Keep regular track of financials, including cash flow and management changes
Investors in Elder Pharma’s fixed deposits (FDs) are worried. According to newspaper reports, the company has not paid the interest or refunded deposits that have matured. Facing financial trouble, it was ordered by the Supreme Court in December 2015 to return Rs 155 crore to its investors, many of whom might have invested their retirement money corpus.
Situations like this deter (small) investors from supposedly-safer instruments than equity. But, they are to be blamed as well.
One of the biggest mistakes retail investors make is not checking the financials of a company before investing. FDs offered by manufacturing companies or non-banking finance companies are not covered under the credit guarantee scheme, unlike bank deposits.
This makes them inherently risky. Investors find these attractive because they offer a premium over bank FDs, sometimes as high as three per cent higher.
“Investors must put only one portion of their risk capital in company FDs. It is only for informed investors,” says Divakar Parthasarathy, co-founder of MeetUrPro.com.
“One must always check the record of the management and balance sheet of the company. Even a cursory review of the balance sheet will show where the money is being spent or in the case of an NBFC, who the borrowers are. Due to the high compliance levels, these kinds of data are easily available in the public domain,” he explains.
A change in the management is something investors must watch out, says Suresh Sadagopan, founder, Ladder7 Financial Advisories. “For instance, the founder may have a particular vision on how to run the company but the second generation may have a different view. So, investors must check the company’s results on a quarterly basis, to see if there is a financial problem,” he says.
Some other things that should alert investors of problems in the company include delays in interest payments or the principal in case of maturity.
While ratings for company deposits are available, it is unwise to rely solely on them, because the methodology is not entirely transparent. Check if the company is generating cash profit and if the cash generated is sufficient to service debts.
If a listed company, one can look at the stock price but remember it can also be manipulated and is not a true indication of the company's ability to pay interest on deposits. “It is safer to go by the experience of other investors. Ask around if they have been getting interest payouts regularly. This information is more dependable,” Sadagopan adds.
Investors can also check the financials of group companies, if there are any. This will show if there is inter-group lending. If there is a huge amount of inter-group lending, it is a concern, points out Parthasarathy.
If you stuck with a bad investment - the company is making losses or has gone bust - there is not much that you can do. Approaching the court is the only way out but that can be a long drawn process. The court can only ask for liquidation. And, it will consider other creditors like banks, vendors and not only depositors. If the court suggests a haircut or discount in the repayment, it is advisable to opt for it.
“Individual investors do not have the resources to fight a legal battle, so it is better to take whatever you can get rather than risk losing your entire investment,” says Sadagopan.
Other than premium in interest rates, another reason company FDs are popular is because agents are incentivised to sell them, says Parthasarathy.