Wish you all a very happy and prosperous new year. Thank you all for visiting and reading this blog.
Monday, December 31, 2007
Wish you all a happy new year
Wish you all a very happy and prosperous new year. Thank you all for visiting and reading this blog.
Friday, December 28, 2007
And I am out !
For sake of disclosure, let me say that I have started exiting my position in MRO-TEK. The stock is almost at 95 and has shown an 80% rise in the last one month. It is now above my calculation of intrinsic value for the stock.
I can see the thrill of momentum investing – instant gratification. In spite of the thrill, I am not planning on changing my approach which I understand well, and have become comfortable with, over the years. In general I have seen my picks rise and approach intrinsic value in 1-2 years. That allows me to analyse the company in detail and build a decent position. Sometime I have been able to even average down on the stock as the price went lower and I developed a better understanding of the company.
A case like MRO-TEK is not really suited to my style of investing. Too soon, too fast. If the stock moves up very fast, I lose interest if it crosses my buy levels as I cannot complete the analysis and would hate to create a big position without understanding the company in depth. This approach is ofcourse contrary to most investors. However I do not have such an approach for the sake of being contrary or just because it is a smarter approach. It is just that with my time constraints and risk aversion, I prefer to analyse a company in detail before I invest in it.
Will the stock go higher …? I have no clue and am not planning to play the stock on that.
As always, please read my disclaimer
I can see the thrill of momentum investing – instant gratification. In spite of the thrill, I am not planning on changing my approach which I understand well, and have become comfortable with, over the years. In general I have seen my picks rise and approach intrinsic value in 1-2 years. That allows me to analyse the company in detail and build a decent position. Sometime I have been able to even average down on the stock as the price went lower and I developed a better understanding of the company.
A case like MRO-TEK is not really suited to my style of investing. Too soon, too fast. If the stock moves up very fast, I lose interest if it crosses my buy levels as I cannot complete the analysis and would hate to create a big position without understanding the company in depth. This approach is ofcourse contrary to most investors. However I do not have such an approach for the sake of being contrary or just because it is a smarter approach. It is just that with my time constraints and risk aversion, I prefer to analyse a company in detail before I invest in it.
Will the stock go higher …? I have no clue and am not planning to play the stock on that.
As always, please read my disclaimer
And I am out !
For sake of disclosure, let me say that I have started exiting my position in MRO-TEK. The stock is almost at 95 and has shown an 80% rise in the last one month. It is now above my calculation of intrinsic value for the stock.
I can see the thrill of momentum investing – instant gratification. In spite of the thrill, I am not planning on changing my approach which I understand well, and have become comfortable with, over the years. In general I have seen my picks rise and approach intrinsic value in 1-2 years. That allows me to analyse the company in detail and build a decent position. Sometime I have been able to even average down on the stock as the price went lower and I developed a better understanding of the company.
A case like MRO-TEK is not really suited to my style of investing. Too soon, too fast. If the stock moves up very fast, I lose interest if it crosses my buy levels as I cannot complete the analysis and would hate to create a big position without understanding the company in depth. This approach is ofcourse contrary to most investors. However I do not have such an approach for the sake of being contrary or just because it is a smarter approach. It is just that with my time constraints and risk aversion, I prefer to analyse a company in detail before I invest in it.
Will the stock go higher …? I have no clue and am not planning to play the stock on that.
As always, please read my disclaimer
I can see the thrill of momentum investing – instant gratification. In spite of the thrill, I am not planning on changing my approach which I understand well, and have become comfortable with, over the years. In general I have seen my picks rise and approach intrinsic value in 1-2 years. That allows me to analyse the company in detail and build a decent position. Sometime I have been able to even average down on the stock as the price went lower and I developed a better understanding of the company.
A case like MRO-TEK is not really suited to my style of investing. Too soon, too fast. If the stock moves up very fast, I lose interest if it crosses my buy levels as I cannot complete the analysis and would hate to create a big position without understanding the company in depth. This approach is ofcourse contrary to most investors. However I do not have such an approach for the sake of being contrary or just because it is a smarter approach. It is just that with my time constraints and risk aversion, I prefer to analyse a company in detail before I invest in it.
Will the stock go higher …? I have no clue and am not planning to play the stock on that.
As always, please read my disclaimer
Monday, December 24, 2007
From Value to momentum – MRO TEK
I generally select and buy stocks where the general enthusiam for them is very low. None of my picks shoot up after I have bought them and so when a few did in the last few months, it was a new experience for me.One such pick was MRO-TEK. I started looking at the Company a few weeks back when the stock was at around 52 per share. My analysis was as follows
About
The company is primarily into end-to-end solutions and hardware/products-provider in data communications, data access and networking fields, offering a wide range of sophisticated LAN/WAN products.
The company has a JV with RAD corporation and a few other technical collaborations. The company had a split of 30-70 of manufacturing v/s trading a few years back. In the recent years, the split has reversed to around 70-30 in terms of revenue
Performance
The company has had very erratic performance. The projections which the company made at the time of the IPO in 2000, were never met (by a huge margin). Since then the performance has been one step forward and one step back. The ROE has fluctuated between 5 and 15 %. Topline has also fluctuated and has grown by 9% per annum and the Net profit has also grown by roughly the same amount.
The margins have held steady at 9-10% and the asset turns have improved from 1.2 to 2.6
Positives
The company has maintained its margins and improved its efficiency ratios. Wcap ratio has improved from 1.5 to 6 due to improvement in inventory and recievable turns. The company has freed up cash and as a result has no debt and almost 40 Crs of cash on the balance sheet.
The company recently completed a buyback program using the surplus cash. The promoters have also been increasing their holding % in the last few years. The company has been paying a decent dividend with a DPS/EPS of around 30-40%.
Negatives
Although the management appears rational, pro-shareholder and is trying to create value, their performance has not been up to the mark. Reading the annual report reminds me of kids in school, who study hard and have the right work ethic, but still manage to flunk one or two subjects each year.
The company operates in a very competitive field with competition from likes of CISCO and LUCENT etc. This industry involves a lot of new technology, high R&D expenditure and high rates of obsolescence. MRO has only recently started investing in R&D and till recent past was mainly a distributor of networking products.
Conclusion
My personal estimate of intrinsic value was around Rs 90/ share. At 52 / share, the company was not a screaming buy, but worth creating an initial position.
I am not too optimistic on the long term economics of the company as this is a very small company in a fast paced and competitive industry. As a result it is diffcult for the company to operate at the top end of the product range and make good margins. Due to my lack of confidence on sustained good performance I conservatively estimated the intrinsic value at around 90 /share
Post script
Once I complete the analysis, I write a single page note detailing my investment thesis. This is more to record my thoughts at the time of the decision. It is useful to keep such notes as I can check them again later and check if my assumptions were true or not.
Well in this case, it never came to that. Almost from the next day the stock suddenly caught the fancy of the market. Somehow everyone has a very different opinion and as a result the stock is up almost 50-60% since then. In my case after creating an initial position, I stop buying it. Personally I buy at 40-50% of my estimate of intrinsic value and if the stock sells above that I don’t do anything. You may think I am leaving money on the table, but I prefer to follow a discplined approach. In my case I am not comfortable with trading and momentum plays and prefer to leave it to other who are better at it.
Valuation logic – 2008 EPS around 6-7 / share
PE ( will explain logic for this in a different post ) = 9-10
Cash / share = 40 Rs/ share
Total = 94 – 110 Rs/share
From Value to momentum – MRO TEK
I generally select and buy stocks where the general enthusiam for them is very low. None of my picks shoot up after I have bought them and so when a few did in the last few months, it was a new experience for me.One such pick was MRO-TEK. I started looking at the Company a few weeks back when the stock was at around 52 per share. My analysis was as follows
About
The company is primarily into end-to-end solutions and hardware/products-provider in data communications, data access and networking fields, offering a wide range of sophisticated LAN/WAN products.
The company has a JV with RAD corporation and a few other technical collaborations. The company had a split of 30-70 of manufacturing v/s trading a few years back. In the recent years, the split has reversed to around 70-30 in terms of revenue
Performance
The company has had very erratic performance. The projections which the company made at the time of the IPO in 2000, were never met (by a huge margin). Since then the performance has been one step forward and one step back. The ROE has fluctuated between 5 and 15 %. Topline has also fluctuated and has grown by 9% per annum and the Net profit has also grown by roughly the same amount.
The margins have held steady at 9-10% and the asset turns have improved from 1.2 to 2.6
Positives
The company has maintained its margins and improved its efficiency ratios. Wcap ratio has improved from 1.5 to 6 due to improvement in inventory and recievable turns. The company has freed up cash and as a result has no debt and almost 40 Crs of cash on the balance sheet.
The company recently completed a buyback program using the surplus cash. The promoters have also been increasing their holding % in the last few years. The company has been paying a decent dividend with a DPS/EPS of around 30-40%.
Negatives
Although the management appears rational, pro-shareholder and is trying to create value, their performance has not been up to the mark. Reading the annual report reminds me of kids in school, who study hard and have the right work ethic, but still manage to flunk one or two subjects each year.
The company operates in a very competitive field with competition from likes of CISCO and LUCENT etc. This industry involves a lot of new technology, high R&D expenditure and high rates of obsolescence. MRO has only recently started investing in R&D and till recent past was mainly a distributor of networking products.
Conclusion
My personal estimate of intrinsic value was around Rs 90/ share. At 52 / share, the company was not a screaming buy, but worth creating an initial position.
I am not too optimistic on the long term economics of the company as this is a very small company in a fast paced and competitive industry. As a result it is diffcult for the company to operate at the top end of the product range and make good margins. Due to my lack of confidence on sustained good performance I conservatively estimated the intrinsic value at around 90 /share
Post script
Once I complete the analysis, I write a single page note detailing my investment thesis. This is more to record my thoughts at the time of the decision. It is useful to keep such notes as I can check them again later and check if my assumptions were true or not.
Well in this case, it never came to that. Almost from the next day the stock suddenly caught the fancy of the market. Somehow everyone has a very different opinion and as a result the stock is up almost 50-60% since then. In my case after creating an initial position, I stop buying it. Personally I buy at 40-50% of my estimate of intrinsic value and if the stock sells above that I don’t do anything. You may think I am leaving money on the table, but I prefer to follow a discplined approach. In my case I am not comfortable with trading and momentum plays and prefer to leave it to other who are better at it.
Valuation logic – 2008 EPS around 6-7 / share
PE ( will explain logic for this in a different post ) = 9-10
Cash / share = 40 Rs/ share
Total = 94 – 110 Rs/share
Sunday, December 16, 2007
It was difficult NOT to do well
2007 has been one of those years where it was difficult NOT to make money in the stock market. At the risk of offending, let me say even a monkey would have made money. Don’t get me wrong, if you have done well this year, it does not make you a monkey :) (by that measure I am a monkey too, not that I am complaining).
The monkey term is more to randomly picking stocks than to a monkey IQ. This was one of those years where almost all types of stocks did well. If you avoided some of the sectors such as IT, everything else was in a bull market. From Aug to Oct the large caps did well and since then the Mid caps have caught fire. I have seen some of the stocks almost double in the last 1-2 months. When I wrote earlier, on midcaps in may there were a decent number of opportunities available. However the valuation gaps have started closing since then and the number of opportunities have come down (although there are still a few around).
So whats in store for the next year? As if I know !! and so does no one else. I have long stopped bothering about market forecast and which sector is going to do well etc etc. The smart thing to do is to analyse companies and if you can find one selling below intrinsic value, buy it. Not all your picks will do well at the same time (unlike 2007!), but a few would.
If I started investing this year or during the current bull run (from 2003 onwards), I would want to re-analyse my approach to ensure that it was due to my own stock picking skills and not due to the rising tide. I do that every year in the following manner
- did my portfolio do better than the market index such as Sensex
- Which stocks did better than average and which did not
- What was the reason for the stocks which overperformed (luck?)
- What the reason for the stocks which underperformed and how to avoid the the cause of the underperformance
It is important to do the above analysis to ensure that the good performance was not due to luck and can be repeated again. Luck can make you money in the short run, but in the long run you will give it back. So it is critical to be brutually honest with yourself.
The monkey term is more to randomly picking stocks than to a monkey IQ. This was one of those years where almost all types of stocks did well. If you avoided some of the sectors such as IT, everything else was in a bull market. From Aug to Oct the large caps did well and since then the Mid caps have caught fire. I have seen some of the stocks almost double in the last 1-2 months. When I wrote earlier, on midcaps in may there were a decent number of opportunities available. However the valuation gaps have started closing since then and the number of opportunities have come down (although there are still a few around).
So whats in store for the next year? As if I know !! and so does no one else. I have long stopped bothering about market forecast and which sector is going to do well etc etc. The smart thing to do is to analyse companies and if you can find one selling below intrinsic value, buy it. Not all your picks will do well at the same time (unlike 2007!), but a few would.
