Tips to invest in holding companies
For investing in a company we often look at numbers such as cash flow, profit growth and price to earning ratio. However, these do not suffice for companies whose main function is to hold shares of other firms. Holding companies, say market experts, can be a good investment option.
"A holding company typically holds majority voting capital in another company,". While some holding companies are pure investment vehicles, some have their own operations too. We will focus on core investment companies, that is, those whose only purpose is to hold shares in other companies.
MODUS OPERANDI
The main income of core investment companies is dividend. "Holding companies are often created by majority shareholders who have long-term commitment to the business to manage their shareholding in group companies," .
These companies own shares of listed group companies as well as non-listed companies. They can also hold shares of companies that are outside the group. They can hold other securities such as bonds and mutual funds as well.
"Besides, they hold brands and managements. Some top people on boards of holding companies work for group companies as well," .
Investment holding companies which generate cash through dividends and capital gains have to pay dividend distribution tax (DDT). For example, a subsidiary, A Ltd, will deduct DDT before distributing dividend to its holding company, AZ Ltd. Now, if AZ Ltd wants to distribute dividend, it will also have to pay DDT. So, there is double taxation. But there is an exception.
"If a holding company gets dividend from a subsidiary in which it owns over 51%, the holding company can claim credit for the tax paid to the extent of DDT paid by the subsidiary company" .
In short, holding companies are subject to DDT but can claim credit on the tax paid to the extent of dividend received from subsidiary companies. However, there are three conditions. "The dividend should be received from the subsidiary company; the subsidiary should have paid DDT on such dividend; and the recipient company should not be a subsidiary of any other company," says Bohra of PwC. This means DDT is applicable on dividend paid by a holding company in excess of dividend it gets from subsidiary companies. In addition, if a holding company does not own over 51% in the step-down company, it will have to pay full DDT, and there will be double taxation.
THINGS TO KNOW
Diversification: Some such companies have holdings across sectors and offer diversification. "There are a lot of advantages of investing in a holding company. They diversify risk," .
"Holding firms normally own stocks across sectors and offer a balanced exposure. There are also Reserve Bank of India guidelines on capital adequacy, risk-adjusted assets and provision for loss-making investments which limit overexposure to a particular investment" .
Discount to Market Value: Holding companies often trade at a discount to their market values. To understand this, consider a holding firm, ABC, which is trading at Rs 160 and holds shares of companies A and B, both of which are listed. A and B trade at Rs 100 each. This means ABC should trade at Rs 200, which is not the case.
This gap of Rs 40 is the valuation discount and occurs because financial data of companies owned by holding firms is not available if it is not listed. In addition, there are no consolidated financial details, says Vanvari. The discount will go away once the latest International Financial Reporting Standards, which require disclosure of consolidated financials, are adopted in India.
"In India, most listed holding companies are quoting at a 30-70% discount to their investments,".
Value Creation: When an unlisted subsidiary is listed, it creates value for shareholders of the holding company as well. "In cases where one is expecting major spin-offs in the holding structure in the near term that may lead to shareholders securing shares of the constituent companies, holding companies may be considered," .
"Holding companies can give good returns if you know when to invest. In the event of demerger or sale of units, you can get a steep discount to the market value,".
On November 25, the shares of Deccan Chronicle Holdings rose over 15% in a weak stock market on reports the company was likely to demerge its units Deccan Chargers and Odyssey. The stock closed 6.45% up at Rs 47.85 on the Bombay Stock Exchange.
Dividend: Unlike any other company, dividend is the key here. However, if the company does not have a majority stake in its subsidiary company, there is double taxation. Investors must look at the company's dividend record. Also, if a company holds its investment only for strategic reasons and does not intend to sell, investing in it may not be a good idea.
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