If credit downgrades are too late, they don't serve any purpose for investors as by then the damage is already done
04-Sep-2019
If you watch the movies of the '70s and '80s, you will notice that the police almost always arrive at the end, when the hero has already beaten up the villains and his goons. In the financial world, credit-rating agencies often play the role of the latecomer police. They often come into action after the stock has already fallen due to some fundamental shortcoming.
See the charts below. In these companies downgrades have occurred in the last one year. As one can observe, the downgrades have occurred after the stocks had already corrected. This suggests that the market had sensed trouble with these companies before credit-rating agencies did. Apart from the companies whose charts have been presented below, quite a few, such as CG Power, Reliance Home Finance, Wockhardt, etc., also exhibit similar phenomenon.
This lapse in timely reporting hasn't gone unnoticed. Since the unfolding of the IL&FS crisis, credit-rating firms have come under the regulatory lens. A recent investigation by Serious Fraud Investigation Office (SFIO) found that credit-rating agencies gave impressive ratings on a regular basis to debt instruments of IL&FS Financial Services despite company's unhealthy financial condition.
This trend of credit-rating agencies falling short of expectations is neither new nor unique to India. In 2008, during the sub-prime crisis in the US, Lehman Brothers was rated 'A' by S&P just six days before its bankruptcy.
Hence, while investors should check credit ratings, they shouldn't excessively rely on them. Studying fundamentals is the only sure way.
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