What are holding companies? And should you invest in them?

Did you know there are businesses with no businesses? You heard it right. There are companies that do not offer any goods or services or have any operations of their own. How do they make money, then? Why do they even exist? Their name explains it - holding companies - meaning they exist to hold stakes or invest in other companies and assets.

The money part? They primarily earn income from dividends and interest on investments. Tata Investment Corporation, Bajaj Holdings, JSW Holdings, Maharashtra Scooter, and Kama Holdings are some publicly listed holding companies with no operations of their own. Their only business is having stakes and investments elsewhere.

So, you have a business that has no operations, no direct earnings, and no concrete outlook. Why should anyone invest in them? The answer lies in their valuations. Holding companies offer a unique value proposition, drawing in the seekers of value.

Value investors' favourites

Holding companies generally trade at steep discounts to their portfolio's value. Simply put, they trade at a price that is lower than the total market price of their investments (portfolio value). For example, Kama Holdings has a 50.3 per cent stake in the chemical giant SRF, which has a market cap of Rs 66,000 crore (as of May 30, 2024). Kama Holdings trades at a market cap of Rs 7,900 crore, a discount of over 76 per cent to its investment value, which includes both SRF and its other unlisted investments.

But, before the value investor in you rushes to invest, know that these discounts are there for a reason.

Why the steep discounts?

• Low on liquidity: Holding companies generally hold large stakes in other companies that cannot be easily offloaded without triggering a price decline. For instance, British American Tobacco (BAT) decided to offload 3-4 per cent of its stake in ITC a few months ago. By the time it sold the stake, ITC had slumped sharply on fears of an oversupply in the market.
  
• Taxing affair: When a holding company sells its investments, it faces a 10 per cent long-term capital gains tax, which reduces its net proceeds. Additionally, since a holding company and its subsidiary are separate legal entities, stringent regulations often restrict the former from selling its stake in the latter or transferring its assets.
  
• No ownership in subsidiaries: A primary reason to buy shares in a company is to become its part owner. However, investors in a holding company have an indirect interest in its subsidiaries rather than direct ownership.

So, are you ready to take on the risks that come with these steep discounts? If so, the next step is to make sure you invest at the right valuations.

How to determine the value of a holding company

Since holding companies earn money from other businesses, their true value cannot be assessed from their earnings. Hence, their valuation is determined by valuing their investments and other assets such as real estate, shares, etc.

How can this be done? By studying their annual reports. Holding companies have quoted investments, which are publicly traded and hence can be easily valued, and unquoted or hidden investments like shares held in an unlisted company. Since their annual reports carry details of all investments, even the hidden ones, valuing them becomes possible. All you have to do is add up the value of these investments.

Investors' corner

To sum up, holding companies offer a unique value play for investors. However, there are some inherent liquidity and regulatory risks associated with holding companies. Also, given that investing in them is a value play, accurately valuing a holding company is pivotal.

Apart from these, there are a few other things you should consider before investing in holding companies:

• Invest when the discount to the portfolio value is high. Discounts tend to revert to historical averages, offering the potential for substantial returns.
  
• Check if the holding company's portfolio is concentrated. A concentrated portfolio can be more volatile, as its performance is tied to a few companies.

Also read: You may gain from this chemical manufacturer despite expensive valuations