Technical updates – Gayatri Projects and IRB Infrastructure

With the economy showing signs of settling down after absorbing the double-whammy of demonetisation and GST implementation, focus of investors and analysts is shifting towards the neglected infrastructure sector once again.

Fortunes of shareholders of two companies from the construction sector - Gayatri Projects and IRB Infrastructure - have taken divergent paths. The stock of Gayatri Projects has gained 47% in the past two years, while the stock of IRB Infra has lost 7%.

On the financial front, Gayatri Projects has a debt/equity ratio of 2.22 and its financial expenses are 200% higher than its net profit. IRB Infra has a lower debt/equity ratio of 1.23 and its financial expenses are 50% higher than its net profit.

Gayatri Projects is trading at a P/E of 9.2. IRB Infra is trading at a four times higher P/E of 39.9. 

Gayatri Projects

The closing stock price of Gayatri Projects formed a 'triple bottom' reversal pattern below its three EMAs during Feb '16 and May '16. That triggered a price recovery that faced strong resistance from its Nov '15 top of 151.50.

A breakout with good volume support above 151.50 on Apr 17 '17 failed to sustain above the resistance level. Another breakout on Jun 5 '17 managed to keep the stock price above the resistance level, which was subsequently tested on Jul 5 '17 and Aug 10 '17 and turned into a support level.

The stock rose to touch a new high of 201.75 on Nov 16 '17 (note that the stock's face value was split from Rs 10 to Rs 2 in Feb '17). Daily technical indicators are looking bullish but showing negative divergences by failing to touch new highs with the stock's price.

Some correction or consolidation may occur. For the past two months, bulls are buying every dip, so corrections have been shallow.

IRB Infrastructure

The closing stock price chart of IRB Infrastructure has frustrated long-term investors but given plenty of opportunities to short-term traders. The chart shows three bearish phases and three bullish phases during the past two years.

Light blue ovals have marked every crossing of the 50 day EMA below (death cross) or above (golden cross) the 200 day EMA. The 200 day EMA itself has meandered sideways for the past two years - giving no advantage to bulls or bears.

Daily technical indicators are looking bearish after correcting overbought conditions. The stock price touched a higher bottom of 200.60 on Aug 10 '17, and may attempt to rise past its May 2 '17 top of 266.80.

(If you wish to enter either of these stocks, or any other stocks from the construction sector, you are on your own. The sector typically has high debt and uneven cash flows and profits.)

Is this a good time to enter SBI stock? - a technical update

The previous technical update to the stock chart pattern of State Bank of India (posted on Apr 2013) contained a bearish view for the following two reasons:

(1) formation of a head-and-shoulders reversal pattern with a downward target of 155 (adjusted for 10:1 stock split in Nov 2014); (2) large unreported NPAs of most PSU banks that exerted downward pressure on the prices of their stocks.

SBI's stock price had corrected down to 145.30 in Aug '13 - overshooting the downside target of the head-and-shoulders pattern. It then rose to 200, only to correct down once again to 145.60 in Feb '14 - forming a 'double bottom' reversal pattern.

The subsequent rally took the stock to a high of 283.40 on May 26 '14, but a 'reversal day' pattern (higher high, lower close) triggered a 6 months long sideways consolidation.

The stock touched a high of 296.80 on Nov 19 '14 - the day before it started trading ex-split (10:1). Such a split is often followed by selling, but the stock continued to rally and rose to touch a high of 335.90 on Jan 28 '15 - short of the lifetime high of 351.50 (touched on Nov 8 '10).

Three of the daily technical indicators - MACD, ROC, RSI - showed negative divergences by touching lower tops even as the stock closed at a 2 years closing high price of 334.45. That was just the signal bears needed.

A 13 months long correction culminated with the formation of a 'falling wedge' pattern, with the stock testing its Feb '14 low on Feb 25 '16. All four technical indicators showed positive divergences by touching higher bottoms (marked by blue arrows).

That triggered an expected upward breakout from the 'falling wedge' and started a rally that is still going strong. 

Note that the first leg of the rally took the stock above its 20 day and 50 day EMAs, followed by a correction that touched a higher bottom on May 23 '16 - a classic technical signal that the bear market was over.

A move above all three EMAs into bull territory, followed by the 'golden cross' of the 50 day EMA above the 200 day EMA (marked by dotted rectangle) on Jul 20 '16 technically confirmed a return to a bull market.

The stock has corrected below its 20 day and 50 day EMAs. All four technical indicators are looking bearish, and three of them - ROC, RSI, Slow stochastic - are looking oversold.

Though some more correction can't be ruled out, the dip is providing an entry opportunity.

Stock Buybacks: A Good Thing or Not?

There are many ways in which a company rewards its shareholders. The most common methods are bonus issues, rights issues, dividends, stock splits and share buybacks.

Bonus issues increase the equity capital. The market price of equity shares gets adjusted according to the issue ratio. So, in theory, there is no gain for shareholders. The company can benefit because the higher capital enables them to borrow more. 

In reality, share price often rises following a bonus issue - particularly for established and financially strong companies - as the lower bonus-adjusted price attracts buyers.

Rights issues increase the equity capital, and sometimes also the reserves if the rights issue is offered at a premium to face value. If the issue price is lower than the market price, shareholders benefit through capital appreciation, even though the market price gets adjusted in the same ratio as the rights issue.

