Factors to keep in mind while deciding whether to invest in a company fixed deposit or not

by Manshu on May 23, 2012

in Fixed Deposits

Last week I wrote about the two big ideas that you should keep in mind while investing in corporate bonds, and this week I’m going to build on that post and write about some factors that will help you build a negative list of companies that you should avoid buying fixed deposits in.

My assumption here is that you want a lot of safety for your bonds, and a part of your portfolio is already invested in equities which exposes you to risk of capital loss, and that’s why you want to play it really safe when investing in bonds or NCDs of a corporate.

Avoid loss making companies

You will see that the difference between the interest rate of a NCD of a well established large, profitable company and a smaller loss making company is hardly 2 or 3 percentage points, and normally for most retail investors who aren’t going to invest a lot in any NCD – this difference will not translate to much in absolute terms. Keeping in mind the small gain and increased risk, I think it doesn’t make much sense to invest in NCDs of companies that are loss making and not very stable.

Avoid companies where promoters have pledged stock

NSE has data on companies where the promoters have pledged stock to raise money and to me this is usually a big red flag because raising money by pledging stock has got to be one of the very last options for any promoter as it can potentially lead to them losing control on their company especially in the ever volatile Indian markets.

Avoid companies where the auditors have mentioned irregularity

The annual report has a section for the auditor’s report where they give comments. Most of the time you won’t find anything of interest here but in some circumstances, the auditors will give comments mentioning some irregularity which is a red flag because who knows what else is going on?

Avoid over-leveraged companies

This is a relative term because a company like Muthoot has to borrow a lot in order to carry out its business while a company that’s not as capital intensive will not need to borrow so much money in the first place. You can look at the debt equity ratios of similar companies to figure out whether the company is over leveraged or not and usually articles about NCD issues touch upon this point and help get a sense of where the company stands with respect to its peers in the debt it has already taken.

Avoid companies with low credit ratings

Every company is required by law to get a rating for its credit issue when it offers new debt. You can read the rating report as well as what it signifies and stay away from companies that aren’t ranked stable or safe for their debt.

Outside of this, there are plenty of articles online that give you a good idea on what’s going on with a company and you should search and browse through a lot of them before deciding to put your money anywhere.

I think it is better to be conservative and stick to the very best issuers as far as NCDs are concerned because usually the few extra percentage points you get by way of interest won’t make up if even one in ten of your NCDs go bust in your investing life-time.

{ 7 comments… read them below or add one }

Amitesh Kishore May 23, 2012 at 6:09 am

Dear @Manshu,
You would be surprised to know that recently I have not read any books related to my profession as financial advisor but the blogs written by some people including you are of great help being abreast to the knowledge base required .
Many congratulations for your site as useful to advisors as for the investors.

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Manshu May 23, 2012 at 6:11 am

That really is surprising and a great compliment. I’m sure being a professional you have a lot to share with others as well, so please do comment from time to time and advance the discussion so everyone can benefit from your insight.

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Manikaran Singal May 25, 2012 at 12:03 pm

Manshu , the article is quite informative for investors.
Though what you have conveyed applies to the all debt instruments of the compnay , but there’s a small mismatch in the title and the content.
You wanted to talk about Fixed deposit , but you actually discussed NCD (Non convertible debentures). Both are debt instruments but the structure of both is different.

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Manshu May 25, 2012 at 7:17 pm

You are absolutely correct Manikaran. Let me re-read this whole thing and edit it to make it consistent. Thanks for pointing it out!

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Govindaswamy J May 25, 2012 at 5:39 pm

Dear Manshu,
I think you missed out one important criterion, namely, ability to pay. Even nominally profitable companies may be draining cash. Hence, cash flow statement should be examined, & companies having negative operating cashflow over 2/3 continuous years should be avoided.

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Manshu May 25, 2012 at 7:08 pm

That’s a great point you bring up and it should be looked up to ensure that the company is not bleeding cash…I can’t think of any examples but I guess there must be a few. Can you think of any examples?

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ankm83 June 6, 2012 at 12:16 am

Company fixed deposits are highly tax ineffcient also, taxed at marginal rate. Debt mutual funds can give comparable post tax returns due to i) lower LT CG tax ii) lower dividend tax 15% for ST & Ultra ST funds. Further, Debt MFs offer lower risk (due to diversification) and higher liquidity. NCDs can also play tax game to a better extent, further companies hitting bourses with NCDs are typically highly rated, at least A+ (lowest rated NCD issuer is Manappuram). Whereas you even have junk grade companies raising FDs, as the fact of matter is that Company law board (regulator for Corporate FDs) doesnt make it compulsary to get credit rating done (While SEBI makes it compulsary for NCDs/bonds).

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