Loss-making cos may be good bets, but not if they are multi-baggers

It is quite puzzling to see the dichotomy in the domestic stock market. While many companies which have posted decent growth in their profits in the last two quarters have failed to see their market caps rising significantly, many midcap companies, which are still making losses, have seen their stock prices multiplying.

About 50 loss-making companies saw their combined market cap moving up 78% in the last one year, while the market cap of BSE as a whole moved up only about 11% year on year. However, some of the individual stocks out of these 50 stocks have seen their market cap moving up 100% to as high as 2,000%. For instance, a small energy-related company, which has made a net loss of over Rs 3 crore in the June 2016 quarter and an annual EPS of less than a rupee for FY2016 has seen its share price moving up 12-fold from its 52-week low.

Three companies viz., Electrotherm (India), Ashima and Hinduja Foundries, which have made net losses in the last five quarters, saw their stock prices jumping 470%, 150% and 100% respectively from their 52-week lows.

Steel giant SAIL has also posted net losses over the last 5 quarters. In fact, its standalone net loss has gone up 66% year-on-year to Rs 535 crore in June 2016 quarter as compared to Rs 322 crore in June 2015 quarter. Despite such soaring losses, the stock price moved up 51% from its 52-week low.

Ideally, one should accumulate stocks of loss-making companies at the bottom of their prices only if one expects the company to turnaround or is hopeful of merger & acquisitions (M&As) event happening at much higher valuation than the current enterprise values. If one decides to buy stocks of loss-making companies after they have become multi-baggers, then mere turnaround is not enough – such turnarounds in the profitability should be large enough to make them still significantly attractive in terms of valuations after considering such surge in the stock prices.

Similarly, if investors decide to buy stocks of loss-making companies on the hope of M&A events, any possible acquisition of such loss-making companies would warrant that the replacement value of assets (including intangible assets) of those companies should be substantially more than their enterprise values estimated after such huge run-up in the stock prices.

Thus, the retail investors should ensure, before buying stocks of loss-making companies which have already become multi-baggers, that they still have possible value accretions in terms of potential earnings or acquisitions.

Otherwise, buying such stock, purely on the basis of perceptions would lead to complete wealth destructions.

(Stocks are mentioned here just for the sake of examples; they do not constitute any buy or sell recommendations)