Last Updated on Nov 22, 2022 by Aradhana Gotur
Private companies vs public companies have been a long-drawn debate. While private companies are known for better performance, public companies are revered for their safety. An investor may be in turmoil if asked to tradeoff risk for return and vice versa. Investing in PSU stocks could be one such scenario where the investor may be in a constant return vs risk battle.
But, what are PSUs? How to spot good PSU stocks and should invest in them for the long run? Well, let us find out!
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What are PSUs?
Public Sector Undertakings or PSUs are companies in which the government holds 51% or more of the company’s outstanding share capital. A government-owned enterprise/corporation, a nationalised company, and even a statutory corporation fall under the purview of PSUs.
They are vital to the country’s economy and have traditionally been considered a decent investment choice. But most investors have a hard time deciding if they are suitable for the long run.
What to keep in mind before investing in PSU stocks?
Following are some key strategies you can apply to decide a PSU stock’s value:
A stronger economy usually reflects on its market indices and stocks. Earnings typically are higher in a well-performing economy. On the other hand, a fall in earnings is observed during economic downturns. Therefore, a PSU with a consistent increase in revenues over several years could be good for long-term investments. Likewise, it’s a good sign if a PSU’s future earning projections are forward-looking.
The P/E (price/earnings) ratio is a standard metric for deciding if a company’s stocks are undervalued or overvalued. It is calculated as:
P/E = Market price per share / Earnings per share
A higher P/E ratio typically indicates an overpriced stock. However, a lower figure means that the stock has an attractive valuation relative to the industry. PSUs can be compared against each other using the P/E ratio, and if the ratio is relatively lower, then the PSU in consideration can make for a good investment.
Dividend consistency is another foolproof benchmark of a financially stable company. Go back 5, 10, or even 20 yrs to analyse a PSU’s dividend consistency. If you see a rising dividend trend over the years, be rest assured that the company has predictable earnings. Such a PSU can be considered for long-term investing.
Debt and current ratio
A company’s debt ratio measures the number of assets it finances through debts. On the contrary, the current ratio decides the firm’s ability to meet debt obligations.
Generally, a higher debt ratio indicates that a company could be a value trap. But a higher current ratio means that a company is more liquid. Both the ratios can help you determine if a PSU stock fits a long-term buy strategy.
The Indian stock market indexes (Sensex and Nifty) are key indicators for interpreting present or future investment possibilities. Stock prices heavily swing on how the economy is performing. If the economy is in a free fall, so will be majority of stocks and vice versa. Contrarian indicators such as mainstream media are another way to understand the market. Using these indicators can help you figure how the economy will affect your long-term plans.
Can PSUs prove to be good investments?
PSUs have been some of the worst performers in the Indian stock markets for several years. But are they wealth destroyers? Here’s a look at the wealth creation potential of PSUs:
Most PSUs in India have sizeable cash flows and yield significant dividends, higher than banks’ interest rates on savings. The CPSE Restructuring Guidelines direct that all central PSUs pay a minimum annual dividend of 30% of PAT or 5% of net worth, whichever is higher.
Most PSUs operate in the highly cyclical power, energy, and heavy metal sectors. Due to the cyclical nature of the commodity business, PSU earnings are not stable. However, the recent rise in commodity prices can lead to a re-assessment of the valuation of PSU stocks.
The growth rate of most PSUs indicates that India has tremendous potential in the power and infrastructure sectors. Most of them trade at five, ten, or similar multiples of their earnings and cash flow. Considering the present valuations, PSUs don’t seem to be at a severe disadvantage and call for a significant re-rating.
India’s socialistic era saw the establishment of some of the major PSUs with significant concessions from the government. Consequently, it is almost impossible to replace the vast infrastructure PSUs have set up and continue to own. Moreover, the sectors where PSUs operate are least likely to face any disturbance from competitors. Like the saying goes, “Too big to fail.”
PSU stocks for the long term: Yay or nay?
Rampant corruption, inefficiency, and bleak prospects of high returns are some factors that tend to keep investors wary of PSU stocks. However, the recent wave of privatisation has completely changed the PSU stocks investment landscape. As a result, long-ignored PSU stocks have come into the limelight, fuelling the market’s faith in the value most PSUs harbour.
Despite their wealth creation potential, most PSUs have seen significant value depreciation over the years. So, the prospect of disinvestment presents some hope of unlocking value and reinstating the market’s faith in the performance of PSUs.
Higher dividend yields, attractive valuations, and the possibility of improved earnings make PSU stocks an appealing investment option.
But the important thing to note is that PSUs lag significantly on the front of long-term returns. Despite decent fundamentals, PSUs currently show poor performance in the long run compared to other companies. They are ideal for medium-term trading opportunities, provided you pick companies with clear earnings visibility or deep discounts in the medium-run.
So, if you’re a long-term investor, you need to consider all of the above-mentioned factors before investing in PSU stocks. It remains to be seen how the future of PSU unfolds in case of a full-fledged divestment.
Picking the right PSU stock is where most investors falter and end up making poor investment choices. However, you can increase your chances of landing a good investment by employing several strategies. These include both fundamental and economic analysis to determine if a PSU is financially healthy. But when it comes to long-term investments, you may want to think twice before going for a PSU. While select pockets in PSUs look pretty attractive, it may be prudent to invest in them as a basket rather than individually. Consult your financial advisor before investing in any stock or financial instrument.