Thursday, April 12, 2012

Rights Issues - get it right!

People like me, who are not hyper-active in the markets tend to sit on decent percentage of cash for extended periods of time. While this cash typically earns the regular 7-8% in liquid funds, I keep on looking for ways to improve the return on this large part of my portfolio. Rights issues are a great way (among others!) to put the cash to some use and earn that extra return. If you are lucky, you will earn lots in rights issues. If you are unlucky, you wont lose much! Me likes! My kind of situation. :-)

Here is how it works..

One should not deploy money in each and every rights issue which hits the market. Some basic pointers..
1) The company should be a decent company, not going at atrocious valuations. (Although it doesn't matter if its a bit expensive)
2) The rights issue price should be at a decent discount to the current market price. So, a Bajaj Hindustan will not do, but a Neuland Labs will do!
3) If its an unknown company will less institutional holding, it would be great. (I will clarify why it is so in due course.)

Lets say that A Ltd is coming out with a rights issue. The ratio is 1 share for every 2 shares held. The CMP is Rs.50 and rights issue price is Rs.30. Record date is April 19, 2012 (Ex-date will be April 18).

1) Buy 100 shares of A Ltd. close to the ex-date, on lets say April 15th itself at Rs.50. (So that on ex-date, the shares will be there in your demat account.)
2) On ex-date, the stock price should fall in the proportion as well as price of the rights issue. (Although, in the recent case of Neuland Labs, it did not fall at all!) Lets say here, it falls by Rs.8 to Rs.42.
3) Sell your original shares on ex-date. There would be a total loss of Rs.800. However, since you sold on ex-date, you are still eligible to apply for the rights issue.
4) Now, you can participate in the rights issue. On the original 100 shares, you will get 50 shares guaranteed (1 for every 2 held) at Rs.30.
5) However, while applying for the rights issue, you can always apply extra. Here, lets say that you applied for 950 extra shares. Total application would be 50+950=1000 shares at Rs.30 each.
6) Now, if all shareholders apply for the issue, you will not get anything extra. So, you will get only 50 shares at Rs.30. Lets say you are able to sell them at Rs.42. Thats a total profit of Rs.600. So, along with earlier loss of Rs.800, net-net, there is a loss of Rs.200 on the entire transaction. Since original position is small, the amount of loss is not much, in absolute terms/as a % of portfolio
7) However, if its an unknown company etc, where other shareholders did not apply, you can get extra allotment. Lets say, you got all 1000 shares you applied for, at Rs.30. And you managed to sell them at Rs.42. Thats a profit of Rs.12000! Minus original loss of Rs.800, which gives us a net profit of Rs.11200. Not bad. (I am not considering short term cap gain tax etc to just to keep things simple.)
8) The only risk here is in a situation where you got full allotment, and by the time the allotment was done, the stock price just crashed much below the rights issue price..then you are in trouble. That is why I laid down some basic pointers above.

So if you are lucky (yes, total luck, not skill!), you will get extra allotment and earn decent amount. If you are not lucky, the loss will not be very high, since initial position itself was small.

Some rights issues in which I got lucky in the recent past were Camlin Fine (got HUGELY lucky here!), SBBJ, etc. Others, in which I was not so lucky (no extra allotment) were Veljan, Sadbhav Engg (this one was interesting, since there were attached warrants too), etc. However, there was no loss in the same. Lets see what happens in Neuland!

One tukka in rights issues, where you get massive allotment, can give a huge alpha to your portfolio. e.g. in Camlin Fine, market price was Rs.105 (Rs.10 paid up), while the rights issue was at Rs.15.75!!! I applied a lot extra and for some reason, I got full allotment! Great return, without much analysis or trouble to the brain! Super balle balle.

Hope you get the rights right! Till then..

Cheers and happy investing!!

1) All the posts on this blog, including this one, are for educational and discussion purposes only.
2) I post articles on individual stocks as well as varied topics like behavioural finance, industry analysis etc. None of the material posted should be regarded as advice to buy/sell any stock. My articles are not recommendations to buy/sell individual stocks, and should not be construed as any form of investment advice.
3) I may have positions in stocks discussed. As a professional advisor, I advise clients regarding investments. They also may or may not have positions in stocks discussed, depending on their decision. 
4) PLEASE DO NOT TAKE BUY/SELL OR ANY INVESTMENT DECISION BASED ON ARTICLES YOU READ ON THE BLOG. These are only meant to provide information and initiate discussion. Final decision is and always should be, yours and only yours!