Dividends benefit shareholders, because it is tax-free cash in their hands. For companies, the cash outgo indicates that the company does have sufficient resources to pay dividends. 

If the company has to resort to debt in order to pay dividend (or tax), then it is a 'red flag'. This is why studying the Cash Flow statement in Annual Reports is so important. It gives a clear view of a company's cash position.

Stock splits do not increase the share capital of a company. The face value of equity shares get reduced and the number of shares increase proportionately. Again, in theory, there is no benefit for shareholders.

However, the increased number of shares in demat accounts usually leads to near-term selling. Eventually the selling subsides. The lower market price of the split shares attracts buyers, pushing up the market price. 

Here is an example of how bonus and splits can enhance value for long-term shareholders.

Back in 2002, ITC shares of Rs 10 face value were trading at around Rs 600 or so. If someone had bought 100 shares, his investment would be worth Rs 60000 - not a small sum 14 years ago. 

If s/he had the foresight to hold on till today, the holding would have increased to 3000 shares of Rs 1 face value - thanks to two bonus issues (1:2 and 1:1) and a stock split (10:1).

At the current (corrected) market price of Rs 300, the shareholding would be worth Rs 9 Lakhs - a 15-fold increase, not counting the substantial dividends paid each year.

Share buybacks - sometimes at a premium to market price - reduce the equity capital to the extent of number of shares bought back. The bought-back shares are extinguished. Shareholders get an exit opportunity at a profit.

In case they hold on, the market price tends to rise after the buyback (due to higher EPS and lower P/E) - providing capital appreciation.

Read more about pros and cons of share buybacks in this article.

Strategies for buying and selling stocks and mutual funds – analysis of readers' exercise (Part II)

Last week, I had analysed the first three questions of the readers' exercise about strategies for buying and selling. Today, the balance three questions are being addressed. To jog reader memories, and for the benefit of those who missed the earlier posts, here are the last three questions:

Q4. You had bought 500 shares of a small cap company about 2 months back. After stagnating for a while, the price recently shot up by 25%. Will you:

(a) sell all 500 shares and book short-term profits?

(b) sell 250 shares and reduce your holding cost on the balance shares?

(c) hold on for higher prices?

(d) buy another 200 shares at the 25% higher price?

Q5. You had bought 1000 shares of another small cap company about 6 months ago. The stock has been stagnating since then. A recent announcement of 20% dividend and a stock-split perked up the price by 10%. Will you:

(a) use the up-tick in price to sell out?

(b) wait for the dividend and stock split and then decide?

(c) buy another 250 shares at the 10% higher price?

Q6. You have been holding a well-managed mid cap MNC company's stock for a couple of years. The company recently announced delisting of its shares from the stock exchanges at a buy-back price that was 15% higher than market. Subsequently the price has spurted by 30%. Will you:

(a) hold on with the hope that the company may increase the buy-back price?

(b) sell your entire holding at the current market price?

(c) sell 80% of your holding now, but keep 20% aside in case the company increases the buy-back price?

(d) sell to the company at the announced buy-back price?

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Q4 and Q5 appear similar, but I would like to point out the differences. Small cap stocks are inherently risky because few analysts cover them and there is little information publicly available about their operations.

As small investors, it should be our primary goal to reduce the risk of losses. A spurt of 25% in 2 months is equivalent to an annual gain of 150%. The logical answers should be (a) or (b). Option (c) won't reduce the risk. Option (d) will increase the risk by buying more at a higher price.

If you have read my post about 'How to use Financial News', you will know that dividend and stock-split announcements can be classified as 'good news'. The effect of such news on the stock's price is temporary - lasting not more than 2-3 days - so it doesn't make much sense to trade on it. So, the logical answer should be (b).

A few words about stock-splits and bonus issues may be in order. In small caps, unscrupulous promoters often announce splits or bonus to jack up the stock's price through circular trading, only to cash out at the higher price and leave small investors in the lurch.

But reputed promoters either use stock splits to increase liquidity of high-priced stocks, or announce bonus shares to indicate that the company is in good enough financial health to shoulder the liability of the increased equity capital.

Theoretically, stock splits and bonus issues do not add to investor wealth because the stock's price gets adjusted after the split/bonus. But what actually happens in the market is beneficial for investors who hold for the longer-term.

Once the increased number of stocks following the split/bonus is credited to investor accounts, there is a tendency towards some selling, which reduces the split/bonus adjusted price some more. After a few months, the selling subsides and the stock price starts to move up again.

For well-managed companies, the price eventually surpasses the split/bonus adjusted price. Typically, a dividend paying company reduces the per-share dividend according to the split/bonus ratio, so that the dividend received by investors prior to the split/bonus remains the same.

Over the next few years, if the per-share dividend is increased (which is often the case), investors gain on both capital account and dividend account without investing a single paisa.

For the last question, option (b) should be the logical answer. Options (a) and (c) are speculation and not investment options. Option (d) leads to capital gains tax as per current rules, since selling to the company does not incur STT (securities transaction tax).

If the stock is infrequently traded, and an investor holds a large chunk, then option (b) may not be practical. Investors would have no choice but to sell the shares back to the company.

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