History is, across industries, a lesson on past failures and future probabilities and this is exceptionally true in the field of investing. To ensure optimal moves in the investment battlefield, we must learn from history, and from the great minds that came before us. In the words of Mexican business magnate Carlos Slim Helu, “Courage taught me no matter how bad a crisis gets ... any sound investment will eventually pay off.” So how do you, as investors, arrive at a security which can be considered sound for investing?
Over the years, everyone from individual investors to the industry at large have indicated a bias for the asset’s size and credit history. When you see that a company’s bonds are rated AAA, or a mutual fund is investing in high credit securities like large cap funds, you go ahead and take the plunge without another moment’s thought. Does that mean that credit history should be the only factor to consider while looking for quality investments to add to your portfolio? History would tend to disagree.
Credit Rating Mismatches
Let us consider the recent case of Switzerland’s banking major Credit Suisse, which prompted a recall of the Lehman Brothers financial crisis of 2008. Even as the mammoth lender has been assuaging concern over its liquidity and capital position, the bank’s shares fell over 55 percent during the last year, bringing its market capitalisation below that of several Indian banks including SBI, HDFC Bank, ICICI Bank, Axis Bank and IndusInd Bank .
To add to its misery, Credit Suisse has recently been struck with a significant downgrade from rating agency S&P Global Ratings, which cut the lender’s long-term rating to one step above junk bond status, owing to “material execution risks” arising from the bank’s attempts to return to stability in the aftermath of multiple scandals and losses.
Credit Suisse is not the only lender in Switzerland to have wreaked havoc on investor sentiment. During the 2008 financial crisis triggered by Lehman, Credit Suisse’s bigger peer UBS Group required a state bailout to recover from the calamity. These cases strongly indicate that neither credit rating, nor size, can be the be all and end all when investors look for quality assets and these are not isolated events.
Turning towards the Indian corridor, it is time to consider how the highly rated companies IL&FS Financial Services and Dewan Housing Finance ended up causing investors heartburn a few years back. According to the National Securities Depository Ltd’s records, both of these companies once issued bonds and commercial papers which were rated AAA by India Ratings and Brickwork respectively.
Come 2018 and the non-bank financing companies started depicting strong signs of failure. In September 2018, IL&FS, the country’s leading infrastructure finance company, defaulted on payment obligations to its lenders, and the ripples were seen across bank loans, term and short-term deposits as well as commercial papers. Even as the country was recovering from the shock, DHFL saw its commercial papers being downgraded to D or default status, pummelled by poor management and low liquidity owing to a lack of trust from investors.
These cases, and many more like it, can attest to the fact that high credit ratings cannot guarantee future performance. So, as savvy investors, what should you do when you want to find quality assets to park your hard-earned money in? How do you go about investing in securities which offer high returns while also mitigating the underlying risk? Because, as Warren Buffett said about investing, “Rule No. 1 is never lose money. Rule No. 2 is never forget Rule No. 1.” Let us look at some of the other factors you should keep in mind, while assessing investment possibilities.
Look at Company Structures
Companies which have a strong and progressive management, bolstered by aggressive marketing and growth outlooks tend to perform well in the longer run since these prerogatives enable innovation and support capital proposals, in addition to ensuring better productivity. Overall, these aspects lead to robust quality, making such companies suitable for ensuring long-term returns on investment. It is true that, in some sectors, innovation isn’t as easy but, in such scenarios, if the business model focuses on cost conscious management, then you can be sure that your investment will pay rich dividends.
Focus on the Results
When a company manages to deliver robust returns across market scenarios and through difficult years, you know you have found a winner. Evaluate the annual financial results going back several years, to understand the factors at play and also keep a keen eye on future forecasts to learn from the past and also pick future-ready investment options. Also consider the cash-flow budgets of possible investment choices as this indicates the flow of funds into and out of the company. This will help you understand how the company is positioned for the future, ensuring optimal investment decisions.
Pick Strong Business Models
When you find a company worth investing in, you must take a deep dive into its products and services, while also studying the demand-supply dynamics governing the entity. You also need to focus on aspects such as the risks and concerns weighing on the company’s outlook for the future, as this will enable you to come to an informed decision on whether or not to invest. Further, when looking at industries centred around innovation, like chemicals and electronics, keep an eye out for companies which invest heavily in R&D as that would become the bedrock for sustainability and resilience.
There is no question about whether or not a company’s credit rating should be a factor you consider while taking investment decisions. However, you need to remember that neither a company’s size, nor its rating can, in isolation, guarantee future performance. Therefore, to arrive at optimal investment decisions, you must also look at additional factors such as the company structure, which should ideally be backed by a strong business model and the capability to deliver robust results.
—-The author, Raghvendra Nath, is Managing Director at Ladderup Wealth Management Pvt Ltd. The views expressed are personal.
(Edited by : C H Unnikrishnan)
First Published: Jan 2, 2023 12:11 PM IST
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