If I started investing this year or during the current bull run (from 2003 onwards), I would want to re-analyse my approach to ensure that it was due to my own stock picking skills and not due to the rising tide. I do that every year in the following manner
- did my portfolio do better than the market index such as Sensex
- Which stocks did better than average and which did not
- What was the reason for the stocks which overperformed (luck?)
- What the reason for the stocks which underperformed and how to avoid the the cause of the underperformance
It is important to do the above analysis to ensure that the good performance was not due to luck and can be repeated again. Luck can make you money in the short run, but in the long run you will give it back. So it is critical to be brutually honest with yourself.
It was difficult NOT to do well
2007 has been one of those years where it was difficult NOT to make money in the stock market. At the risk of offending, let me say even a monkey would have made money. Don’t get me wrong, if you have done well this year, it does not make you a monkey :) (by that measure I am a monkey too, not that I am complaining).
The monkey term is more to randomly picking stocks than to a monkey IQ. This was one of those years where almost all types of stocks did well. If you avoided some of the sectors such as IT, everything else was in a bull market. From Aug to Oct the large caps did well and since then the Mid caps have caught fire. I have seen some of the stocks almost double in the last 1-2 months. When I wrote earlier, on midcaps in may there were a decent number of opportunities available. However the valuation gaps have started closing since then and the number of opportunities have come down (although there are still a few around).
So whats in store for the next year? As if I know !! and so does no one else. I have long stopped bothering about market forecast and which sector is going to do well etc etc. The smart thing to do is to analyse companies and if you can find one selling below intrinsic value, buy it. Not all your picks will do well at the same time (unlike 2007!), but a few would.
If I started investing this year or during the current bull run (from 2003 onwards), I would want to re-analyse my approach to ensure that it was due to my own stock picking skills and not due to the rising tide. I do that every year in the following manner
- did my portfolio do better than the market index such as Sensex
- Which stocks did better than average and which did not
- What was the reason for the stocks which overperformed (luck?)
- What the reason for the stocks which underperformed and how to avoid the the cause of the underperformance
It is important to do the above analysis to ensure that the good performance was not due to luck and can be repeated again. Luck can make you money in the short run, but in the long run you will give it back. So it is critical to be brutually honest with yourself.
The monkey term is more to randomly picking stocks than to a monkey IQ. This was one of those years where almost all types of stocks did well. If you avoided some of the sectors such as IT, everything else was in a bull market. From Aug to Oct the large caps did well and since then the Mid caps have caught fire. I have seen some of the stocks almost double in the last 1-2 months. When I wrote earlier, on midcaps in may there were a decent number of opportunities available. However the valuation gaps have started closing since then and the number of opportunities have come down (although there are still a few around).
So whats in store for the next year? As if I know !! and so does no one else. I have long stopped bothering about market forecast and which sector is going to do well etc etc. The smart thing to do is to analyse companies and if you can find one selling below intrinsic value, buy it. Not all your picks will do well at the same time (unlike 2007!), but a few would.
If I started investing this year or during the current bull run (from 2003 onwards), I would want to re-analyse my approach to ensure that it was due to my own stock picking skills and not due to the rising tide. I do that every year in the following manner
- did my portfolio do better than the market index such as Sensex
- Which stocks did better than average and which did not
- What was the reason for the stocks which overperformed (luck?)
- What the reason for the stocks which underperformed and how to avoid the the cause of the underperformance
It is important to do the above analysis to ensure that the good performance was not due to luck and can be repeated again. Luck can make you money in the short run, but in the long run you will give it back. So it is critical to be brutually honest with yourself.
Wednesday, December 12, 2007
Ashok leyland - Private market value
I had written on Ashok leyland earlier.
My valuation was as follows
The company sells at a PE of 12. The current EPS is around 3.3 per share. The company can be expected to grow at 10-12% over the next few years. In addition the company has some competitive advantage such as a known brand name (especially in the south), long operating history and experience in the market, rational management and a decent distrubution/ service network.The company can be valued at around 16-18 times PE and given an intrinsic value of around 60 Rs/ share.
I recently got this email from Vishnu
I have been going through Eicher JV deal with VOLVO. It would be great if you can share your opinions.
Story:
Eicher is stepping down its Commercial Vehicle and Component business into a JV with VOLVO which is paying 275 million USD in CASH and 75 million USD in terms of VOLVO's truck distribution business in the JV.
Valuations:
Cash(VOLVO) is paying 1045
VOLVO India Truck distribution 142
TOTAL VOLVO Share (45.6%) 1187
EICHER Share in JV (54.4%) 1416.070175
Eicher Market cap 1314
* All figures are in Crores (INR)
I have already shared my opinion on the above opportunity with him. What struck me was that the deal involved the Commercial vehicle business and the deal was valued at approximately 2000 crs. Eicher motor’s CV business had a PAT of roughly 62 crs (pretax – 82 Crs) and hence the private market value (the amount that a private investor would be willing to pay for the company, in its entirety, were it not public) seems to be around 25-30 times earnings
So Ashok leyland can be valued at 70-90 Rs/share by the above metric. My own conservative estimate was around 60/share.
Whats the point of this analysis ? well private market valuation is another approach to valuation. It may be more than your own estimate as it may include controlling premium. However if you can find the private market value to a business you are looking at, it helps in calculating the intrinsic value.
In case you are wondering if I really benifited from my research, I did not completely. I have this tendency to do detailed analysis and build my position over a period of a few months especially if the price drops reaches or drops below 50% of my estimate of intrinsic value. Ashok leyland is around 54 now, so basically the price went up before I could go beyond my initial position. That unfortunately has happened several times this year.
Why should a quick price increase be unfortunate? Well that’s another post for this wacky idea.
My valuation was as follows
The company sells at a PE of 12. The current EPS is around 3.3 per share. The company can be expected to grow at 10-12% over the next few years. In addition the company has some competitive advantage such as a known brand name (especially in the south), long operating history and experience in the market, rational management and a decent distrubution/ service network.The company can be valued at around 16-18 times PE and given an intrinsic value of around 60 Rs/ share.
I recently got this email from Vishnu
I have been going through Eicher JV deal with VOLVO. It would be great if you can share your opinions.
Story:
Eicher is stepping down its Commercial Vehicle and Component business into a JV with VOLVO which is paying 275 million USD in CASH and 75 million USD in terms of VOLVO's truck distribution business in the JV.
Valuations:
Cash(VOLVO) is paying 1045
VOLVO India Truck distribution 142
TOTAL VOLVO Share (45.6%) 1187
EICHER Share in JV (54.4%) 1416.070175
Eicher Market cap 1314
* All figures are in Crores (INR)
I have already shared my opinion on the above opportunity with him. What struck me was that the deal involved the Commercial vehicle business and the deal was valued at approximately 2000 crs. Eicher motor’s CV business had a PAT of roughly 62 crs (pretax – 82 Crs) and hence the private market value (the amount that a private investor would be willing to pay for the company, in its entirety, were it not public) seems to be around 25-30 times earnings
So Ashok leyland can be valued at 70-90 Rs/share by the above metric. My own conservative estimate was around 60/share.
Whats the point of this analysis ? well private market valuation is another approach to valuation. It may be more than your own estimate as it may include controlling premium. However if you can find the private market value to a business you are looking at, it helps in calculating the intrinsic value.
In case you are wondering if I really benifited from my research, I did not completely. I have this tendency to do detailed analysis and build my position over a period of a few months especially if the price drops reaches or drops below 50% of my estimate of intrinsic value. Ashok leyland is around 54 now, so basically the price went up before I could go beyond my initial position. That unfortunately has happened several times this year.
Why should a quick price increase be unfortunate? Well that’s another post for this wacky idea.
Ashok leyland - Private market value
I had written on Ashok leyland earlier.
My valuation was as follows
The company sells at a PE of 12. The current EPS is around 3.3 per share. The company can be expected to grow at 10-12% over the next few years. In addition the company has some competitive advantage such as a known brand name (especially in the south), long operating history and experience in the market, rational management and a decent distrubution/ service network.The company can be valued at around 16-18 times PE and given an intrinsic value of around 60 Rs/ share.
I recently got this email from Vishnu
I have been going through Eicher JV deal with VOLVO. It would be great if you can share your opinions.
Story:
Eicher is stepping down its Commercial Vehicle and Component business into a JV with VOLVO which is paying 275 million USD in CASH and 75 million USD in terms of VOLVO's truck distribution business in the JV.
Valuations:
Cash(VOLVO) is paying 1045
VOLVO India Truck distribution 142
TOTAL VOLVO Share (45.6%) 1187
EICHER Share in JV (54.4%) 1416.070175
Eicher Market cap 1314
* All figures are in Crores (INR)
I have already shared my opinion on the above opportunity with him. What struck me was that the deal involved the Commercial vehicle business and the deal was valued at approximately 2000 crs. Eicher motor’s CV business had a PAT of roughly 62 crs (pretax – 82 Crs) and hence the private market value (the amount that a private investor would be willing to pay for the company, in its entirety, were it not public) seems to be around 25-30 times earnings
So Ashok leyland can be valued at 70-90 Rs/share by the above metric. My own conservative estimate was around 60/share.
Whats the point of this analysis ? well private market valuation is another approach to valuation. It may be more than your own estimate as it may include controlling premium. However if you can find the private market value to a business you are looking at, it helps in calculating the intrinsic value.
In case you are wondering if I really benifited from my research, I did not completely. I have this tendency to do detailed analysis and build my position over a period of a few months especially if the price drops reaches or drops below 50% of my estimate of intrinsic value. Ashok leyland is around 54 now, so basically the price went up before I could go beyond my initial position. That unfortunately has happened several times this year.
Why should a quick price increase be unfortunate? Well that’s another post for this wacky idea.
My valuation was as follows
The company sells at a PE of 12. The current EPS is around 3.3 per share. The company can be expected to grow at 10-12% over the next few years. In addition the company has some competitive advantage such as a known brand name (especially in the south), long operating history and experience in the market, rational management and a decent distrubution/ service network.The company can be valued at around 16-18 times PE and given an intrinsic value of around 60 Rs/ share.
I recently got this email from Vishnu
I have been going through Eicher JV deal with VOLVO. It would be great if you can share your opinions.
Story:
Eicher is stepping down its Commercial Vehicle and Component business into a JV with VOLVO which is paying 275 million USD in CASH and 75 million USD in terms of VOLVO's truck distribution business in the JV.
Valuations:
Cash(VOLVO) is paying 1045
VOLVO India Truck distribution 142
TOTAL VOLVO Share (45.6%) 1187
EICHER Share in JV (54.4%) 1416.070175
Eicher Market cap 1314
* All figures are in Crores (INR)
I have already shared my opinion on the above opportunity with him. What struck me was that the deal involved the Commercial vehicle business and the deal was valued at approximately 2000 crs. Eicher motor’s CV business had a PAT of roughly 62 crs (pretax – 82 Crs) and hence the private market value (the amount that a private investor would be willing to pay for the company, in its entirety, were it not public) seems to be around 25-30 times earnings
So Ashok leyland can be valued at 70-90 Rs/share by the above metric. My own conservative estimate was around 60/share.
Whats the point of this analysis ? well private market valuation is another approach to valuation. It may be more than your own estimate as it may include controlling premium. However if you can find the private market value to a business you are looking at, it helps in calculating the intrinsic value.
In case you are wondering if I really benifited from my research, I did not completely. I have this tendency to do detailed analysis and build my position over a period of a few months especially if the price drops reaches or drops below 50% of my estimate of intrinsic value. Ashok leyland is around 54 now, so basically the price went up before I could go beyond my initial position. That unfortunately has happened several times this year.
Why should a quick price increase be unfortunate? Well that’s another post for this wacky idea.
Sunday, December 09, 2007
Maintenance capex calculation
I discussed about maintenance capex and its relation with Free cash flow. To recap
Free cash flow = Net earnings + depreciation – maintenance capex
And free cash flow is the money the owner of business can take out or re-invest in the business.
Maintenance capex however does not have a precise formulae. That does not mean you cannot calculate it. But as you can see, if valuation is based on free cash flow which itself is based on an imprecise measure such as maintenance capex, it cannot be precise in itself.
Valuation depends on free cash flow, project growth rates , terminal value and the discount rates. All these are estimates and hence valuation is itself an estimate. That is the reason I find it assuming when analysts give reports where they give precise valuation targets and on top of that even the duration (next one year !!) when the target would be met.
So, coming back to maintenance capex, how do I estimate it? let me warn you at the outset. My approach is self developed, imprecise and only roughly right.
I will use my valuation template to explain my approach
Worksheet – anal – In this worksheet I fill up the sales, depreciation, wcap etc. On line 26, I calculate the additional capex (additional fixed asset and Wcap for the year). Line 27 is capex as % of sales. This gives me a capex trend (total) for a period of time for the business. I then use this trend to estimate the maintenance capex.
