8 ways to identify profitable shares

[K.Karthik Raja]

8 ways to identify profitable shares

Though investment opportunities abound all the time and in almost all
situations, they may not be very easy to identify. A shrewd and
discerning investor will usually find opportunities for making money
in places, and in situations, where a less discerning one will not.
The best investment opportunities are often found in the most unlikely
of places and situations. For example, in the beginning of 1994 few
could have predicted that the shares of the then relatively unknown
company like Infosys Technologies [Get Quote], focusing primarily on
Y2K software projects, would provide one of the best investment
opportunities of the last decade.

Let us consider some typical situations which provide excellent
investment opportunities.

1. Turnaround situations

A turnaround situation exists when a company that has been making
losses for a number of years starts turning the corner and is expected
to begin making profits. Since the company has been making losses, its
shares are likely to be quoted at very low prices, often below par.
Once the company wipes out its accumulated losses and begins to make
profits, its changed fortunes are bound to be reflected in a sharp and
steep rise in the price of its shares. This rise can be as high as 200
to 300 per cent in one year.

SAIL [Get Quote] (Steel Authority of India) is an outstanding example
of a successful turnaround company in recent years. At one stage, in
October 2003, its share price had fallen to as low a figure as Rs 6
per share. Due to a turnaround in the fortunes of the steel industry
and the company by early 2004, its share price had soared to Rs 55 per
share, notching up a capital appreciation of 916 per cent in a matter
of a little over three months.

However, while investing in a turnaround company you should make sure
that the reversal in the company's performance is not going to be a
flash in the pan and short-lived. The turnaround should be sustained
over a sufficiently long period of time for you to profit from it.

2. Amalgamations and mergers

The amalgamation of one company with another, or the merger of two
companies into one company, is normally advantageous for both
companies. Amalgamations and mergers are mostly resorted to with the
object of strengthening the finances and operations of both companies
by forming one consolidated company. In some cases of amalgamations or
mergers, a high growth, profit-making company combines with a company
which has large accumulated losses so that substantial tax benefits
can be derived by setting off the profits of the former against the
losses of the latter.

Sometimes, companies manufacturing similar or complementary products
and catering to overlapping markets find it advantageous to merge
because they can substantially cut down on overhead, and operational
and sales expenses. Similarly, overhead and other expenses can be
trimmed considerably if a company merges with its own subsidiary
company. It is also much easier for a company to diversify and grow by
merging with an established company than by setting up new units and
nursing them through their gestation periods.

After the merger, the new combined company generally performs much
better than the combined performance of its component companies prior
to the merger. Hence, news of impending amalgamations and mergers
always has a bullish effect on share prices of the companies involved.
This is the main reason why companies going in for amalgamations and
mergers provide an attractive investment opportunity.

3. Takeovers and acquisitions

A takeover is initiated when a business house, a company, or a group
of companies acting in concert take over a large enough chunk of
another company's shares to displace the old management and give the
new management complete control over the company. A takeover bid
usually results in frantic, large-scale buying of shares by both the
competing groups in an effort to acquire more shares than the other.
As a result, share prices are pushed up to levels far above their
intrinsic worth.

Takeover bids, whether successful or not, provide an opportunity for
ordinary investors to make money. In addition, takeovers often benefit
the company and its shareholders by giving it a new, dynamic and
growth-oriented management. Often this factor alone provides a good
reason for investing in the shares of a company which is the target of
a takeover bid.

Sometimes a company, a business house or a group of companies acting
in concert acquire control over another company through a negotiated
purchase of the shareholding of the existing management. This is
different from the usual takeover bid because it doesn't involve large-
scale competitive buying of shares in the stock markets and,
therefore, doesn't really have a big impact on the company's share
prices. In such cases, share prices usually move up or down depending
upon the reputation and record of the company's new management.

4. Changes in government policies

Major changes in government policies often benefit some companies by
opening up new avenues for growth and higher profits and such
companies provide excellent investment opportunities for investors who
are quick in recognizing the implications of such policy changes. In
the early 1980s, removal of price controls over cement ushered in a
period of high growth for ACC and other cement companies.

