The recent instances of corporate governance concerns in stocks like Gensol and IndusInd Bank and the resulting crack in stock prices has led to significant despair amongst investors. Therefore, it becomes important for new investors to follow some cardinal rules while putting in their money in the stock market. Saurabh Mukherjea, Founder & CIO, Marcellus lists out five red flags that every investor must watch out for and shares his mantra on how they can avoid silent traps.
What are the silent traps for investors in India
Given the euphoria in the stock markets many investors rush in to invest with hopes of garnering stroking returns. According to Mukherjea this is not the best way to enter markets. He pointed out that having a reasonably strong savings is often the first stepping stone for entering markets, “My suggestion is that potential investors must have at least two years of living expenses in a bank Fixed Deposit or a liquid fund before beginning to invest in stock markets. The stock market is volatile, the world over. Therefore when you enter the stock market, have a couple of years of buffer.” Instead what’s often the case is that many people enter the markets after raising money through unsecured loans or via credot cars. This according to him is a strict no.
He explained that just buffers are not enough. As the old saying goes, never put all your eggs in one basket. He advises that, “Assuming you’ve got the buffers sorted out, diversify them, even if it is within India. Don’t have more than 20% of your portfolio in small and midcaps.”
On the point of diversification, he believes that diversifying in equities across India and the United States could be one welcome approach. Giving his reasons and the investment rationale, he added that, “ You don’t want the whole world, at the very least diversify across Indian and American equities. As I said, the long-term capital gain structure is the same, most brokerage apps in India now have easy access to the American market. The Indian and American markets are the two best performing markets in the world and thankfully these are the two least correlated large stock markets in the world. If you have 50:50 in either market and you rebalance annually, your returns will be above 11%.”
What are the five red flags that every investor must watch out for
Saurabh Mukherjea also listed out the key factors that every investor must keep in mind while choosing stocks-
1. Where is the money: According to Mukherjea, it is important to trace the money trail before investing in a company. “If a company is raising money at the top of the stock market, and that money isn’t showing up on the balance sheet in terms of Capex very quickly, that should be a relatively easy red flag,” he added.
2. Check auditor’s background: The second is checking the auditor’s background. He pointed out that it “is reasonably easy to check, the auditor’s or the Chartered accountant’s number is given. If there is any anomaly, then be careful. It’s easy to check auditors out on the Internet.”
3. Who are board members: This is again information easily available. The composition of the board is crucial. “If the board is dominated by the same family, the promoter family and hired executives with the Independent Directors coming from the same community as the promoter, I think that’s the third red flag right,” he explained.
4.Capex timeline: Fourth, if a Capex project is announced, Mukherjea suggests that investors need to look out for actual merit of these projects. According to him capital intensive sectors may see a whole of capex announcements but “if in a non-capital intensive sector, the promoter is constantly announcing Capex projects, I think it’s worth looking under the hood whether the announced project is simply an excuse for stealing money from the company.”
5. Diversification crucial: According to Mukherjea, one sure formula for failure is concentrating too much in the small and midcap space. According to him, small and midcaps should comprise only 20% of one’s portfolio. Moreover, it is important to diversify into other markets and asset classes. He believes that diversifying into US equities is a good idea as they are trading at a discount to Nifty and moreover “US and Indian markets are least correlated.”