For ex: if the business has an asset turn (on average) of 2, then I would assume capex as 2.5% of sales
Sales = 100
Asset = 50
Inflation increase in sales = 5
Corresponding asset required = 2.5 (2.5% of sales)
If the business is asset heavy (commodity industry) then the maintenance capex as % of sales is high.
If the asset turn is 1, then maintenance capex would be roughly 5% of sales. You can compare this % with depreciation as a % of sales to see if both are roughly equal.
You may find some errors in my worksheet and I plan to load an updated version soon. I don’t use these worksheet very frequently now. After using these worksheets for several years, I am now in a position where I can look at the numbers and estimate if the company looks roughly undervalued. A lot of companies don’t pass that test and are rejected outright. If a company passes that filter, I fill up the excel and go through the entire exercise (which is not very precise in itself)
I have loaded a few samples in the google groups. If you go through this exercise yourself several times, you will see patterns and it will be faster for you too.
In addition to the above excel, please have a look at the excel – Quantitative calculation – worksheet : Maintenance capex to see the relationship between Sales, Asset turns, Maintenance capex and ROC.
Ofcourse you can have a counter argument – who the hell wants to go through such an elaborate exercise to value a company? Don’t I have better things to do in life :)
Free cash flow = Net earnings + depreciation – maintenance capex
And free cash flow is the money the owner of business can take out or re-invest in the business.
Maintenance capex however does not have a precise formulae. That does not mean you cannot calculate it. But as you can see, if valuation is based on free cash flow which itself is based on an imprecise measure such as maintenance capex, it cannot be precise in itself.
Valuation depends on free cash flow, project growth rates , terminal value and the discount rates. All these are estimates and hence valuation is itself an estimate. That is the reason I find it assuming when analysts give reports where they give precise valuation targets and on top of that even the duration (next one year !!) when the target would be met.
So, coming back to maintenance capex, how do I estimate it? let me warn you at the outset. My approach is self developed, imprecise and only roughly right.
I will use my valuation template to explain my approach
Worksheet – anal – In this worksheet I fill up the sales, depreciation, wcap etc. On line 26, I calculate the additional capex (additional fixed asset and Wcap for the year). Line 27 is capex as % of sales. This gives me a capex trend (total) for a period of time for the business. I then use this trend to estimate the maintenance capex.
For ex: if the business has an asset turn (on average) of 2, then I would assume capex as 2.5% of sales
Sales = 100
Asset = 50
Inflation increase in sales = 5
Corresponding asset required = 2.5 (2.5% of sales)
If the business is asset heavy (commodity industry) then the maintenance capex as % of sales is high.
If the asset turn is 1, then maintenance capex would be roughly 5% of sales. You can compare this % with depreciation as a % of sales to see if both are roughly equal.
You may find some errors in my worksheet and I plan to load an updated version soon. I don’t use these worksheet very frequently now. After using these worksheets for several years, I am now in a position where I can look at the numbers and estimate if the company looks roughly undervalued. A lot of companies don’t pass that test and are rejected outright. If a company passes that filter, I fill up the excel and go through the entire exercise (which is not very precise in itself)
I have loaded a few samples in the google groups. If you go through this exercise yourself several times, you will see patterns and it will be faster for you too.
In addition to the above excel, please have a look at the excel – Quantitative calculation – worksheet : Maintenance capex to see the relationship between Sales, Asset turns, Maintenance capex and ROC.
Ofcourse you can have a counter argument – who the hell wants to go through such an elaborate exercise to value a company? Don’t I have better things to do in life :)
Maintenance capex calculation
I discussed about maintenance capex and its relation with Free cash flow. To recap
Free cash flow = Net earnings + depreciation – maintenance capex
And free cash flow is the money the owner of business can take out or re-invest in the business.
Maintenance capex however does not have a precise formulae. That does not mean you cannot calculate it. But as you can see, if valuation is based on free cash flow which itself is based on an imprecise measure such as maintenance capex, it cannot be precise in itself.
Valuation depends on free cash flow, project growth rates , terminal value and the discount rates. All these are estimates and hence valuation is itself an estimate. That is the reason I find it assuming when analysts give reports where they give precise valuation targets and on top of that even the duration (next one year !!) when the target would be met.
So, coming back to maintenance capex, how do I estimate it? let me warn you at the outset. My approach is self developed, imprecise and only roughly right.
I will use my valuation template to explain my approach
Worksheet – anal – In this worksheet I fill up the sales, depreciation, wcap etc. On line 26, I calculate the additional capex (additional fixed asset and Wcap for the year). Line 27 is capex as % of sales. This gives me a capex trend (total) for a period of time for the business. I then use this trend to estimate the maintenance capex.
For ex: if the business has an asset turn (on average) of 2, then I would assume capex as 2.5% of sales
Sales = 100
Asset = 50
Inflation increase in sales = 5
Corresponding asset required = 2.5 (2.5% of sales)
If the business is asset heavy (commodity industry) then the maintenance capex as % of sales is high.
If the asset turn is 1, then maintenance capex would be roughly 5% of sales. You can compare this % with depreciation as a % of sales to see if both are roughly equal.
You may find some errors in my worksheet and I plan to load an updated version soon. I don’t use these worksheet very frequently now. After using these worksheets for several years, I am now in a position where I can look at the numbers and estimate if the company looks roughly undervalued. A lot of companies don’t pass that test and are rejected outright. If a company passes that filter, I fill up the excel and go through the entire exercise (which is not very precise in itself)
I have loaded a few samples in the google groups. If you go through this exercise yourself several times, you will see patterns and it will be faster for you too.
In addition to the above excel, please have a look at the excel – Quantitative calculation – worksheet : Maintenance capex to see the relationship between Sales, Asset turns, Maintenance capex and ROC.
Ofcourse you can have a counter argument – who the hell wants to go through such an elaborate exercise to value a company? Don’t I have better things to do in life :)
Free cash flow = Net earnings + depreciation – maintenance capex
And free cash flow is the money the owner of business can take out or re-invest in the business.
Maintenance capex however does not have a precise formulae. That does not mean you cannot calculate it. But as you can see, if valuation is based on free cash flow which itself is based on an imprecise measure such as maintenance capex, it cannot be precise in itself.
Valuation depends on free cash flow, project growth rates , terminal value and the discount rates. All these are estimates and hence valuation is itself an estimate. That is the reason I find it assuming when analysts give reports where they give precise valuation targets and on top of that even the duration (next one year !!) when the target would be met.
So, coming back to maintenance capex, how do I estimate it? let me warn you at the outset. My approach is self developed, imprecise and only roughly right.
I will use my valuation template to explain my approach
Worksheet – anal – In this worksheet I fill up the sales, depreciation, wcap etc. On line 26, I calculate the additional capex (additional fixed asset and Wcap for the year). Line 27 is capex as % of sales. This gives me a capex trend (total) for a period of time for the business. I then use this trend to estimate the maintenance capex.
For ex: if the business has an asset turn (on average) of 2, then I would assume capex as 2.5% of sales
Sales = 100
Asset = 50
Inflation increase in sales = 5
Corresponding asset required = 2.5 (2.5% of sales)
If the business is asset heavy (commodity industry) then the maintenance capex as % of sales is high.
If the asset turn is 1, then maintenance capex would be roughly 5% of sales. You can compare this % with depreciation as a % of sales to see if both are roughly equal.
You may find some errors in my worksheet and I plan to load an updated version soon. I don’t use these worksheet very frequently now. After using these worksheets for several years, I am now in a position where I can look at the numbers and estimate if the company looks roughly undervalued. A lot of companies don’t pass that test and are rejected outright. If a company passes that filter, I fill up the excel and go through the entire exercise (which is not very precise in itself)
I have loaded a few samples in the google groups. If you go through this exercise yourself several times, you will see patterns and it will be faster for you too.
In addition to the above excel, please have a look at the excel – Quantitative calculation – worksheet : Maintenance capex to see the relationship between Sales, Asset turns, Maintenance capex and ROC.
Ofcourse you can have a counter argument – who the hell wants to go through such an elaborate exercise to value a company? Don’t I have better things to do in life :)
Monday, December 03, 2007
maintenance capex and FCF
I received the following question from sanjay shetty via email. I will try to answer the question and have also simplified it via several assumptions
You mentioned you "use maintenance capex needed to support unit volumes or competitive position (maintenance capex)."
I downloaded your Excel sheets couldn't figure out the basis for calculation of the same, especially as companies don't give break ups of maintenance capex. If you could explain would be great.
Maybe my understanding is incorrect, however I feel that all Purchase of Fixed assets should be deducted from Free Cash Flow especially when the amount out there is a yearly spend by the company to grow it's business.
Let me start with the following definition for free cash flow (paraphrased) as given by warren buffet
Free cash flow = Net earnings + depreciation – maintenance capex
Now you can take the above formulae as a given or debate whether it is correct. I think it is correct as free cash flow is basically discretionary cash which the owners (actually managers on their behalf) of the business can choose whichever way to invest. It is discretionary cash because the business is left with this cash after it has incurred the required capex to maintain its current position in terms of volume and competitive position. If it does not do that, then the business will start degrading and may eventually be wiped out.
Now the discretionary cash can be spent in the following ways
1. Invest in the buiness itself if the returns are good – most common approach. Value adding if the business earns more than cost of capital . for ex: ITC, asian paints, HLL etc. This investment is in fixed assets and working capital
2. Accquire other company – Eg. Marico
3. Return cash to shareholder via dividends or share buyback
4. Just hold cash and do nothing – Ex: Merck, Novartis etc
Now the question – How to calculate maintenance capex? There is no precise formulae for that. The best you can do is to arrive at a rough number as companies don’t give this number. Let take the definition above and let me give my approach
If the maintenance capex is to maintain unit volumes, then value sales would be growing at the rate of inflation. So lets take a hypothetical case (simplified)
Sales = 100
Return on equity = 20% ( debt = 0)
Net margin = 10%
Total asset / sales = 2
Total asset = 50
Depreciation = 5 % of asset
Now in year 2
Sales = 105 (5 % inflation)
ROE = 20%
Net margin = 10%
Total asset / sales = 2
Total asset = 52.5
FCF = 10.5+2.5-2.5 [ asset increase = 2.5 ]
So in the simple case above FCF is equal to Net profit. Ofcourse reality is not so simple. However once you get an idea of the basic concept, you can do a rough estimation of the maintenance capex and free cash flow.
Key point to remember – If the ROE is in excess of 15%, generally the depreciation will covers the maintenance capex and the Net profit will be almost equal to free cash flow.
Exception to the above can be seen in some companies such as Gujarat gas/ HLL etc where the Working capital throws off cash and hence the FCF is actually greater than the free cash flow.
So in response to the question above, I would say that some amount of the Fixed asset has to be adjusted , but I would not deduct all the addition. For ex: A company launches a very profitable product and due to volume growth puts up a new plant. The cash flow may be negative during that year and then become positive a few years later. If you focus on the cash flow based on actual capex, you may undervalue the company when it is investing in a profitable venture and over value a company which is not investing and just milking its assets.
The above post may appear fairly academic and boring, but I think the question asked by sanjay goes to the core of how to value a company.
Next post : I will try to explain how I calculate FCF using the excels I have uploaded
You mentioned you "use maintenance capex needed to support unit volumes or competitive position (maintenance capex)."
I downloaded your Excel sheets couldn't figure out the basis for calculation of the same, especially as companies don't give break ups of maintenance capex. If you could explain would be great.
Maybe my understanding is incorrect, however I feel that all Purchase of Fixed assets should be deducted from Free Cash Flow especially when the amount out there is a yearly spend by the company to grow it's business.
Let me start with the following definition for free cash flow (paraphrased) as given by warren buffet
Free cash flow = Net earnings + depreciation – maintenance capex
Now you can take the above formulae as a given or debate whether it is correct. I think it is correct as free cash flow is basically discretionary cash which the owners (actually managers on their behalf) of the business can choose whichever way to invest. It is discretionary cash because the business is left with this cash after it has incurred the required capex to maintain its current position in terms of volume and competitive position. If it does not do that, then the business will start degrading and may eventually be wiped out.
