The two sides of the equity pendulum: Opportunity in adversity vs problem of plenty

livemint.com:

Warren Buffett says, “A full wallet is like a full bladder; you may have the urge to pee it away!" When there is abundance, many companies add greater capacities than required and some become lax on financial prudence. As a result, good times lay the seeds of tough times. The last large investment cycle that India witnessed was in the 2003-2007 period.

Given the abundance this cycle created, the system witnessed many excesses at the corporate level. While excesses, in essence, strained balance sheets, these strains were caused due to various approaches. Some instances are as under: ⦁ Acquisitions: A prominent auto component manufacturer acquired 22 companies in a period of 9 years starting 2005.

Many of these acquisitions were overseas. The company was witnessing strong growth in the boom period and had ambitions of becoming large globally. Since the company used debt financing for its acquisitions, as growth tapered down during the slowdown, the company found it difficult to service debt.

This company went bankrupt around 2017. Acquisitions-for-growth was widely followed strategy in this period and many companies, included some larger respected business houses, engaged in the same. Numerous ill-conceived acquisitions at the peak of the cycle, either permanently or temporarily stunted growth of companies.

⦁ Financial Engineering: A leading textiles manufacturer and exporter, having large forex receivables, entered into complex derivative contracts to cover Euro/ USD receivables. It so turned out that this transaction was at worst a financial engineering transaction (not a hedge) and at best a lack of appreciation of risks inherent in the derivative instrument. The result was, as currency markets went against the company,