Scout for Special situations in Secondary Market

Profitable investment opportunities exist in the secondary market. However, they are often not easy to identify. You have to be alert, discerning and also lucky to locate them. They perhaps occur with greater likelihood in the following situations:

Turnaround Situations: A turnaround occurs when a company steeped in bad performance and losses for years begins to recover. Because of its dismal past and accumulated losses, its shares often sell at a discount – a Rs 10 per value share may sell for Rs 2 to Rs 5. When the company recovers fully and can look forward to a confident future, the share price appreciates dramatically. A Rs 10 par value share may zoom to Rs 20 to Rs 40 or even more. Some examples of such turnaround performance are: EID parry, SAIL and Arvind Mills. In cases of this kind, investors who anticipate the turnaround ahead of the market and buy when the share prices are relatively depressed, gain substantially. In other words, they reap the rewards for their alertness and perceptiveness.

An investment analyst says: It takes about six months for a turnaround to present its improved performance to the market. The scrip then will be in the market’s eye for at least another six months. In other words, if one buys at the start of a turnaround one can sell after a year and still get the best price, while qualifying for long term capital gains for tax purposes.

Amalgamations: An amalgamation also referred to as a merger, refers to a combination of two (or more) companies into one company. Generally, an amalgamation is advantageous to both the companies as it results in operational economies, better utilization of tax shields, and risk reduction. Hence shares of companies participating in an amalgamation scheme tend to be attractive investment opportunities.

In particular an amalgamation favors a weaker company more. Recall how SEWA Papers – Ballarpur Industries merger provided substantial benefits to the shareholders of SEWA Papers.

Takeovers: A takeover involves the acquisition of a certain block of equity capital of a company which enables the acquirer (also referred to as the raider) to exercise control over the affairs of the company. Whenever there is a takeover bid, the market price of the target company tends to shoot up because of frantic buying by the raider as well as the existing controlling group (which is interested in consolidating its holding to avert the takeover bid) We have witnessed this in many cases like DCM, Escorts, Raasi Cement, and Indian Aluminium. Whether successful or not, takeover bids provide opportunities for the shareholders of target company to sell their shares at inflated prices and for other investors who buy in anticipation of the price rise.

Bonus Candidates: Bonus shares are shares issued to existing shareholders when reserves are capitalized. To illustrate the nature of this capitalization, consider the following data for a company:

Paid up equity capital (10 million shares of Rs 10 each): Rs 100 million

Reserves and surplus: Rs 300 million

If the company issues bonus shares in the ratio 1:1 (1bonus share for every share held in the company) Rs 100 million of reserves and surplus has to be capitalized. When that is done, the following picture emerges:

Paid up equity capital Rs 200 million
(20 million shares of Rs 10 each)

Reserves and surplus: Rs 200 million.

In the wake of a bonus issue (1) the shareholder proportional ownership remains unchanged and (2) the book value per share, the earnings per share, and the market price per share decrease, but the number of shares increases. This implies that the issue of bonus shares is more or less a financial gimmick without any real impact on the welfare of equity shareholders. Still shareholders greet bonus issues with a lot of cheer. Why? The primary reasons are: (1) Shareholders regard a bonus issue as a firm indication that the prospects of the company are bright they can look forward to higher earnings and dividends. (2) The bonus issue tends to bring the share price within a more popular range and hence stimulates greater investor interest.