In your interest.
Online Personal Finance Magazine
No beating about the bush.
The Bombay Stock Exchange has identified those stocks which are illiquid as per SEBI’s new definition and will move them to a separate trading window which will begin from 8th April. Some well known companies are also in the list
Acting on a recent directive from the Securities and Exchange Board of India (SEBI), the Bombay Stock Exchange (BSE), vide notice 20130401-39, has shortlisted all the ‘illiquid’ stocks and moved them to a separate window which will be traded from 8 April 2013.
The number of such stocks is 2,050 and represents over 50% of the ‘actively’ traded stocks on BSE! Some of the illiquid stocks which maybe familiar to investors include Dr Agarwals Eye Hospital, Asit C Mehta Financial Services, SKP Securities, Almondz Global Securities, Lumax Automotive Systems, Allsec Technologies, Bannari Amman Spinning Mills, Indus Fila, Rane Brake Lining, Rane Engine Valve, Ginni Filaments and Khaitan (India).
As per our analysis on the BSE website, the total number of stocks on BSE is 6,922. Out of this, only 3,888 stocks (including ETFs and such) are ‘active’, while 1,312 stocks are suspended and 1,722 stocks are delisted. The number of so called ‘active’ stocks is little over 50% of the BSE’s entire universe. This means, only 1,838 or just 26.55% of the entire BSE universe will be remaining and actively traded in the ‘normal’ segment of the exchange, if the illiquid stocks are moved to a separate window.
The implications of this move could be far reaching. This will further reduce the number of stocks traded on the exchange, making it difficult for investors to invest in niche or specialised companies (which are normally illiquid).
We had written about this in an earlier post. You can read about it here: Curbing manipulation in illiquid stocks: Another harebrained idea by SEBI?
The illiquid stocks which have been shortlisted will be moved to the “periodic call auction” window from 8 April 2013 onwards, where marketmen can trade on such stocks. The liquidity situation will be monitored by the exchanges every quarter. Every quarter, the exchange will review liquidity and add or remove stocks from the normal segment to the so called “periodic call auction” window where illiquid stocks are traded.
These stocks which are part of the 2,050 illiquid stocks, according to BSE, have failed to meet SEBI’s criteria for meeting definitions of liquidity for the quarter ended March 2013. As per SEBI circular no. CIR/MRD/DP/6/2013 dated 14 February 2013, a scrip is shortlisted as illiquid if all the following conditions are met:
The entire list of 2,050 stocks can be found here: (click here)
Rising royalty on their Indian operations will remain an overhang for the stocks of foreign consumer companies
The Indian consumer sector is a long-term growth opportunity led by growing incomes and increasing propensity to spend. It is dominated by foreign consumer companies which have been excellent long-term value creators. But now several foreign consumer companies are imposing royalties on their Indian operations.
Hindustan Unilever and Nestle India have already revised royalty rates, while Colgate and GSK Consumer are sitting on the fence. While it is difficult to predict the timing of any potential change in royalty rates, it will remain an overhang for the stocks. This is according to Nomura Equity Research in its report on the Indian consumer sector.
The idea behind the royalty hikes is that the Indian subsidiary needs to pay more to get access to the parent company’s technology and R&D capabilities and the right to leverage on the global portfolio in India. The increase in both the cases is a gradual change, which cushions the burden on minority shareholders. While it is difficult to conclusively say if the increase in royalty rates is justified, it does take out the near-term uncertainty over these companies. However, in the long-term, it does raise the question on how the move will impact the interests of minority shareholders, says Nomura.
The net impact on earnings is not much, according to Nomura’s analysts. While there will be some impact on earnings both for Hindustan Unilever as well as for Nestle India of the increases in royalty rates, the quantum will not be large. For Nestle India, the increase will kick in only on 1 January 2014, and for Hindustan Unilever, the increase in royalty rate will be 50bps (basis points) each year for the next two years starting 1 April 2014. The companies will also have the option of passing on these increases to consumers at an appropriate time. Royalty rates are high in the consumer sector relative to other sectors. Even if we look outside the consumer sector, there are a large number of listed subsidiaries of MNCs (multinational companies) which pay royalties to the parent. Some of the more prominent names and the royalty rates for them are below. Excluding Maruti, the royalty rates paid by both Nestle India and Hindustan Unilever are higher than those paid by companies in other sectors.
