By Ananya Roy
Riding a megatrend entices most investors, and rightfully so. It is one of the most appealing ways of creating long-term wealth. But this endeavour comes with a crucial catch. When a megatrend picks up pace, hordes of players join the race. But most of them succumb, and only a handful emerge as winners. In fact, one of the most cited statistics is that 9 out of 10 startups fail.
A whole bunch of factors need to come together to make a winner – effective product and marketing strategy, strong leadership, skilled employees, fiscal prudence, flexibility, and being at the right place at the right time. So, cherry-picking winners is a tall ask. Even VC investors spread out their bets over multiple investments, knowing that most of them will fail.
That said, it is not as difficult to identify the out-and-out traps. In this article, we shall look at five early warning signals which can help us sidestep such traps in a megatrend.
Behind every winner, we have a long road littered with fallen angels
Consider how Zomato and Swiggy have become household names in India’s rapidly growing food-delivery market. They have the cracked the code with restaurant and delivery partners, and algorithms to make the most of their resources. They are even attempting the next big wave of quick commerce. But against every Swiggy and Zomato, we have a long list with the likes of Juzi, Tiny Owl, Dazo, and Foodpanda which have all but dropped off the face of the earth (or at least, India).
Another megatrend in the midst of breakneck acceleration is AI. There is no doubt that AI will shape the future of not just technology, but also life itself. But the way that things have been going, the AI megatrend may be teetering on the edge of a bubble. A whopping 44% of US VC investments made in 2024 went towards AI. The quantum of investments made in semiconductor chips is staggering, but the results so far are not quite up to the mark yet. So, it is a given that most of these startups riding (or claiming to ride) the AI wave are headed for failure.
Finally, let’s talk about the megatrend that’s been the centre of contention – climate change. Even as some governments opt out of climate-change initiatives, India has been going full throttle. Be it solar or nuclear or EV, the Indian government has stepped up its PLIs and has even kicked off design-linked initiatives. Capital had also been flowing freely in the industry with both, VC/PE funds and IPOs drawing in investor capital. But from the looks of it, this has led to “excesses”, to put it lightly. Be it the fund diversion towards personal use at Blusmart/Gensol or the invoicing issues at Ola Electric, the rot in the industry is now being brought to the fore as competition from incumbents intensifies. Gensol Engineering and Ola Electric have eroded about 85% and 50% of investor wealth since recent highs.
#1. Shortcut shortfall, and the role of auditors
Good governance is key. Investors’ decisions to trust businesses are based on their audited financials. But what if those financials hide the true picture? Effectively, that would be garbage in, garbage out (GIGO) for investing decisions. So, any business that displays a tendency for shady behind-the-books shortcuts, should be avoided like the plague. Of course, this is easier said than done.
While the auditor’s report should ideally include an opinion to indicate suspicious financials, but as the latest Gensol case shows, that is hardly ever the case. Instead, auditors tend to give up the business. So, a frequent change in a company’s auditors should be considered a massive red flag. A good example of this is Byju’s, which saw back-to-back auditor resignations starting way back in FY21, several years before insolvency proceedings were formally initiated against it in 2024.
#2. When business structures confound, watch out for related party transactions
It is not unusual for a business to have a holding company, sister-concerns, and subsidiaries. But when the shareholding goes both ways, or there are too many entities involved, it can confound analysts and investors alike. While this is not a red flag in itself (several large conglomerates have confounding business structures), if it comes with large related party transactions, it should make investors sit up and take notice.
Gensol had funnelled funds to its subsidiary Blusmart by buying EVs and leasing them out to the green ride-hailing platform. In the process, it had also rerouted funds via its EV dealer for manipulating Gensol’s stock price, and for personal use. In fact, loan guarantees taken for related party loans need not even be reported on the books. This should serve as a call to action for accounting regulators.
#3. The debt trap
In some businesses, debt is unavoidable. In fact, financial leverage amplifies the returns for equity shareholders. But as they say, too much of a good thing can be bad for you.
High debt on a company’s books can be seen through common financial ratios such as debt-to-equity, interest coverage, and debt service coverage. If debt is used to fund unproductive activities such as paying dividends or towards avoidable expenses, it goes against the very principle of fiscal prudence. Such companies should not be touched with a ten-foot pole.
Similarly, large and rising debt on the books that is not matched with commensurate growth in revenues and profits, is often a precursor to bankruptcy. Case in point: Gensol. Its debt had exploded from Rs 11 Crore in March 2021 to more than Rs 2,000 Crore now, while revenues, profitability, and internal accruals struggled to keep pace. Result? Its debt-to-equity ratio expanded exponentially to almost 3.5x – well within the territory where all bets are off.
#4. The problem of promoter pledge
When promoters resort to pledging a bulk of their shareholding, they are essentially risking loss of control in the company. If their financials come under stress, the lenders holding the pledged shares would be well within their rights to sell off the shares. This would hit the stock (if it’s listed) and also reduce the promoter’s holding in the company.
Moreover, if the stock price falls due to some unrelated reason, the value of the pledged holdings would fall and could trigger a margin call. This could set off a vicious cycle which requires further pledging of promoter-shares, leading to even higher risk of losing control of the business.
Keeping in mind these risks, promoter-pledging is perceived as a sign of financial distress in the business. While Aster DM was able to quickly fix the situation by releasing a bulk of the pledged shares and this enthused investors, others have not been as fortunate. High promoter pledge was the harbinger of things to come at Reliance Capital several years back, and was a warning sign for Gensol as well.
Gensol’s management had pledged more than 80% of their shares in the company, and the recent selloff by its lenders has led to promoter shareholding falling from more than 70% in FY20 to just about 35% as of March 2025.
#5. Insider information
In an ideal world with perfectly efficient markets, all material information about a business would be publicly available. But practically, we are faced with information asymmetry – management and leadership tend to have a deeper understanding of the business and its outlook than retail investors. So, events such as management exits and promoter stake sale can be perceived as glimpses into that insider information.
Some churn in management is par for the course in any business. Leaders could be moving out for greener pastures, or due to disagreements with the leadership’s vision for the business. But frequent back-to-back exits could indicate shady business that the exiting management is distancing itself from. Similarly, if the promoter offloads its stake in the business, it could also be a sign of brewing trouble.
That said, insider-signals such as these, should be used with caution. By themselves, they could be harmless. For instance, a promoter could be selling shares to meet personal expenses. But if the insider-signals are reiterated over time and come from multiple insiders, while being in conjunction with other early warnings signals, it warrants a deeper look into the business. For example, Enron had seen a massive sale of promoter-stake before its collapse. And Ola Electric has recently seen a string of senior management exits.
While these early warning signs should help sidestep most of the traps, investors are limited by the information available publicly. If that information is incomplete or suspect, it can lead to some bad eggs falling through the cracks. So, to protect their portfolios from any traps which manage to seep through, investors are advised to ensure that their portfolios remain well-diversified.
Disclaimer:
Note: We have relied on data from www.Screener.in throughout this article. Only in cases where the data was not available, have we used an alternate, but widely used and accepted source of information.
The purpose of this article is only to share interesting charts, data points and thought-provoking opinions. It is NOT a recommendation. If you wish to consider an investment, you are strongly advised to consult your advisor. This article is strictly for educative purposes only.
Ananya Roy is the founder of Credibull Capital, a SEBI-registered investment adviser. An alumnus of NIT, IIM, and a CFA charter-holder, she pens her views on the economy and stock markets.
Disclosure: The writer and his dependents do not hold the stocks discussed in this article.
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