In 1988, the lifting of price controls over aluminium boosted the
profits of companies, like Hindustan Aluminium and Indian Aluminium.
Later, the strong package of financial incentives and disincentives
contained in the budgets for 1993-94 and 1994-95 ushered in a period
of high growth for computer software companies, like Infosys
Technologies, Wipro [Get Quote], Satyam [Get Quote] Computers, I-flex
[Get Quote] and Rolta; hotel companies, such as Indian Hotels, East
India Hotels and Asian Hotel, and power sector companies, like Tata
Power [Get Quote] and BSES (now called Reliance Energy [Get Quote]).

Changes in government policy can also sometimes affect a company
adversely. If you are a shareholder and are quick to foresee the
implication of such a change, you can sell your shares before their
prices begin to fall. For example, the cuts in customs duties on
imported steel items in 2004 made it more difficult for Indian steel
companies, like SAIL, TISCO [Get Quote] and Essar Gujarat to compete
with cheap steel imports. Shrewd investors reacted quickly to these
disadvantageous budgetary provisions and immediately offloaded their
steel shares. However, these detrimental changes in excise and customs
duties did not imply the death-knell of the steel industry, which
bounced back smartly after 2-3 tears.

5. Technological innovations

We are living in a society which is increasingly dominated by
technology. Accordingly, alert investors on the lookout for big gains
will find suitable investment opportunities in companies, which go in
for technological innovations in a big way. For example, IT services
companies, biotechnology companies and telecommunication companies are
major beneficiaries of technological changes.

6. Anticipating the future

The best investment opportunities are available to those who can
successfully anticipate the future.

How do you anticipate the future? The best way to do so is to be
always alert to what is happening around you. The seeds of the future
are present today.

For example, if you live in an industrial city or area, you cannot
help but notice the steadily deteriorating condition of the
environment. Water and air are becoming rapidly polluted. The day is
not far off when the pollution levels will become intolerable and will
pose a major health hazard to the population. Environmental pollution
is becoming an area of serious concern to the public and the
government.

The Water Pollution and Air Pollution Acts have already been passed by
Parliament and the government has established a new department, known
as the Department of Environment, for implementing these laws. All
these developments are pointers to an emerging high-growth area,
namely, the manufacture of air pollution and water pollution control
equipment. These developments also point to a high growth in
healthcare.

7. International trends

Globalization is the buzzword since the 1990s. No country in the world
can now hope to remain immune from the influence of international
economic trends. As a result, it has now become imperative for Indian
stock market investors to keep a close watch on international economic
developments and to analyze their likely impact on the performance of
Indian companies. For example, the signing of the WTO (World Trade
Organization) agreement opened up high growth opportunities for Indian
food, pharma, textile and IT exporters.

It has also created the conditions required for a sustained long-term
growth in the volume of world sea-borne trade, thus significantly
improving the prospects of Indian shipping companies, like Great
Eastern Shipping and Shipping Corporation of India [Get Quote].

In the 21st century, a stock market investor who is aware of what is
happening in the larger world beyond India's borders and who keeps a
close tab on major international developments will definitely find
himself in a more advantageous position vis-�-vis an inward-looking
investor whose awareness is confined only to what happens within the
country.

8. Sunrise industries

The term sunrise industries refers to the new and emerging industries
of the future. Early investment made in those companies which have
been correctly identified as the future leaders of such nascent
industries have always provided and will continue to provide truly
attractive returns to patient and farsighted investors.

In the 1960s, for example, the sunrise industries in India were
scooters, synthetic textiles, and five-star hotel chains. If at that
time you had bought shares in Bajaj Auto [Get Quote], Indian Hotels,
Century Spinning (now known as Century Textiles [Get Quote]) or
Gwalior Rayon (now renamed Grasim [Get Quote]) you could have
accumulated a huge fortune in the last 30 years.

The sunrise industries of the 21st century are likely to be computer
software, computer training, bio-technology, electronic mail,
processed foods, telecommunications, corporate hospitals, budget
hotels, private airlines, oil exploration, pollution control,
diagnostic kits, fast-food chains and departmental stores. If you are
serious about making money then you simply cannot afford to ignore
sunrise industries