Now the discretionary cash can be spent in the following ways
1. Invest in the buiness itself if the returns are good – most common approach. Value adding if the business earns more than cost of capital . for ex: ITC, asian paints, HLL etc. This investment is in fixed assets and working capital
2. Accquire other company – Eg. Marico
3. Return cash to shareholder via dividends or share buyback
4. Just hold cash and do nothing – Ex: Merck, Novartis etc
Now the question – How to calculate maintenance capex? There is no precise formulae for that. The best you can do is to arrive at a rough number as companies don’t give this number. Let take the definition above and let me give my approach
If the maintenance capex is to maintain unit volumes, then value sales would be growing at the rate of inflation. So lets take a hypothetical case (simplified)
Sales = 100
Return on equity = 20% ( debt = 0)
Net margin = 10%
Total asset / sales = 2
Total asset = 50
Depreciation = 5 % of asset
Now in year 2
Sales = 105 (5 % inflation)
ROE = 20%
Net margin = 10%
Total asset / sales = 2
Total asset = 52.5
FCF = 10.5+2.5-2.5 [ asset increase = 2.5 ]
So in the simple case above FCF is equal to Net profit. Ofcourse reality is not so simple. However once you get an idea of the basic concept, you can do a rough estimation of the maintenance capex and free cash flow.
Key point to remember – If the ROE is in excess of 15%, generally the depreciation will covers the maintenance capex and the Net profit will be almost equal to free cash flow.
Exception to the above can be seen in some companies such as Gujarat gas/ HLL etc where the Working capital throws off cash and hence the FCF is actually greater than the free cash flow.
So in response to the question above, I would say that some amount of the Fixed asset has to be adjusted , but I would not deduct all the addition. For ex: A company launches a very profitable product and due to volume growth puts up a new plant. The cash flow may be negative during that year and then become positive a few years later. If you focus on the cash flow based on actual capex, you may undervalue the company when it is investing in a profitable venture and over value a company which is not investing and just milking its assets.
The above post may appear fairly academic and boring, but I think the question asked by sanjay goes to the core of how to value a company.
Next post : I will try to explain how I calculate FCF using the excels I have uploaded
maintenance capex and FCF
I received the following question from sanjay shetty via email. I will try to answer the question and have also simplified it via several assumptions
You mentioned you "use maintenance capex needed to support unit volumes or competitive position (maintenance capex)."
I downloaded your Excel sheets couldn't figure out the basis for calculation of the same, especially as companies don't give break ups of maintenance capex. If you could explain would be great.
Maybe my understanding is incorrect, however I feel that all Purchase of Fixed assets should be deducted from Free Cash Flow especially when the amount out there is a yearly spend by the company to grow it's business.
Let me start with the following definition for free cash flow (paraphrased) as given by warren buffet
Free cash flow = Net earnings + depreciation – maintenance capex
Now you can take the above formulae as a given or debate whether it is correct. I think it is correct as free cash flow is basically discretionary cash which the owners (actually managers on their behalf) of the business can choose whichever way to invest. It is discretionary cash because the business is left with this cash after it has incurred the required capex to maintain its current position in terms of volume and competitive position. If it does not do that, then the business will start degrading and may eventually be wiped out.
Now the discretionary cash can be spent in the following ways
1. Invest in the buiness itself if the returns are good – most common approach. Value adding if the business earns more than cost of capital . for ex: ITC, asian paints, HLL etc. This investment is in fixed assets and working capital
2. Accquire other company – Eg. Marico
3. Return cash to shareholder via dividends or share buyback
4. Just hold cash and do nothing – Ex: Merck, Novartis etc
Now the question – How to calculate maintenance capex? There is no precise formulae for that. The best you can do is to arrive at a rough number as companies don’t give this number. Let take the definition above and let me give my approach
If the maintenance capex is to maintain unit volumes, then value sales would be growing at the rate of inflation. So lets take a hypothetical case (simplified)
Sales = 100
Return on equity = 20% ( debt = 0)
Net margin = 10%
Total asset / sales = 2
Total asset = 50
Depreciation = 5 % of asset
Now in year 2
Sales = 105 (5 % inflation)
ROE = 20%
Net margin = 10%
Total asset / sales = 2
Total asset = 52.5
FCF = 10.5+2.5-2.5 [ asset increase = 2.5 ]
So in the simple case above FCF is equal to Net profit. Ofcourse reality is not so simple. However once you get an idea of the basic concept, you can do a rough estimation of the maintenance capex and free cash flow.
Key point to remember – If the ROE is in excess of 15%, generally the depreciation will covers the maintenance capex and the Net profit will be almost equal to free cash flow.
Exception to the above can be seen in some companies such as Gujarat gas/ HLL etc where the Working capital throws off cash and hence the FCF is actually greater than the free cash flow.
So in response to the question above, I would say that some amount of the Fixed asset has to be adjusted , but I would not deduct all the addition. For ex: A company launches a very profitable product and due to volume growth puts up a new plant. The cash flow may be negative during that year and then become positive a few years later. If you focus on the cash flow based on actual capex, you may undervalue the company when it is investing in a profitable venture and over value a company which is not investing and just milking its assets.
The above post may appear fairly academic and boring, but I think the question asked by sanjay goes to the core of how to value a company.
Next post : I will try to explain how I calculate FCF using the excels I have uploaded
You mentioned you "use maintenance capex needed to support unit volumes or competitive position (maintenance capex)."
I downloaded your Excel sheets couldn't figure out the basis for calculation of the same, especially as companies don't give break ups of maintenance capex. If you could explain would be great.
Maybe my understanding is incorrect, however I feel that all Purchase of Fixed assets should be deducted from Free Cash Flow especially when the amount out there is a yearly spend by the company to grow it's business.
Let me start with the following definition for free cash flow (paraphrased) as given by warren buffet
Free cash flow = Net earnings + depreciation – maintenance capex
Now you can take the above formulae as a given or debate whether it is correct. I think it is correct as free cash flow is basically discretionary cash which the owners (actually managers on their behalf) of the business can choose whichever way to invest. It is discretionary cash because the business is left with this cash after it has incurred the required capex to maintain its current position in terms of volume and competitive position. If it does not do that, then the business will start degrading and may eventually be wiped out.
Now the discretionary cash can be spent in the following ways
1. Invest in the buiness itself if the returns are good – most common approach. Value adding if the business earns more than cost of capital . for ex: ITC, asian paints, HLL etc. This investment is in fixed assets and working capital
2. Accquire other company – Eg. Marico
3. Return cash to shareholder via dividends or share buyback
4. Just hold cash and do nothing – Ex: Merck, Novartis etc
Now the question – How to calculate maintenance capex? There is no precise formulae for that. The best you can do is to arrive at a rough number as companies don’t give this number. Let take the definition above and let me give my approach
If the maintenance capex is to maintain unit volumes, then value sales would be growing at the rate of inflation. So lets take a hypothetical case (simplified)
Sales = 100
Return on equity = 20% ( debt = 0)
Net margin = 10%
Total asset / sales = 2
Total asset = 50
Depreciation = 5 % of asset
Now in year 2
Sales = 105 (5 % inflation)
ROE = 20%
Net margin = 10%
Total asset / sales = 2
Total asset = 52.5
FCF = 10.5+2.5-2.5 [ asset increase = 2.5 ]
So in the simple case above FCF is equal to Net profit. Ofcourse reality is not so simple. However once you get an idea of the basic concept, you can do a rough estimation of the maintenance capex and free cash flow.
Key point to remember – If the ROE is in excess of 15%, generally the depreciation will covers the maintenance capex and the Net profit will be almost equal to free cash flow.
Exception to the above can be seen in some companies such as Gujarat gas/ HLL etc where the Working capital throws off cash and hence the FCF is actually greater than the free cash flow.
So in response to the question above, I would say that some amount of the Fixed asset has to be adjusted , but I would not deduct all the addition. For ex: A company launches a very profitable product and due to volume growth puts up a new plant. The cash flow may be negative during that year and then become positive a few years later. If you focus on the cash flow based on actual capex, you may undervalue the company when it is investing in a profitable venture and over value a company which is not investing and just milking its assets.
The above post may appear fairly academic and boring, but I think the question asked by sanjay goes to the core of how to value a company.
Next post : I will try to explain how I calculate FCF using the excels I have uploaded
Thursday, November 29, 2007
Grindwell norton and Free cash flow
I received the following email from sanjay shetty and decided to post it as he has asked a very important question on valuation. I have done some work on it on my own and have put the results in the worksheet – Quantitative calculations.xls
You can download is from here or use the download link in the side bar. Please see the tabs – Maintenance capex and FCF anal.
My responses are in italics. There is a follow up question from sanjay on maintenance capex. I will post on it in detail shortly with an example. If you have looked at my valuation templates, you may have noticed that I use FCF based on maintenance capex for valuation purposes
Hi Rohit,
I've been viewing your blog, after your comment on my blog (http://indiainvestor.wordpress.com).
I had a few questions for you.
What methodology are you using to value companies in India?
DCF, comparitive or relative valuation, sum of parts etc. I try to value a company based on multiple approaches and also depending on the nature of the company
Are you using a Discounted Cash Flow method to calculate Intrinsic value? If so, are you checking the Free Cash Flow, how are you calculating it?
yes, i use free cash flow. I however do not use capital expenditure directly. I use maintenance capex needed to support unit volumes or competitive position (maintenance capex). Difficult for me to explain in brief. i have a few excels uploaded in my google group explaining the calculation.
I've see most of the companies I've analyzed seem to be blowing enormous amounts of cash, with almost negative free cash flow which is worrying. -
I think the key point is whether the capex is maintenance or for growth / accquisition. Let's take a short example. If a company earns 5% on capital , and has 10% margins (asset turn is 0.5). Then to grow by 5%, the company will use all its free cash flow. Also 5% growth is roughly inflation, so in this case the company is using all its free cash for maintenance capex
In case of a company growing by 20% and 10% margins (asset turns is 2), growth of 5% requires only 50% of the netprofit . The rest is cash flow which company can use to aqcuire other companies, give dividend or build assets. This is the case with grindwell norton. Grindwell has low FCF as it is investing the surplus cash in assets to increase volumes.
Hope the above clarifies .i have tried to provide a quick explaination and have left a few things out (like adding back depreciation)
Take for instance Grindwell Norton, which you've recently mentioned on your blog, Every thing seems rosy however Free Cash Flow is the concern.
I have taken out the detailed calculations by sanjay and put the final computations
Free Cash Flow
Mar’ 02 29.178
Mar '03 21.802
Mar '04 17.149
Mar '05 18.481
Mar '06 3.121
The worrying fact about this company is the amount of cash it's blowing, though currently it's Sales, ROIC etc. are all healthy and growing.
Free Cash flow growth is actually going from bad to worse. I'm calculating Free Cash Flow as Net Cash from Operations minus Capital Expenditure which is Purchase of Fixed Assets.
You can download is from here or use the download link in the side bar. Please see the tabs – Maintenance capex and FCF anal.
My responses are in italics. There is a follow up question from sanjay on maintenance capex. I will post on it in detail shortly with an example. If you have looked at my valuation templates, you may have noticed that I use FCF based on maintenance capex for valuation purposes
Hi Rohit,
I've been viewing your blog, after your comment on my blog (http://indiainvestor.wordpress.com).
I had a few questions for you.
What methodology are you using to value companies in India?
DCF, comparitive or relative valuation, sum of parts etc. I try to value a company based on multiple approaches and also depending on the nature of the company
Are you using a Discounted Cash Flow method to calculate Intrinsic value? If so, are you checking the Free Cash Flow, how are you calculating it?
yes, i use free cash flow. I however do not use capital expenditure directly. I use maintenance capex needed to support unit volumes or competitive position (maintenance capex). Difficult for me to explain in brief. i have a few excels uploaded in my google group explaining the calculation.
I've see most of the companies I've analyzed seem to be blowing enormous amounts of cash, with almost negative free cash flow which is worrying. -
I think the key point is whether the capex is maintenance or for growth / accquisition. Let's take a short example. If a company earns 5% on capital , and has 10% margins (asset turn is 0.5). Then to grow by 5%, the company will use all its free cash flow. Also 5% growth is roughly inflation, so in this case the company is using all its free cash for maintenance capex
In case of a company growing by 20% and 10% margins (asset turns is 2), growth of 5% requires only 50% of the netprofit . The rest is cash flow which company can use to aqcuire other companies, give dividend or build assets. This is the case with grindwell norton. Grindwell has low FCF as it is investing the surplus cash in assets to increase volumes.
Hope the above clarifies .i have tried to provide a quick explaination and have left a few things out (like adding back depreciation)
Take for instance Grindwell Norton, which you've recently mentioned on your blog, Every thing seems rosy however Free Cash Flow is the concern.
I have taken out the detailed calculations by sanjay and put the final computations
Free Cash Flow
Mar’ 02 29.178
Mar '03 21.802
Mar '04 17.149
Mar '05 18.481
Mar '06 3.121
The worrying fact about this company is the amount of cash it's blowing, though currently it's Sales, ROIC etc. are all healthy and growing.
Free Cash flow growth is actually going from bad to worse. I'm calculating Free Cash Flow as Net Cash from Operations minus Capital Expenditure which is Purchase of Fixed Assets.
