxury Time Products too, has scanty volumes.
Volumes on the platform may never grow to the size witnessed on the main board due to low levels of trading. However, investors need not fear liquidity risk for the first three years post-listing.
SEBI stipulates that the merchant bankers should act as market makers in the stock for three years.
This means that the appointed market makers will provide two-way quotes for the stock. They will hold a certain number of shares of the company and facilitate trading in that security by becoming the counter party to a buyer or a seller in the stock. So, it may not happen that you want to exit the stock but there is no buyer on the other side.