Looking for stocks headed for better times? Here are 5 signals

Low returns in asset classes such as gold, real estate and bonds have made many individual investors dabble into equity. Some choose to take the less painful mutual fund route, the adventurous lot goes for direct stock-picking. While it takes years to master the art and science of stock-picking, experts offer some hand-holding in the form of indicators for better times ahead for a stock.

Promoter buying

There could be many reasons why a promoter is selling, but there could be only one reason behind why a promoter is buying — the stock is attractive. When the promoter is purchasing shares from the open market, it is safe to assume that the shares are undervalued.

“If the promoter chooses to convert optionally convertible preference shares into equity shares at a premium to the market price, rest assured the business is grossly undervalued,” says N Arunagiri, MD and CIO of Chennai-based TrustLine India, a portfolio management services provider.

If you see promoter's converting warrants at a sizeable premium to current price of the shares, then it shows that promoter sees better times ahead.  Effectively, these actions increase the percentage ownership of the promoter in the company as compared to other non-promoter shareholders. In good times, the promoters want to keep more of the rewards the business generates by hiking their stake in the company.

Some smart investors also keep a track of placements to the promoter and promoter purchases from the open market. But be careful, do not construe shares transfer between two promoter entities as promoter buying. “Promoter buying generally is seen positively. However, if you see a promoter buying his shares from the market immediately after an IPO, he is trying to pump up the share price,” says Viraj Mehta, head-PMS, Equirus Securities. Also steer clear of small sporadic purchases by promoters.

“Do check the shareholding pattern of the company. If you see sustained increase in promoter’s ownership over a few quarters, then you can conclude that the promoters have a positive view on that business,” says Rusmik Oza, senior vice president and head-midcaps, Kotak Securities.

Management actions

Many companies are run by professional managers. In some companies the promoters leave all business decisions to professional managers. Top management of a company has a good understanding of the business prospects. If you see substantial increase in the employee stock options in the top management’s compensation packages in manager-driven companies, there could be a case of better times ahead. It holds the other way round too.

“If you see large selling by ESOP holders and top management by the company ahead of a milestone event or earning release, be cautious,” says Arunagiri.

Buybacks where the promoters are not participating

“Buyback is done for two motives. First, it allows the company to distribute cash in a tax-efficient manner and second it signals that the stock is relatively undervalued and supports the stock price,” says Oza. Many companies announce buyback and you should clearly understand the motive behind the buyback. Recently many government owned companies announced buybacks. The government too participated in those buyback and tendered the shares to achieve the disinvestment targets set. Here the motive was very much clear - to further the disinvestment process.

If the promoter does not participate in the buyback offer, then his ownership in the company goes up in percentage terms after the buyback concludes. “Look for those buybacks where the company is buying back at least 10% of outstanding equity,” says Arunagiri. In such companies the promoter’s share in the company goes up substantially. Such companies can be looked at for investment purpose.

To avoid the burden of dividend distribution tax some companies announce buyback to distribute cash in lieu of dividends. These companies need not necessarily make great investments at that price. “If a company is opting for buybacks at regular intervals and the promoter is not tendering his shares in it, it could be a great investment. While dividend is a one-time cash payout and has no impact on the business in the following year, the buybacks keep eroding the equity base of the company which in turn enhances the return on capital for shareholders,” says Mehta.

Action in subsidiaries

Many times investors keep a track of listed companies and the corporate actions associated with them. But some listed companies are mere holding companies and their financials do not show the true worth on standalone basis. You have to look at the wholly owned subsidiaries to understand the growth opportunities. “If you see a subsidiary placing shares to large institutional investor or a technology partner overseas at a significant price – closer to the market price of the listed company or even higher, then that subsidiary may bring in the growth in future,” says Arunagiri.

New product launches

“Keep a track of new product launches announced by the company. These can open doors to opportunities of growth,” says Oza. New product launched can bring in blockbuster profits in businesses such as pharma, automobile, some white goods and patented product businesses.

Above factors should be used to screen hundreds of companies listed in stock markets. Companies showing these indicators do not make a ‘must buy’ just because they satisfy one or more such conditions. One has to drill deeper into the business and financials along with valuations the business commands before biting the bullet.