Grindwell norton and Free cash flow
I received the following email from sanjay shetty and decided to post it as he has asked a very important question on valuation. I have done some work on it on my own and have put the results in the worksheet – Quantitative calculations.xls
You can download is from here or use the download link in the side bar. Please see the tabs – Maintenance capex and FCF anal.
My responses are in italics. There is a follow up question from sanjay on maintenance capex. I will post on it in detail shortly with an example. If you have looked at my valuation templates, you may have noticed that I use FCF based on maintenance capex for valuation purposes
Hi Rohit,
I've been viewing your blog, after your comment on my blog (http://indiainvestor.wordpress.com).
I had a few questions for you.
What methodology are you using to value companies in India?
DCF, comparitive or relative valuation, sum of parts etc. I try to value a company based on multiple approaches and also depending on the nature of the company
Are you using a Discounted Cash Flow method to calculate Intrinsic value? If so, are you checking the Free Cash Flow, how are you calculating it?
yes, i use free cash flow. I however do not use capital expenditure directly. I use maintenance capex needed to support unit volumes or competitive position (maintenance capex). Difficult for me to explain in brief. i have a few excels uploaded in my google group explaining the calculation.
I've see most of the companies I've analyzed seem to be blowing enormous amounts of cash, with almost negative free cash flow which is worrying. -
I think the key point is whether the capex is maintenance or for growth / accquisition. Let's take a short example. If a company earns 5% on capital , and has 10% margins (asset turn is 0.5). Then to grow by 5%, the company will use all its free cash flow. Also 5% growth is roughly inflation, so in this case the company is using all its free cash for maintenance capex
In case of a company growing by 20% and 10% margins (asset turns is 2), growth of 5% requires only 50% of the netprofit . The rest is cash flow which company can use to aqcuire other companies, give dividend or build assets. This is the case with grindwell norton. Grindwell has low FCF as it is investing the surplus cash in assets to increase volumes.
Hope the above clarifies .i have tried to provide a quick explaination and have left a few things out (like adding back depreciation)
Take for instance Grindwell Norton, which you've recently mentioned on your blog, Every thing seems rosy however Free Cash Flow is the concern.
I have taken out the detailed calculations by sanjay and put the final computations
Free Cash Flow
Mar’ 02 29.178
Mar '03 21.802
Mar '04 17.149
Mar '05 18.481
Mar '06 3.121
The worrying fact about this company is the amount of cash it's blowing, though currently it's Sales, ROIC etc. are all healthy and growing.
Free Cash flow growth is actually going from bad to worse. I'm calculating Free Cash Flow as Net Cash from Operations minus Capital Expenditure which is Purchase of Fixed Assets.
You can download is from here or use the download link in the side bar. Please see the tabs – Maintenance capex and FCF anal.
My responses are in italics. There is a follow up question from sanjay on maintenance capex. I will post on it in detail shortly with an example. If you have looked at my valuation templates, you may have noticed that I use FCF based on maintenance capex for valuation purposes
Hi Rohit,
I've been viewing your blog, after your comment on my blog (http://indiainvestor.wordpress.com).
I had a few questions for you.
What methodology are you using to value companies in India?
DCF, comparitive or relative valuation, sum of parts etc. I try to value a company based on multiple approaches and also depending on the nature of the company
Are you using a Discounted Cash Flow method to calculate Intrinsic value? If so, are you checking the Free Cash Flow, how are you calculating it?
yes, i use free cash flow. I however do not use capital expenditure directly. I use maintenance capex needed to support unit volumes or competitive position (maintenance capex). Difficult for me to explain in brief. i have a few excels uploaded in my google group explaining the calculation.
I've see most of the companies I've analyzed seem to be blowing enormous amounts of cash, with almost negative free cash flow which is worrying. -
I think the key point is whether the capex is maintenance or for growth / accquisition. Let's take a short example. If a company earns 5% on capital , and has 10% margins (asset turn is 0.5). Then to grow by 5%, the company will use all its free cash flow. Also 5% growth is roughly inflation, so in this case the company is using all its free cash for maintenance capex
In case of a company growing by 20% and 10% margins (asset turns is 2), growth of 5% requires only 50% of the netprofit . The rest is cash flow which company can use to aqcuire other companies, give dividend or build assets. This is the case with grindwell norton. Grindwell has low FCF as it is investing the surplus cash in assets to increase volumes.
Hope the above clarifies .i have tried to provide a quick explaination and have left a few things out (like adding back depreciation)
Take for instance Grindwell Norton, which you've recently mentioned on your blog, Every thing seems rosy however Free Cash Flow is the concern.
I have taken out the detailed calculations by sanjay and put the final computations
Free Cash Flow
Mar’ 02 29.178
Mar '03 21.802
Mar '04 17.149
Mar '05 18.481
Mar '06 3.121
The worrying fact about this company is the amount of cash it's blowing, though currently it's Sales, ROIC etc. are all healthy and growing.
Free Cash flow growth is actually going from bad to worse. I'm calculating Free Cash Flow as Net Cash from Operations minus Capital Expenditure which is Purchase of Fixed Assets.
Tuesday, November 27, 2007
Some interesting ideas
I have been looking at the following two companies for the past few weeks. I have yet to make up my mind on them. I generally prefer to buy at 50% of conservatively calculated intrinsic value of the company. Both the companies trade at a discount to instrinsic value, but above the 50% mark.
The companies are
Grindwell norton
SRF
My personal notes on each company
Grindwell norton
Grindwell norton is in the business of abrasives and refractories. The industry is dominated by two player – Carborundum and grindwell norton. Grindwell has been doing fairly well for the past few years. It has an average ROC of 15%+ for the past few years. It has been able to maintain a NPM of 10%+. The average sales growth has been over 15% on an average and the NP growth in excess of 20%. The asset ratios have improved, especially the Wcap ratio and the profit margins have improved from 7-8% to 10-11%. The company enjoys reasonable competitive advantage due to R&D support by parent, strong sales force, decent brand and a wide customer base. There are reasonable entry barriers in the industry too.
Grindwell has recently sold a stake and netted almost 100 Crs from the sale. The Company is debt free and has almost 100-150 Cr in cash and investments. The company is however trading at 20-30% discount to intrinsic value which is above my target price
SRF
SRF has the following business segments – Technical textile divison which is
includes tyre re-inforcements, belting fabrics etc. This division makes up almost 50% of the revenue, but contributes to less than 10% of total profits with Pre-tax margins of around 10%. This business segment is facing a lot of competition and has seen margins drop for the last few years. The chemical business makes up 40% of the revenue and almost 90% of the profit. This division is highly profitable with pretax margins in excess of 50%. The profitability of this division has gone up in the last few years. The rest of the revenue is from packaging films business. This business made a loss in 2006 and has just turned around in the current year.
The company has seen margins rise from 4% to around 10% (excluding one time CER gains). The ROC is around 15%+. Sales growth has been 15%+ and NP growth has been 20%+. The company looks undervalued on current measures. However the key point is the sustainability of the margins in the chemicals business. It is diffcult to see how the division would maintain such high margins. If the net margin of the company were to drop to around 6-7% from current levels (which are roughly the average margins), then the EV/Net profit ratio would be around 9-10. At these levels the company is at best undervalued by 20-30%. Need to do more analysis.
The companies are
Grindwell norton
SRF
My personal notes on each company
Grindwell norton
Grindwell norton is in the business of abrasives and refractories. The industry is dominated by two player – Carborundum and grindwell norton. Grindwell has been doing fairly well for the past few years. It has an average ROC of 15%+ for the past few years. It has been able to maintain a NPM of 10%+. The average sales growth has been over 15% on an average and the NP growth in excess of 20%. The asset ratios have improved, especially the Wcap ratio and the profit margins have improved from 7-8% to 10-11%. The company enjoys reasonable competitive advantage due to R&D support by parent, strong sales force, decent brand and a wide customer base. There are reasonable entry barriers in the industry too.
Grindwell has recently sold a stake and netted almost 100 Crs from the sale. The Company is debt free and has almost 100-150 Cr in cash and investments. The company is however trading at 20-30% discount to intrinsic value which is above my target price
SRF
SRF has the following business segments – Technical textile divison which is
includes tyre re-inforcements, belting fabrics etc. This division makes up almost 50% of the revenue, but contributes to less than 10% of total profits with Pre-tax margins of around 10%. This business segment is facing a lot of competition and has seen margins drop for the last few years. The chemical business makes up 40% of the revenue and almost 90% of the profit. This division is highly profitable with pretax margins in excess of 50%. The profitability of this division has gone up in the last few years. The rest of the revenue is from packaging films business. This business made a loss in 2006 and has just turned around in the current year.
The company has seen margins rise from 4% to around 10% (excluding one time CER gains). The ROC is around 15%+. Sales growth has been 15%+ and NP growth has been 20%+. The company looks undervalued on current measures. However the key point is the sustainability of the margins in the chemicals business. It is diffcult to see how the division would maintain such high margins. If the net margin of the company were to drop to around 6-7% from current levels (which are roughly the average margins), then the EV/Net profit ratio would be around 9-10. At these levels the company is at best undervalued by 20-30%. Need to do more analysis.
Some interesting ideas
I have been looking at the following two companies for the past few weeks. I have yet to make up my mind on them. I generally prefer to buy at 50% of conservatively calculated intrinsic value of the company. Both the companies trade at a discount to instrinsic value, but above the 50% mark.
The companies are
Grindwell norton
SRF
My personal notes on each company
Grindwell norton
Grindwell norton is in the business of abrasives and refractories. The industry is dominated by two player – Carborundum and grindwell norton. Grindwell has been doing fairly well for the past few years. It has an average ROC of 15%+ for the past few years. It has been able to maintain a NPM of 10%+. The average sales growth has been over 15% on an average and the NP growth in excess of 20%. The asset ratios have improved, especially the Wcap ratio and the profit margins have improved from 7-8% to 10-11%. The company enjoys reasonable competitive advantage due to R&D support by parent, strong sales force, decent brand and a wide customer base. There are reasonable entry barriers in the industry too.
Grindwell has recently sold a stake and netted almost 100 Crs from the sale. The Company is debt free and has almost 100-150 Cr in cash and investments. The company is however trading at 20-30% discount to intrinsic value which is above my target price
SRF
SRF has the following business segments – Technical textile divison which is
includes tyre re-inforcements, belting fabrics etc. This division makes up almost 50% of the revenue, but contributes to less than 10% of total profits with Pre-tax margins of around 10%. This business segment is facing a lot of competition and has seen margins drop for the last few years. The chemical business makes up 40% of the revenue and almost 90% of the profit. This division is highly profitable with pretax margins in excess of 50%. The profitability of this division has gone up in the last few years. The rest of the revenue is from packaging films business. This business made a loss in 2006 and has just turned around in the current year.
The company has seen margins rise from 4% to around 10% (excluding one time CER gains). The ROC is around 15%+. Sales growth has been 15%+ and NP growth has been 20%+. The company looks undervalued on current measures. However the key point is the sustainability of the margins in the chemicals business. It is diffcult to see how the division would maintain such high margins. If the net margin of the company were to drop to around 6-7% from current levels (which are roughly the average margins), then the EV/Net profit ratio would be around 9-10. At these levels the company is at best undervalued by 20-30%. Need to do more analysis.
The companies are
Grindwell norton
SRF
My personal notes on each company
Grindwell norton
Grindwell norton is in the business of abrasives and refractories. The industry is dominated by two player – Carborundum and grindwell norton. Grindwell has been doing fairly well for the past few years. It has an average ROC of 15%+ for the past few years. It has been able to maintain a NPM of 10%+. The average sales growth has been over 15% on an average and the NP growth in excess of 20%. The asset ratios have improved, especially the Wcap ratio and the profit margins have improved from 7-8% to 10-11%. The company enjoys reasonable competitive advantage due to R&D support by parent, strong sales force, decent brand and a wide customer base. There are reasonable entry barriers in the industry too.
Grindwell has recently sold a stake and netted almost 100 Crs from the sale. The Company is debt free and has almost 100-150 Cr in cash and investments. The company is however trading at 20-30% discount to intrinsic value which is above my target price
SRF
SRF has the following business segments – Technical textile divison which is
includes tyre re-inforcements, belting fabrics etc. This division makes up almost 50% of the revenue, but contributes to less than 10% of total profits with Pre-tax margins of around 10%. This business segment is facing a lot of competition and has seen margins drop for the last few years. The chemical business makes up 40% of the revenue and almost 90% of the profit. This division is highly profitable with pretax margins in excess of 50%. The profitability of this division has gone up in the last few years. The rest of the revenue is from packaging films business. This business made a loss in 2006 and has just turned around in the current year.
The company has seen margins rise from 4% to around 10% (excluding one time CER gains). The ROC is around 15%+. Sales growth has been 15%+ and NP growth has been 20%+. The company looks undervalued on current measures. However the key point is the sustainability of the margins in the chemicals business. It is diffcult to see how the division would maintain such high margins. If the net margin of the company were to drop to around 6-7% from current levels (which are roughly the average margins), then the EV/Net profit ratio would be around 9-10. At these levels the company is at best undervalued by 20-30%. Need to do more analysis.
