Saturday, May 26, 2012

Are you riding this stock bubble?

2011 was a year that most equity investors in India would want to erase from their memory. The BSE-Sensex had ended the year down by almost 25% from a year ago. Though the Indian share markets recovered somewhat in the new year, the benchmark index is still down about 10% on a year-on-year basis. But there is this particular segment of stocks that has been outperforming the broad market by a massive margin. In fact, if you consider the change in their share price over the last one year, most of these stocks have delivered hefty returns.

Can you guess which stocks we are referring to? The answer is stocks of multinational companies (MNCs). But why have these stocks gained so much? Do they have such strong fundamentals that they have been unaffected by all the issues and concerns weighing over the Indian economy? The answer is no.

If you may recall, the minimum public shareholding rule was announced back in 2010. As per this guideline, all listed public sector companies are expected to maintain a minimum public shareholding of 10%. On the other hand, for listed private sector entities the threshold is set higher at 25%. To put it in other words, private sector promoter are required to bring their shareholding down to below 75% of the total equity. The deadline for complying by these guidelines is June 2013.

But how does this relate to investors piling up MNC stocks? Let us explain. Many of the MNC stocks listed on the Indian share markets do not have the minimum shareholding requirement as per the mandate. The promoters of these companies have two options to deal with the situation. Either they can dilute their shareholding and raise the public shareholding. Or the promoters can raise their stake to over 90% and delist from the stock exchanges. In the case of MNCs, the likelihood of the second possibility is significant. They often prefer to delist than to dilute their stakes. Some argue that even paying a significant premium would not be difficult for MNCs given the financial muscle of their parent companies.

So the entire run up of MNC stocks has been in the anticipation of delisting gains. Agreed that most of the MNC stocks have good fundamentals and strong balance sheets. But do these qualities call for so much of a premium over their counterparts? We do not think so. As per our dictionary, this is nothing but mere speculation. Would you like to bet your hard-earned money on the shaky premise that a company may delist from the bourses? What if the company chooses not to? Then prepare yourself for a massive loss as the stocks crash.

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