As diversification takes spotlight for India Inc, here’s what equity investors should do

Synopsis

In fact, such a plan, especially when it is in a sector where the company doesn’t have core competency may even become a distraction and may also paralyze it from making any other investment that could reap higher rewards. Another spillover of such plans is that they tend to intensify the competition and cause FOMO among the existing players, which eventually leads to more capex than required.

ETMarkets.com

Strategic investments, especially mergers and acquisitions, have become the new fad in India as companies with deep pockets shell out huge amounts to pursue inorganic growth. This frenzy is witnessed across sectors, with recent major investments seen from paints & cement to media & entertainment, from transport logistics to pharma. The aim is to be at the forefront of capitalizing on the market’s emerging opportunities. With the intent to rapidly scale, many companies are paying astonishingly high premium prices for acquisitions. Moreover, most of these plans are solely being funded with debt, making certain deal values more questionable. In this context, history does force us to ponder on whether these plans as well as the premiums paid are justified?

While any capex plan that yields value to the company is an investment, a failed capex leads to a sunk cost that ultimately is borne by the shareholders of the company. If a firm hits the bull’s eye by recognizing the right opportunity, it may bolster its prospects, lead to deeper market penetration, aid in driving return ratios upwards and be accretive for shareholders. However, the scenario can turn quite ugly if the capex doesn’t result in desired outcomes. In fact, such a plan, especially when it is in a sector where the company doesn’t have core competency may even become a distraction and may also paralyze it from making any other investment that could reap higher rewards. Another spillover of such plans is that they tend to intensify the competition and cause FOMO among the existing players, which eventually leads to more capex than required.

Along with questions of poor capital allocation, such plans need more scrutiny especially when companies resort to debt as a source of funds to honor the deals and promises. As evident from one of the past leaders in the wind energy space, if things get tricky, the firm eventually ends up in deep trouble, bogged down under a mountain of debts and uncertainties, with a question of sustainability in the future. A similar consequence was witnessed when a media major in the past forayed into the infra sector while it was hot and ended up defaulting on credit payments leading to massive wealth erosion for investors.

So the key here is that investors need to be very cautious while investing in such companies. Over the long run, very few companies have been able to successfully diversify into unrelated sectors and make good returns for their shareholders. As a result, investors should carefully evaluate such plans, check the debt levels of such companies, and especially in trying times like these stick to investing in efficient companies that are able to sustainably generate higher return ratios.

Technical Outlook

Following weak global cues, Nifty50 closed this week on a sharply negative note. The index decisively has broken below the crucial support of 15,700 and this implies that further downside from here. While the market sentiments are highly bearish, the indices have become oversold in the immediate to short term. Even the major global indices are trading at the falling channel support. Therefore, a brief short-covering bounce cannot be ruled out. We suggest traders maintain a mild negative to a neutral outlook going ahead and use any bounce as an exit opportunity. Immediate support and resistance are now placed at 15,200 and 16,200 respectively.

image1Agencies


Expectations of the week

Indian indices are expected to be jittery, moving in tandem with weakness in the global peers as investors remain concerned about sky-rocketed inflation. Given the lack of major domestic events and the continuing dominance of global macros, market participants will keenly monitor the movement in the dollar index, crude oil prices and development of the Covid situation in China as well as India. With S&P 500 as well as our banking index officially in the bear market territory, fear will remain elevated. Investors are therefore advised to remain cautious and to initiate making small selective investments in fundamentally superior companies that are available at reasonable valuations. Nifty 50 closed the week at 15,293.50, down by 5.61%.

(Disclaimer: The opinions expressed in this column are that of the writer. The facts and opinions expressed here do not reflect the views of www.economictimes.com.)

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