Thursday, November 22, 2007
Real estate valuation - Random thoughts
I have been reading the book ‘Seeking wisdom – From darwin to munger’ which talks of various mental models and applying them to a problem to analyse it in detail.
The book is itself inspired by charlie munger and his lecture on the same topic. I have attempted to apply some models to valuing and analysing real estate.
The first post was valuing the real estate as a financial asset like stocks and bonds
The second post was trying to invert the problem.
The third post was looking at psychological baises in valuation of real estate. I will follow up with more posts on the same topic with other models.
I would like to add a personal approach for a first time buyer (buying for personal use)
If you are buying a house to stay (not investment), the maximum value of the investment would be driven by two numbers – EMI and personal debt to equity.
Let me explain
Suppose I earn 40000 as net income. My current networth ( all stocks, bonds, cash etc) is 10 lacs (10 lacs = 1 million). To be on the safe side, I would look at a house where my EMI is around 16000 / month (40% of net income)
So based on the above EMI, I can afford a loan of around 16 lacs at an interest of 10% for a 20 year tenure.
Assuming I have to put up 20% of the value of the house, I would look at a maximum investment of 20 lacs (2 million).
For a 16 lacs loan, my personal debt to equity is around 1.6 (16/10). This is higher than what I am comfortable. However it is not too high if you are in your 20s or 30s and have a long career ahead.
The above is a very simplistic approach and may sound conservative. But I prefer to plan for adversity and for a situation where things can go wrong. Buying a house as a first time buyer is less of an investment for me and more of having a roof on my head (in worst possible situation).
Some bad reasons for buying real estate
- Because the price has risen a lot lately or because the broker is predicting a rise.
- Because one can never lose in real estate
- Because your friend is buying it
- Because you can get a loan to buy it
- FII / Institutional investors are investing money – This is really a strange reason. FII/ foreign investors may have a good reason or maybe they are just following the herd. Just because an investor is an FII does not mean they have extra brains. Sometimes they are worse than an ordinary investor
A few links to value real estate
http://en.wikipedia.org/wiki/Real_estate_appraisal
Real estate valuation and analysis – read on the Cap rate which is similar to the P/R ratio
Deepak shenoy’s real estate cash flow calculator – Excellent worksheet to value real estate. Please read his terms.
The book is itself inspired by charlie munger and his lecture on the same topic. I have attempted to apply some models to valuing and analysing real estate.
The first post was valuing the real estate as a financial asset like stocks and bonds
The second post was trying to invert the problem.
The third post was looking at psychological baises in valuation of real estate. I will follow up with more posts on the same topic with other models.
I would like to add a personal approach for a first time buyer (buying for personal use)
If you are buying a house to stay (not investment), the maximum value of the investment would be driven by two numbers – EMI and personal debt to equity.
Let me explain
Suppose I earn 40000 as net income. My current networth ( all stocks, bonds, cash etc) is 10 lacs (10 lacs = 1 million). To be on the safe side, I would look at a house where my EMI is around 16000 / month (40% of net income)
So based on the above EMI, I can afford a loan of around 16 lacs at an interest of 10% for a 20 year tenure.
Assuming I have to put up 20% of the value of the house, I would look at a maximum investment of 20 lacs (2 million).
For a 16 lacs loan, my personal debt to equity is around 1.6 (16/10). This is higher than what I am comfortable. However it is not too high if you are in your 20s or 30s and have a long career ahead.
The above is a very simplistic approach and may sound conservative. But I prefer to plan for adversity and for a situation where things can go wrong. Buying a house as a first time buyer is less of an investment for me and more of having a roof on my head (in worst possible situation).
Some bad reasons for buying real estate
- Because the price has risen a lot lately or because the broker is predicting a rise.
- Because one can never lose in real estate
- Because your friend is buying it
- Because you can get a loan to buy it
- FII / Institutional investors are investing money – This is really a strange reason. FII/ foreign investors may have a good reason or maybe they are just following the herd. Just because an investor is an FII does not mean they have extra brains. Sometimes they are worse than an ordinary investor
A few links to value real estate
http://en.wikipedia.org/wiki/Real_estate_appraisal
Real estate valuation and analysis – read on the Cap rate which is similar to the P/R ratio
Deepak shenoy’s real estate cash flow calculator – Excellent worksheet to value real estate. Please read his terms.
Real estate valuation - Random thoughts
I have been reading the book ‘Seeking wisdom – From darwin to munger’ which talks of various mental models and applying them to a problem to analyse it in detail.
The book is itself inspired by charlie munger and his lecture on the same topic. I have attempted to apply some models to valuing and analysing real estate.
The first post was valuing the real estate as a financial asset like stocks and bonds
The second post was trying to invert the problem.
The third post was looking at psychological baises in valuation of real estate. I will follow up with more posts on the same topic with other models.
I would like to add a personal approach for a first time buyer (buying for personal use)
If you are buying a house to stay (not investment), the maximum value of the investment would be driven by two numbers – EMI and personal debt to equity.
Let me explain
Suppose I earn 40000 as net income. My current networth ( all stocks, bonds, cash etc) is 10 lacs (10 lacs = 1 million). To be on the safe side, I would look at a house where my EMI is around 16000 / month (40% of net income)
So based on the above EMI, I can afford a loan of around 16 lacs at an interest of 10% for a 20 year tenure.
Assuming I have to put up 20% of the value of the house, I would look at a maximum investment of 20 lacs (2 million).
For a 16 lacs loan, my personal debt to equity is around 1.6 (16/10). This is higher than what I am comfortable. However it is not too high if you are in your 20s or 30s and have a long career ahead.
The above is a very simplistic approach and may sound conservative. But I prefer to plan for adversity and for a situation where things can go wrong. Buying a house as a first time buyer is less of an investment for me and more of having a roof on my head (in worst possible situation).
Some bad reasons for buying real estate
- Because the price has risen a lot lately or because the broker is predicting a rise.
- Because one can never lose in real estate
- Because your friend is buying it
- Because you can get a loan to buy it
- FII / Institutional investors are investing money – This is really a strange reason. FII/ foreign investors may have a good reason or maybe they are just following the herd. Just because an investor is an FII does not mean they have extra brains. Sometimes they are worse than an ordinary investor
A few links to value real estate
http://en.wikipedia.org/wiki/Real_estate_appraisal
Real estate valuation and analysis – read on the Cap rate which is similar to the P/R ratio
Deepak shenoy’s real estate cash flow calculator – Excellent worksheet to value real estate. Please read his terms.
The book is itself inspired by charlie munger and his lecture on the same topic. I have attempted to apply some models to valuing and analysing real estate.
The first post was valuing the real estate as a financial asset like stocks and bonds
The second post was trying to invert the problem.
The third post was looking at psychological baises in valuation of real estate. I will follow up with more posts on the same topic with other models.
I would like to add a personal approach for a first time buyer (buying for personal use)
If you are buying a house to stay (not investment), the maximum value of the investment would be driven by two numbers – EMI and personal debt to equity.
Let me explain
Suppose I earn 40000 as net income. My current networth ( all stocks, bonds, cash etc) is 10 lacs (10 lacs = 1 million). To be on the safe side, I would look at a house where my EMI is around 16000 / month (40% of net income)
So based on the above EMI, I can afford a loan of around 16 lacs at an interest of 10% for a 20 year tenure.
Assuming I have to put up 20% of the value of the house, I would look at a maximum investment of 20 lacs (2 million).
For a 16 lacs loan, my personal debt to equity is around 1.6 (16/10). This is higher than what I am comfortable. However it is not too high if you are in your 20s or 30s and have a long career ahead.
The above is a very simplistic approach and may sound conservative. But I prefer to plan for adversity and for a situation where things can go wrong. Buying a house as a first time buyer is less of an investment for me and more of having a roof on my head (in worst possible situation).
Some bad reasons for buying real estate
- Because the price has risen a lot lately or because the broker is predicting a rise.
- Because one can never lose in real estate
- Because your friend is buying it
- Because you can get a loan to buy it
- FII / Institutional investors are investing money – This is really a strange reason. FII/ foreign investors may have a good reason or maybe they are just following the herd. Just because an investor is an FII does not mean they have extra brains. Sometimes they are worse than an ordinary investor
A few links to value real estate
http://en.wikipedia.org/wiki/Real_estate_appraisal
Real estate valuation and analysis – read on the Cap rate which is similar to the P/R ratio
Deepak shenoy’s real estate cash flow calculator – Excellent worksheet to value real estate. Please read his terms.
Tuesday, November 20, 2007
Real estate valuation - Psychological biases
I think there are several psychological baises working in case of real estate. The first is incentive caused bais. Typically real estate is sold via brokers or by sales agents of the builder. They have an incentive to sell the property and typically earn a commision based on sale price. It is quite obvious that the broker or sales agent would be motivated to sell at as high price as possible. In addition it is likely that he will give you a bullish outlook for the property prices.
The second strong bias is social- proof and deprival super reaction tendency. You see you friend buy a property and make easy money. At the same if you have not invested money and feel deprival super reaction tendency as everyone one else is making easy money.
So these two tendencies work together and motivate us to look for a property. Combine this with the incentive caused bias where the broker is constantly trying to create a scarcity (he will tell you that he has a lot of buyers and even you don’t buy now then the price will go up), lack of information and overoptimism on our part and this creates a combined effect. All these factors add up and can cause the buyer to become irrational.
I personally think the risk of bubbles are higher in real estate for the following reasons
- the common notion that real estate cannot lose value and represent something limited which is land
- High amount of leverage. Typically loans on a property is around 20%
- Lack of transparency and information in this market.
- All the above psychological factors
The second strong bias is social- proof and deprival super reaction tendency. You see you friend buy a property and make easy money. At the same if you have not invested money and feel deprival super reaction tendency as everyone one else is making easy money.
So these two tendencies work together and motivate us to look for a property. Combine this with the incentive caused bias where the broker is constantly trying to create a scarcity (he will tell you that he has a lot of buyers and even you don’t buy now then the price will go up), lack of information and overoptimism on our part and this creates a combined effect. All these factors add up and can cause the buyer to become irrational.
I personally think the risk of bubbles are higher in real estate for the following reasons
- the common notion that real estate cannot lose value and represent something limited which is land
- High amount of leverage. Typically loans on a property is around 20%
- Lack of transparency and information in this market.
- All the above psychological factors
Real estate valuation - Psychological biases
I think there are several psychological baises working in case of real estate. The first is incentive caused bais. Typically real estate is sold via brokers or by sales agents of the builder. They have an incentive to sell the property and typically earn a commision based on sale price. It is quite obvious that the broker or sales agent would be motivated to sell at as high price as possible. In addition it is likely that he will give you a bullish outlook for the property prices.
The second strong bias is social- proof and deprival super reaction tendency. You see you friend buy a property and make easy money. At the same if you have not invested money and feel deprival super reaction tendency as everyone one else is making easy money.
So these two tendencies work together and motivate us to look for a property. Combine this with the incentive caused bias where the broker is constantly trying to create a scarcity (he will tell you that he has a lot of buyers and even you don’t buy now then the price will go up), lack of information and overoptimism on our part and this creates a combined effect. All these factors add up and can cause the buyer to become irrational.
I personally think the risk of bubbles are higher in real estate for the following reasons
- the common notion that real estate cannot lose value and represent something limited which is land
- High amount of leverage. Typically loans on a property is around 20%
- Lack of transparency and information in this market.
- All the above psychological factors
The second strong bias is social- proof and deprival super reaction tendency. You see you friend buy a property and make easy money. At the same if you have not invested money and feel deprival super reaction tendency as everyone one else is making easy money.
So these two tendencies work together and motivate us to look for a property. Combine this with the incentive caused bias where the broker is constantly trying to create a scarcity (he will tell you that he has a lot of buyers and even you don’t buy now then the price will go up), lack of information and overoptimism on our part and this creates a combined effect. All these factors add up and can cause the buyer to become irrational.
I personally think the risk of bubbles are higher in real estate for the following reasons
- the common notion that real estate cannot lose value and represent something limited which is land
- High amount of leverage. Typically loans on a property is around 20%
- Lack of transparency and information in this market.
- All the above psychological factors
Sunday, November 18, 2007
Real estate valuation - Inverting the problem
As Charlie munger says, it is useful to invert a problem and think through. So let me try that and please bear with me on the mental acrobatics.In the last post, I developed the basic logic that real estate valuation depends on the rentals. Lets say you are looking at a property valued at say 50 lacs (5 million) . Now the reason to invest in this property is that you expect to make more than fixed income. Lets say you expect 15% p.a.
