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8 ways to identify profitable shares
S S Grewal and Navjot Grewal
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November 28, 2007

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.

Excerpt from, Profitable Investment in Shares by S S Grewal and Navjot Grewal. Price Rs. 145.

S S Grewal was an ex-IAS officer with an educational background spanning science, engineering, literature, and economics, and was a practicing investment consultant since 1985.

Navjot Grewal is a specialist in industrial psychology and has been a keen investor on the stock markets.

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