Valuations of consumer companies continue to remain at high levels relative to their long-term average. Within MNC companies, Hindustan Unilever, Nestle India, GSK Consumer and Colgate Palmolive trade at an average 26.1x FY15F (Nomura’s estimate), about 23% premium versus domestic consumer companies. While the companies have historically traded at a premium to domestic companies, the premium has shrunk over the past five years. If over the longer term royalty rates continue to rise, MNC firms are likely to become less attractive to minority shareholders. However, there is no risk in the medium term, as MNC companies continue to have a more complete portfolio of brands and have a significant head start versus domestic companies in the segments in which they operate in.
Nomura continues to prefer ITC among large cap consumer stocks, where visibility of earnings growth is much higher. It expects ITC to pass on the recent rise in excise duty and VAT (value added tax) in certain states by way of price hikes. Its long-term target of growing the cigarette business EBIT (earnings before interest and tax) by 15%-16% remains intact and is supported by valuations of 23.4x versus Hindustan Unilever at 25.7x and Nestle at 25.1x. In mid caps, Nomura prefers Emami which should deliver an 18% earnings growth over the next couple of years, and the stock currently trades at 20x FY15F earnings, a significant discount to the sector.
Between 1998-2013, out of a total of 3,785 days, movement in the CNX 500 was outside 3 sigma on 60 occasions, that is 1.59% of the total. By normal distribution, less than 0.03% observations should fall outside the 3 sigma
In the world of investments, returns are measured by the first moment of prices (mean) and the risks are measured by the second moment (standard deviation or sigma). Most of the classical theories of finance are based on the assumption that the returns are normally distributed. In the probability theory, the normal distribution is a bell shaped curve of probability values for various natural events—hence the word ‘normal’. This distribution assumes that the tails or the ends are flatter and extreme events are rare. For example, this means that the probability of returns moving more than three standard deviations beyond the mean is 0.03%, or virtually nil. But what is ‘normal’ in markets?
In the Indian context, taking daily CNX 500 data from 1 January 1998 to 28 February 2013 (more than 15 years), 99.73% of the daily returns should ideally fall within -4.97% and 5.09%. Or less than 0.03% observations should fall outside the 3 sigma.
Out of a total of 3,785 daily observations during the period of analysis, 60 times the returns were outside 3 sigma in the case of CNX 500, that is 1.59% of the total observations. Clearly much more than we bargain for. The rule book says that if we are looking at daily events, a 5 sigma event would occur once in 4,776 years. A 6 sigma event would occur once in 1.388 million years and after that, the numbers are, let's just say too big to bother.
On 17 May 2004, the financial market experienced a more than 7 standard deviation fall, when markets crashed due to political uncertainty. Markets fell more than 5 to 6 standard deviations many times in 2007 and 2008, owing to global melt down. Similarly, the market posted a more than 9 standard deviation gain, once again due to the political scenario in the country at that time.
In reality, we have experienced 5, 6, 7 or even more than that, sigma events more frequently than what the normal distribution suggests and we dare to accept.
This is true globally, not just in India. For instance, Goldman Sachs, Citigroup, UBS, Merrill Lynch, all experienced large (as large as 25) sigma events on multiple days in 2007 and 2008. There was the South East Asian crisis, the 11 September 2001 attacks on the World Trade Centre, the Euro crisis, all in the past two decades.
It is not just that these events occur more frequently, these events have greater impact, as well. The impact is, in fact, higher due to the surprise element attached to them. It hits one at the place where it hurts the most and makes it very difficult to recover.
Our observations suggest that the distribution is more leptokurtic in nature, with fatter tails. This means that more observations are concentrated around the mean and tails are fatter, or have greater number of observations than suggested by the normal distribution.
So what we must do is first, acknowledge the limitation of our knowledge that we cannot explain everything and second, we must believe that such events occur more frequently than we had thought. This must call for better risk management systems. Perhaps these events indicate that we must prepare for more incorrigible things that will happen.
What this also points to is that the assumption of normal distribution does not hold. Hence, financial mathematicians must look at distributions with fatter tails for building their theories and models.
Additionally, Daniel Kahneman’s prospect theory says that humans are more likely to act to avoid loss than to achieve a gain, articulated very well in his book “Thinking fast and slow”. If we accept this to be true, then it becomes all the more important for the theorists and professional money managers to rethink the way they build models or the appropriateness of the models which they use.
As for the investors, it would be wise to question their financial advisor on the soundness of their advice during a large sigma event!
(Nupur Pavan Bang is a senior researcher at the Centre for Investment, Indian School of Business, Hyderabad. Khemchand H Sakaldeepi is a researcher at the Centre for Investment, Indian School of Business, Hyderabad.)