So the property should be worth 1 Cr (10 million) in the next five years. Such a property to sell at 10 Million, should atleast yield a rent of 40000 Rs/ month (assuming a P/R of 20). For some one to pay a rent of 40000/month, that individual should be earning atleast 170000 rs / month pre-tax.
How did I come up with number? assume a 30% tax rate and that a person would not prefer to spend more than 30% of his net income on rent in the long run. So we are talking of a person making 20-22 lacs per annum.
I agree salaries in india are rising and will continue to do so, but think of it this way - How many people can earn 20-22 lacs per annum (or 50000 usd ). To give a comparison, 50000 usd income is around the median income in the US too. On the flip side, with dollar depreciation and margins of IT/BPO companies getting squezed do you think it is feasible for indian companies to keep increasing salaries at 15% for the next 5-6 years and still be competitive?
Going one step further, if the investor thinks he can sell the property for 10 million , the person buying it will have to do a similar math. If the next investor expects 15% p.a , then he may agree to buy the property for 10 Million at a P/R of 20. However the property should then be 20 million, 10 years from now and needs a tenant making 40 lacs p.a (100000 dollars) to support the rents.
At any point during the next 10 years, if the above assumptions break, due to drop in salaries or recesion, the P/R (like P/E of a stock) could fall and returns could drop. I would agree that in the above scenario there are a lot of assumptions and ifs and buts. However one should think hard before going ahead with a big investment decision.
Please note that I am not talking of local knowledge of real estate. If someone has special knowledge of an area and knows that the area would develop in the next few years, then that person has an information edge and can make high returns. My example is of a general case of an apartment in a city which is what most of the investors put their money in.
Real estate valuation - Inverting the problem
As Charlie munger says, it is useful to invert a problem and think through. So let me try that and please bear with me on the mental acrobatics.In the last post, I developed the basic logic that real estate valuation depends on the rentals. Lets say you are looking at a property valued at say 50 lacs (5 million) . Now the reason to invest in this property is that you expect to make more than fixed income. Lets say you expect 15% p.a.
So the property should be worth 1 Cr (10 million) in the next five years. Such a property to sell at 10 Million, should atleast yield a rent of 40000 Rs/ month (assuming a P/R of 20). For some one to pay a rent of 40000/month, that individual should be earning atleast 170000 rs / month pre-tax.
How did I come up with number? assume a 30% tax rate and that a person would not prefer to spend more than 30% of his net income on rent in the long run. So we are talking of a person making 20-22 lacs per annum.
I agree salaries in india are rising and will continue to do so, but think of it this way - How many people can earn 20-22 lacs per annum (or 50000 usd ). To give a comparison, 50000 usd income is around the median income in the US too. On the flip side, with dollar depreciation and margins of IT/BPO companies getting squezed do you think it is feasible for indian companies to keep increasing salaries at 15% for the next 5-6 years and still be competitive?
Going one step further, if the investor thinks he can sell the property for 10 million , the person buying it will have to do a similar math. If the next investor expects 15% p.a , then he may agree to buy the property for 10 Million at a P/R of 20. However the property should then be 20 million, 10 years from now and needs a tenant making 40 lacs p.a (100000 dollars) to support the rents.
At any point during the next 10 years, if the above assumptions break, due to drop in salaries or recesion, the P/R (like P/E of a stock) could fall and returns could drop. I would agree that in the above scenario there are a lot of assumptions and ifs and buts. However one should think hard before going ahead with a big investment decision.
Please note that I am not talking of local knowledge of real estate. If someone has special knowledge of an area and knows that the area would develop in the next few years, then that person has an information edge and can make high returns. My example is of a general case of an apartment in a city which is what most of the investors put their money in.
Tuesday, November 13, 2007
Real estate valuation - I
If like me you believe the basic definition that the intrinsic worth of an asset is the sum total of all the cash flows one would receive out of an asset from now onwards, then real estate could be analysed using the same approach as stocks or bonds.
Using that logic, we can say that there are two components to the cash flow
1. Rent which is equivalent of dividends
2. Final sale price of the asset (real estate) which is the same as the sale price one would get from a stock or bond
Like stocks, it is easy to get the value of rent (or dividend), but difficult to get the final selling price. In case of real estate the final selling price would depend on the state of real estate market, interest rate, economic activity of that area and location of the real estate. This is similar to stocks where the final selling price depends on a large number of factors, most of which cannot be predicted.
Using the same analogy, if it is possible to value a stock roughly, if not with precision, then one should be able to get some idea whether the real estate asset is under valued, over valued or fairly priced.
I recently read an article in fortune on real estate valuation, current pricing and likely future of the same in the US
Real estate : Buy hold or Sell
I have included a few paras from the article which are very relevant for valuing real estate
Many factors determine the value of a house. A family would consider the quality of local schools, the number of bedrooms, the size of the yard. Economists assessing a region look at interest rates, employment, and population growth. But over time the most reliable guide to home values is rents.
In most markets people won't lay out much more in monthly costs to own a house or condo than they would to rent a similar property unless they expect a huge profit when they sell. Indeed, speculators chasing quick profits did a lot to inflate the recent bubble.
But once the fervor fades, prices must fall to restore their normal, long-term relationship with rents. Rents exercise a kind of inevitable gravitational pull on prices. The ratio of prices to rents "behaves much like price/earnings ratios for stocks," says Yale economist Robert Shiller. "Like P/Es, price-to-rent ratios are mean-reverting." In other words, while prices soar from time to time, sending the ratio to exceptional heights, sooner or later the relationship is bound to return to its historical average.
The last para above is very important. Kaushik in his blog has posted several times on the rent for several properties in places like bangalore. Although this is anecdotal evidence, I would not discount it completely.
So based on this evidence if the rent is say 20000 per month, we are talking a valuation of 48 lacs for a 3 bedroom apartment ( 1 lac = 100000)
Rent = 20000/ month = 2.4 lacs p.a. For P/R ( price to rent like PE ratio) of 20, the valuation is 48 lacs.
The only variable in the above equation which can be debated is the P/R ratio. I will discuss about this in more detail in the next post, but think of it this way – the inverse of P/R is the yield on the real estate. For P/R of 20, the yield is around 5%. Globally, most investors demand a yield of 5-7% on an average. So a P/R ratio of 20 is around the average and may not be too low.
Net post : Looking real estate valuation using the ‘invert the problem’ approach.
Using that logic, we can say that there are two components to the cash flow
1. Rent which is equivalent of dividends
2. Final sale price of the asset (real estate) which is the same as the sale price one would get from a stock or bond
Like stocks, it is easy to get the value of rent (or dividend), but difficult to get the final selling price. In case of real estate the final selling price would depend on the state of real estate market, interest rate, economic activity of that area and location of the real estate. This is similar to stocks where the final selling price depends on a large number of factors, most of which cannot be predicted.
Using the same analogy, if it is possible to value a stock roughly, if not with precision, then one should be able to get some idea whether the real estate asset is under valued, over valued or fairly priced.
I recently read an article in fortune on real estate valuation, current pricing and likely future of the same in the US
Real estate : Buy hold or Sell
I have included a few paras from the article which are very relevant for valuing real estate
Many factors determine the value of a house. A family would consider the quality of local schools, the number of bedrooms, the size of the yard. Economists assessing a region look at interest rates, employment, and population growth. But over time the most reliable guide to home values is rents.
In most markets people won't lay out much more in monthly costs to own a house or condo than they would to rent a similar property unless they expect a huge profit when they sell. Indeed, speculators chasing quick profits did a lot to inflate the recent bubble.
But once the fervor fades, prices must fall to restore their normal, long-term relationship with rents. Rents exercise a kind of inevitable gravitational pull on prices. The ratio of prices to rents "behaves much like price/earnings ratios for stocks," says Yale economist Robert Shiller. "Like P/Es, price-to-rent ratios are mean-reverting." In other words, while prices soar from time to time, sending the ratio to exceptional heights, sooner or later the relationship is bound to return to its historical average.
The last para above is very important. Kaushik in his blog has posted several times on the rent for several properties in places like bangalore. Although this is anecdotal evidence, I would not discount it completely.
So based on this evidence if the rent is say 20000 per month, we are talking a valuation of 48 lacs for a 3 bedroom apartment ( 1 lac = 100000)
Rent = 20000/ month = 2.4 lacs p.a. For P/R ( price to rent like PE ratio) of 20, the valuation is 48 lacs.
The only variable in the above equation which can be debated is the P/R ratio. I will discuss about this in more detail in the next post, but think of it this way – the inverse of P/R is the yield on the real estate. For P/R of 20, the yield is around 5%. Globally, most investors demand a yield of 5-7% on an average. So a P/R ratio of 20 is around the average and may not be too low.
Net post : Looking real estate valuation using the ‘invert the problem’ approach.
Real estate valuation - I
If like me you believe the basic definition that the intrinsic worth of an asset is the sum total of all the cash flows one would receive out of an asset from now onwards, then real estate could be analysed using the same approach as stocks or bonds.
Using that logic, we can say that there are two components to the cash flow
1. Rent which is equivalent of dividends
2. Final sale price of the asset (real estate) which is the same as the sale price one would get from a stock or bond
Like stocks, it is easy to get the value of rent (or dividend), but difficult to get the final selling price. In case of real estate the final selling price would depend on the state of real estate market, interest rate, economic activity of that area and location of the real estate. This is similar to stocks where the final selling price depends on a large number of factors, most of which cannot be predicted.
Using the same analogy, if it is possible to value a stock roughly, if not with precision, then one should be able to get some idea whether the real estate asset is under valued, over valued or fairly priced.
I recently read an article in fortune on real estate valuation, current pricing and likely future of the same in the US
Real estate : Buy hold or Sell
I have included a few paras from the article which are very relevant for valuing real estate
Many factors determine the value of a house. A family would consider the quality of local schools, the number of bedrooms, the size of the yard. Economists assessing a region look at interest rates, employment, and population growth. But over time the most reliable guide to home values is rents.
In most markets people won't lay out much more in monthly costs to own a house or condo than they would to rent a similar property unless they expect a huge profit when they sell. Indeed, speculators chasing quick profits did a lot to inflate the recent bubble.
But once the fervor fades, prices must fall to restore their normal, long-term relationship with rents. Rents exercise a kind of inevitable gravitational pull on prices. The ratio of prices to rents "behaves much like price/earnings ratios for stocks," says Yale economist Robert Shiller. "Like P/Es, price-to-rent ratios are mean-reverting." In other words, while prices soar from time to time, sending the ratio to exceptional heights, sooner or later the relationship is bound to return to its historical average.
The last para above is very important. Kaushik in his blog has posted several times on the rent for several properties in places like bangalore. Although this is anecdotal evidence, I would not discount it completely.
So based on this evidence if the rent is say 20000 per month, we are talking a valuation of 48 lacs for a 3 bedroom apartment ( 1 lac = 100000)
Rent = 20000/ month = 2.4 lacs p.a. For P/R ( price to rent like PE ratio) of 20, the valuation is 48 lacs.
The only variable in the above equation which can be debated is the P/R ratio. I will discuss about this in more detail in the next post, but think of it this way – the inverse of P/R is the yield on the real estate. For P/R of 20, the yield is around 5%. Globally, most investors demand a yield of 5-7% on an average. So a P/R ratio of 20 is around the average and may not be too low.
Net post : Looking real estate valuation using the ‘invert the problem’ approach.
Using that logic, we can say that there are two components to the cash flow
1. Rent which is equivalent of dividends
2. Final sale price of the asset (real estate) which is the same as the sale price one would get from a stock or bond
Like stocks, it is easy to get the value of rent (or dividend), but difficult to get the final selling price. In case of real estate the final selling price would depend on the state of real estate market, interest rate, economic activity of that area and location of the real estate. This is similar to stocks where the final selling price depends on a large number of factors, most of which cannot be predicted.
Using the same analogy, if it is possible to value a stock roughly, if not with precision, then one should be able to get some idea whether the real estate asset is under valued, over valued or fairly priced.
I recently read an article in fortune on real estate valuation, current pricing and likely future of the same in the US
Real estate : Buy hold or Sell
I have included a few paras from the article which are very relevant for valuing real estate
Many factors determine the value of a house. A family would consider the quality of local schools, the number of bedrooms, the size of the yard. Economists assessing a region look at interest rates, employment, and population growth. But over time the most reliable guide to home values is rents.
In most markets people won't lay out much more in monthly costs to own a house or condo than they would to rent a similar property unless they expect a huge profit when they sell. Indeed, speculators chasing quick profits did a lot to inflate the recent bubble.
But once the fervor fades, prices must fall to restore their normal, long-term relationship with rents. Rents exercise a kind of inevitable gravitational pull on prices. The ratio of prices to rents "behaves much like price/earnings ratios for stocks," says Yale economist Robert Shiller. "Like P/Es, price-to-rent ratios are mean-reverting." In other words, while prices soar from time to time, sending the ratio to exceptional heights, sooner or later the relationship is bound to return to its historical average.