Wednesday, April 4, 2012

Skill v/s luck in investing - the eternal debate

I am very sure that we all have been part of this debate at one time or another in our investing lives. In my experience, the more drunk the participants, the more lively is the debate! :-)

There are some who really believe in their own prowess and opine that skill is the only factor which dictates success in investing. Well, perhaps these people have been fooled by randomness or have never been hit by a black swan event. These people should really read Taleb. :-)
There are others who say that investing is as good as (or as bad as) gambling. They opine that performance in investing is a matter of sheer luck. Believers in the Efficient Market Theory would surely say that if you are outperforming the market, it is only because you have been lucky. Well, these people should read Buffett! :-)

In my view, the answer lies somewhere in between and is a combination of luck and skill. Its like marriage. One would be lucky to get a good wife, but one has to be skillful so that she remains good to you! :-) Success in investing is a matter of luck as well as skill. However, the percentage of both differs in different situations.
E.g. There is skill involved in earning money as well as in not losing money. So if you avoided something bad, thats skill too. On the other hand, many times, one earns money by luck too.

But in my experience, here is what most people do. If they make money, its all skill, but if they lose money, its all bad luck!! I don't think thats a very great way of approaching things. Crediting skill when we make money leads to overconfidence and stupid decisions in future. Blaming luck when you lose money does not let us introspect and correct our mistakes since we think that we did not make a mistake, it was just bad luck!

Let me share a couple of my experiences with you.

1) Albright Chemicals (now, Rhodia Specialty Chemicals)
Albright was not an extraordinary business. But still, I had bought it for a specific reason. The company was available at a market cap of about Rs.50 cr. (Today its Rs.126 cr). The company had also published an advertisement for selling their land in Ambernath. The 26 acre piece of land would be worth about Rs.50 cr. Now, since it was very clear that they wanted to sell this land, its value becomes material. I thought the business to be worth Rs.45-50 cr plus the land worth Rs.50 cr more, giving a valuation of Rs.80 cr, after deducting Rs.20 cr if debt. So, something worth Rs.80 cr was available for Rs.50 cr. Decent logic, I felt, and I bought the stock.
After some time, suddenly, Solvay acquired Albright's parent, triggering an open offer. The stock price reacted and I sold at a decent profit.
Now, the question is, was this skill or luck? I believe the end result was a matter of pure luck. I had bought it primarily because of expectation of land sale, leading to increased valuation for the stock. The price did increase, but for a different reason. The land still remains unsold!! So, even though the end result was as per expectation, the reason for the end result were not as per expectation. Now, thats luck, wont you say?

So, in my view, if you bought something with certain expectations, and in future, the expectations materialised just as per your view, due to which you earned the desired profit, then its skill. Otherwise, even if you earned the profit, its all luck!

2) Provogue Ltd.
Boy, was that an adventure or what! :-) Although, I must say that it was not a very comfortable adventure! I did earn decent returns here, but it was all pure dumb luck. Absolutely no doubt about it!
The reasons why I bought the stock can be found here.
After some time, due to some changes which occurred in the situation, I decided to sell it before ex-date.
Now, all that I had thought would happen, did not happen!
- I had thought that on ex-date, the stock price wont fall much. Maaan, it fell huge!
- The reason I sold, was that relisting of Provogue could take lot of time..but it got relisted pretty fast.
- Creating free shares of Prozone was the main reason for getting into Provogue. That, it seems, would not have happened! :-)
So, absolute dumb luck it is!

There are other cases where I think I applied decent amount of skill..but there is no fun in talking about success stories, right? :-)

So all in all, we should always remain grounded, with understanding of the reality that luck does play a role in investing. Luck is something we cannot control, but skill is something we can develop. Let us all concentrate on that but not consider ourselves to be exceptionally skilled just because we earned money. If we do that, there would be no room for self-improvement.

On the same topic, me and my friend Ninad often discuss about the idea of positioning yourself for luck. If you can get yourself in situations where multiple lucky things can happen to you or no un-lucky thing can happen, that would be really something! But, that would be a topic for a separate post, I hope!

Till then,

Cheers and happy-go-lucky investing! :-)