Mar 21, 2008

Where are all the 'cash cows' of brokerages? - ET

The bear assault on medium- and small-cap shares, since mid-January, has killed the cash-cows of brokerages, especially those which service retail clients.

While the massive fall in these shares would have otherwise triggered a bout of fresh 'buy' ratings, as seen in the five-year bull run, this time, brokerages seem hesitant to take such calls amid concerns over adverse impact of global slowdown on business prospects and valuations of these companies.

Analysts in these brokerages are no longer recommending potential "multi-baggers", a euphemism for stocks that are expected to rise multi-folds. This is in stark contrast to the scenario prior to mid-January (start of the ongoing bear phase), when the seemingly never-ending list of multi-baggers, mostly mid-caps, had confused investors.

The question is, what has changed for medium- and small-cap companies in the last couple of months? Fund managers say valuations have corrected in line with the changes in global business scenario.

Also, with fund-raising plans of several companies hitting the roadblock after the fall in stock markets and interest rates still remaining high, there are concerns that their expansion plans could be delayed or shelved which, in turn, may affect their future earnings, they say.

Reflecting these concerns also is much sharper fall in valuations of mid-cap and small-cap indices in comparison to the broader indices. For instance, the BSE Midcap index slipped nearly 4,000 points, or 40%, from its peak of 10,113 recorded on January 1, '08. Against this, the Sensex has fallen 28% to 14,809 during the period.

"Valuations of several companies are on the basis of their expansion plans; many of them would be implemented only two-three years down the line. There are concerns that these companies may not achieve their targets," said a CIO at a domestic mutual fund.

The period prior to December '07 saw promoters and top officials of small companies visit reputed brokerages regularly, hoping to sell their growth story to the research analysts, who would in turn recommend the stock ideas to their clients.

Brokerages also regularly held investor conferences, inviting several companies to speak about their growth and other plans to potential investors. Companies made such visits usually with an intention to boost their valuations ahead of a fund-raising exercise from the stock market.

Some brokerages added to this frenzy in mid-cap shares, which is usually triggered by active participation from retail investors, through "unconventional methods of stock-picking". A retail brokerage, as part of its attempts to cater to its clients' demand for "cheaper" stocks, is believed to have collated a list of stocks with prices in two-digits.

"Several retail investors mistake valuation of a share to the stock price figures unlike textbook methods like PE (price-to earnings) ratio," said a senior official at Mumbai-based brokerage, Sharekhan. Simplifying the official's point with an example, if XYZ shares are trading at Rs 1,000 and its PE ratio is 15, while ABC shares are at Rs 50 and its PE ratio is 20, such retail investors would prefer ABC shares because of their lower price.

Heightened investor interest in mid- and small-cap shares drove prices way ahead of their value, while analysts justified these price jumps with the embedded value theme.

This method evaluates a company's worth, taking into account the valuation of its subsidiaries, listed or unlisted, and certain assets, that are not part of the core business. The sharp correction across the board, over the last couple of months, has disturbed analyst calculations of arriving at a value for such companies.