Clash of conventions

Is volatility good? Can you trust promoters pledging their shares? Do cash-rich companies need investors?

By Mohan Sule

Stocks have been volatile of late, rising and falling with the flow of news. A sudden development interrupts consecutive days of unilateral direction of the market. On some other occasions, equities plunge or surge with equal ferocity on alternate trading sessions or even intra day. Events influencing investing are not necessarily confined to India. Stalling of key bills in the Rajya Sabha pulls down the market and so also improvement in US jobs data, sparking fears of US Federal Reserve sticking to its course of hiking interest rates from June. Similarly, cut in lending rates by China’s central bank casts a gloom on worries that the move will increase consumption of commodities by the largest manufacturer in the world and thereby boost prices as well as on concerns that the issue of retrospective collection of minimum alternative tax will drag on in courts. Besides the softening of the position of Greece on payment of debt instalments, putting on block a couple more PSUs for stake-sale and reworking the urea subsidy mechanism to kick start fertilizer production induce optimism. In short, the market is jumping from one issue to another without letting the resolution of earlier problems to percolate. This is because valuations have raced so much ahead, taking for granted that the NDA government will be bombarding the economy by one reform after another. Earlier, the delay by parliament in approving increase in FDI in the insurance sector to 49% was painted as the ultimate reform on which the well being of the economy hinged. Now it appears that the passage of the amended Land Acquisition Bill is the final frontier for India to conquer.

It should be evident by now that the Narendra Modi government wants to take one step at a time, covering its tracks even if it means delays, so it cannot be accused of carrying out reforms at the behest of certain sections of industry or to appease some other segment. In the process, however, it is the retail investor who is left wondering if the market flux is here to stay or temporary. Yet, realization in emerging that volatility may not be bad after all. For every foreign institutional investor fed up with the dodgy interpretation of tax rules in India, there might be a mutual fund familiar with the grinding speed with which the bureaucracy functions but still believes in the India growth story. The wild fluctuations are more likely to be a clash of opposing views rather than a reflection of a shallow market. The correction and recovery ensure valuations do not enter bubble territory or a downturn. A secular trend is more dangerous as it exemplifies unwarranted pessimism or irrational exuberance. The severe market gyrations should lead to rethinking of the vanilla concept of bull and bear phases. The other is of pledging of shares by promoters, which triggers a reflex ` sell’ action by investors, conjecturing all sorts of dark scenarios ranging from extravagant lifestyle of the owners to mismanagement.

Not all companies operate in ever-green sectors such as FMCG, pharmaceuticals and tech. A developing country needs capital-intensive industries. These companies have lots of debt, low promoter holding and ongoing capital expenditure. Shares are mortgaged to fulfil promoters’ contribution or to buy more shares to retain controlling interest after equity dilution. Better a promoter who publicly pledges his shares and invites focus on his company than who liquidates his holding in trickles and dribbles while the going is good. An extreme view is that it is only a matter of time before such inefficient promoters are dislodged in favour of an agile management. Another traditional position is being threatened in the face-off between companies preferring to keep investors happy with liberal dividends and those that are undertaking expansion and diversification for capital appreciation. Investor activists demand cash-rich companies to go for buybacks or increase the dividend rate and, in the process, further boost their valuations. The problem is that the perceived tax-free status of dividends despite the dividend distribution tax attracts risk-averse investors to dividend-yielding scrips over taxable fixed deposits or growth stocks. The fear is that acquisitions will result in leveraging of the balance sheet and sometimes turn out to be bad fits. Capacity expansion can go horribly wrong if anticipated demand does not materialise or there is disruption in the market. Yet, dividend yield too varies depending on the mood of the market. Just as interest rates recede, premium on companies with generous payouts also shoots up in a bull run. So if equity investing is providing risk capital, why chase overvalued companies not in need of cash?