The last para above is very important. Kaushik in his blog has posted several times on the rent for several properties in places like bangalore. Although this is anecdotal evidence, I would not discount it completely.
So based on this evidence if the rent is say 20000 per month, we are talking a valuation of 48 lacs for a 3 bedroom apartment ( 1 lac = 100000)
Rent = 20000/ month = 2.4 lacs p.a. For P/R ( price to rent like PE ratio) of 20, the valuation is 48 lacs.
The only variable in the above equation which can be debated is the P/R ratio. I will discuss about this in more detail in the next post, but think of it this way – the inverse of P/R is the yield on the real estate. For P/R of 20, the yield is around 5%. Globally, most investors demand a yield of 5-7% on an average. So a P/R ratio of 20 is around the average and may not be too low.
Net post : Looking real estate valuation using the ‘invert the problem’ approach.
Wednesday, November 07, 2007
Financial institutions and risk
update: 09-Nov - A great post on the valuation of financial firms and the diffculty of doing so ...see here
I have written on banking earlier. You can find my analysis of allahabad bank here. Most of you must be aware of the subprime crisis. I discussed it briefly here.
Banks and financial instutions by their very nature are highly leveraged organizations. So the risk of bankruptcy and losses is higher with banks. Citibank is one of the largest bank in the world and has seen its stock drop by 35% this year. The CEO has just resigned. You can read all about the crisis here.
So what does citibank and the subprime crisis have to do with banking in india. Well a lot … Let me digress and tell you a short story.
The year is 1996 or maybe 1997. I was starting to invest and saw an article on IFCI (I guess you must have already got the hint or must be thinking ….what a Bozo !). Well, the article said that IFCI is a good opportunity as it was near its 52 week low and had a dividend yield of almost 5-6 % (don’t remember the numbers exactly). So thinking that I had found a good opportunity I promptly bought some stock.
Fast forward: 1998-1999. IFCI is a government controlled institution. Politicians look at it as their piggy bank. So if you are a well connected businessman, launch a project, get funding from IFCI, take your money out and refer the company to BIFR. So by 1999, I think IFCI had more than 12% NPA and was bankrupt. There was hardly any dividend and the stock had tanked by more than 70%.
So the moral is …..
1. Don’t base your investments on someone else’s analysis
2. Investing based only on dividend yields is not a good idea. Investing in financial institution based only on dividend yields is a very bad idea unless the financial institution is sound and can maintain the dividend.
So what has happened with citibank is possible with Indian banks too. Banks have a lot of leeway in hiding bad loans. Indian public sector banks due to political interference can end up with even more and these bad loans or assets come out only later. It is difficult to judge asset quality just from the balance sheet
Added note: I have an NRI friend who had invested in citibank based on the dividend yield. Just out of curiosity I downloaded the AR of the bank and my head started spining. It is more than 100 pages, very complex and very difficult to understand (especially for me and may be the CEO too who got fired for not understanding or maybe underestimating the risks).
I have written on banking earlier. You can find my analysis of allahabad bank here. Most of you must be aware of the subprime crisis. I discussed it briefly here.
Banks and financial instutions by their very nature are highly leveraged organizations. So the risk of bankruptcy and losses is higher with banks. Citibank is one of the largest bank in the world and has seen its stock drop by 35% this year. The CEO has just resigned. You can read all about the crisis here.
So what does citibank and the subprime crisis have to do with banking in india. Well a lot … Let me digress and tell you a short story.
The year is 1996 or maybe 1997. I was starting to invest and saw an article on IFCI (I guess you must have already got the hint or must be thinking ….what a Bozo !). Well, the article said that IFCI is a good opportunity as it was near its 52 week low and had a dividend yield of almost 5-6 % (don’t remember the numbers exactly). So thinking that I had found a good opportunity I promptly bought some stock.
Fast forward: 1998-1999. IFCI is a government controlled institution. Politicians look at it as their piggy bank. So if you are a well connected businessman, launch a project, get funding from IFCI, take your money out and refer the company to BIFR. So by 1999, I think IFCI had more than 12% NPA and was bankrupt. There was hardly any dividend and the stock had tanked by more than 70%.
So the moral is …..
1. Don’t base your investments on someone else’s analysis
2. Investing based only on dividend yields is not a good idea. Investing in financial institution based only on dividend yields is a very bad idea unless the financial institution is sound and can maintain the dividend.
So what has happened with citibank is possible with Indian banks too. Banks have a lot of leeway in hiding bad loans. Indian public sector banks due to political interference can end up with even more and these bad loans or assets come out only later. It is difficult to judge asset quality just from the balance sheet
Added note: I have an NRI friend who had invested in citibank based on the dividend yield. Just out of curiosity I downloaded the AR of the bank and my head started spining. It is more than 100 pages, very complex and very difficult to understand (especially for me and may be the CEO too who got fired for not understanding or maybe underestimating the risks).
Financial institutions and risk
update: 09-Nov - A great post on the valuation of financial firms and the diffculty of doing so ...see here
I have written on banking earlier. You can find my analysis of allahabad bank here. Most of you must be aware of the subprime crisis. I discussed it briefly here.
Banks and financial instutions by their very nature are highly leveraged organizations. So the risk of bankruptcy and losses is higher with banks. Citibank is one of the largest bank in the world and has seen its stock drop by 35% this year. The CEO has just resigned. You can read all about the crisis here.
So what does citibank and the subprime crisis have to do with banking in india. Well a lot … Let me digress and tell you a short story.
The year is 1996 or maybe 1997. I was starting to invest and saw an article on IFCI (I guess you must have already got the hint or must be thinking ….what a Bozo !). Well, the article said that IFCI is a good opportunity as it was near its 52 week low and had a dividend yield of almost 5-6 % (don’t remember the numbers exactly). So thinking that I had found a good opportunity I promptly bought some stock.
Fast forward: 1998-1999. IFCI is a government controlled institution. Politicians look at it as their piggy bank. So if you are a well connected businessman, launch a project, get funding from IFCI, take your money out and refer the company to BIFR. So by 1999, I think IFCI had more than 12% NPA and was bankrupt. There was hardly any dividend and the stock had tanked by more than 70%.
So the moral is …..
1. Don’t base your investments on someone else’s analysis
2. Investing based only on dividend yields is not a good idea. Investing in financial institution based only on dividend yields is a very bad idea unless the financial institution is sound and can maintain the dividend.
So what has happened with citibank is possible with Indian banks too. Banks have a lot of leeway in hiding bad loans. Indian public sector banks due to political interference can end up with even more and these bad loans or assets come out only later. It is difficult to judge asset quality just from the balance sheet
Added note: I have an NRI friend who had invested in citibank based on the dividend yield. Just out of curiosity I downloaded the AR of the bank and my head started spining. It is more than 100 pages, very complex and very difficult to understand (especially for me and may be the CEO too who got fired for not understanding or maybe underestimating the risks).
I have written on banking earlier. You can find my analysis of allahabad bank here. Most of you must be aware of the subprime crisis. I discussed it briefly here.
Banks and financial instutions by their very nature are highly leveraged organizations. So the risk of bankruptcy and losses is higher with banks. Citibank is one of the largest bank in the world and has seen its stock drop by 35% this year. The CEO has just resigned. You can read all about the crisis here.
So what does citibank and the subprime crisis have to do with banking in india. Well a lot … Let me digress and tell you a short story.
The year is 1996 or maybe 1997. I was starting to invest and saw an article on IFCI (I guess you must have already got the hint or must be thinking ….what a Bozo !). Well, the article said that IFCI is a good opportunity as it was near its 52 week low and had a dividend yield of almost 5-6 % (don’t remember the numbers exactly). So thinking that I had found a good opportunity I promptly bought some stock.
Fast forward: 1998-1999. IFCI is a government controlled institution. Politicians look at it as their piggy bank. So if you are a well connected businessman, launch a project, get funding from IFCI, take your money out and refer the company to BIFR. So by 1999, I think IFCI had more than 12% NPA and was bankrupt. There was hardly any dividend and the stock had tanked by more than 70%.
So the moral is …..
1. Don’t base your investments on someone else’s analysis
2. Investing based only on dividend yields is not a good idea. Investing in financial institution based only on dividend yields is a very bad idea unless the financial institution is sound and can maintain the dividend.
So what has happened with citibank is possible with Indian banks too. Banks have a lot of leeway in hiding bad loans. Indian public sector banks due to political interference can end up with even more and these bad loans or assets come out only later. It is difficult to judge asset quality just from the balance sheet
Added note: I have an NRI friend who had invested in citibank based on the dividend yield. Just out of curiosity I downloaded the AR of the bank and my head started spining. It is more than 100 pages, very complex and very difficult to understand (especially for me and may be the CEO too who got fired for not understanding or maybe underestimating the risks).
Tuesday, November 06, 2007
A deep value stock
Prof bakshi had posted a quiz to his students. You can find the answer to his question in the comments section. I have posted on the same company earlier.
In addition you may find my response in the comments section too. There are several other answers from others in the comments section such as VST, wyeth, divyashakti granite etc. Some of the ideas sound pretty interesting and I would be looking at them closely.
My suggestion – if you are interested in value investing, read prof bakshi’s posts ,articles and interviews. There is a lot you can learn from him.
As an aside - i am reading a book : seeking wisdom - from darwin to munger. This book has been recommended by charlie munger himself. I dont remember the exact comment, but it seems he liked the book so much he bought a copy of this book for all his friends and relatives. He also said that if there are more books like this, he could bankrupt gifting them. I am not sure of the authenticity of the comment. But after reading 60 odd pages, i can tell you that this is a great book, especially if you are looking at developing a latticework of mental models. For those you who may not know charlie munger, he is the vice chairman of berkshire hathaway and a long term partner of warren buffett.
In addition you may find my response in the comments section too. There are several other answers from others in the comments section such as VST, wyeth, divyashakti granite etc. Some of the ideas sound pretty interesting and I would be looking at them closely.
My suggestion – if you are interested in value investing, read prof bakshi’s posts ,articles and interviews. There is a lot you can learn from him.
As an aside - i am reading a book : seeking wisdom - from darwin to munger. This book has been recommended by charlie munger himself. I dont remember the exact comment, but it seems he liked the book so much he bought a copy of this book for all his friends and relatives. He also said that if there are more books like this, he could bankrupt gifting them. I am not sure of the authenticity of the comment. But after reading 60 odd pages, i can tell you that this is a great book, especially if you are looking at developing a latticework of mental models. For those you who may not know charlie munger, he is the vice chairman of berkshire hathaway and a long term partner of warren buffett.
A deep value stock
Prof bakshi had posted a quiz to his students. You can find the answer to his question in the comments section. I have posted on the same company earlier.
In addition you may find my response in the comments section too. There are several other answers from others in the comments section such as VST, wyeth, divyashakti granite etc. Some of the ideas sound pretty interesting and I would be looking at them closely.
My suggestion – if you are interested in value investing, read prof bakshi’s posts ,articles and interviews. There is a lot you can learn from him.
As an aside - i am reading a book : seeking wisdom - from darwin to munger. This book has been recommended by charlie munger himself. I dont remember the exact comment, but it seems he liked the book so much he bought a copy of this book for all his friends and relatives. He also said that if there are more books like this, he could bankrupt gifting them. I am not sure of the authenticity of the comment. But after reading 60 odd pages, i can tell you that this is a great book, especially if you are looking at developing a latticework of mental models. For those you who may not know charlie munger, he is the vice chairman of berkshire hathaway and a long term partner of warren buffett.
In addition you may find my response in the comments section too. There are several other answers from others in the comments section such as VST, wyeth, divyashakti granite etc. Some of the ideas sound pretty interesting and I would be looking at them closely.
My suggestion – if you are interested in value investing, read prof bakshi’s posts ,articles and interviews. There is a lot you can learn from him.
As an aside - i am reading a book : seeking wisdom - from darwin to munger. This book has been recommended by charlie munger himself. I dont remember the exact comment, but it seems he liked the book so much he bought a copy of this book for all his friends and relatives. He also said that if there are more books like this, he could bankrupt gifting them. I am not sure of the authenticity of the comment. But after reading 60 odd pages, i can tell you that this is a great book, especially if you are looking at developing a latticework of mental models. For those you who may not know charlie munger, he is the vice chairman of berkshire hathaway and a long term partner of warren buffett.
Friday, November 02, 2007
Sundaram Finance Spreadsheet
I have uploaded the spreadsheet for sundaram finance in valueinvestor india google group.
Please use link - http://groups.google.com/group/valueinvestorindia to download the file. Please also see the disclaimer, as I am not recommending this stock. The spreadsheet analysis (correct or wrong) is my personal analysis of the company.
You can find the sum of the part analysis of the company under the tab – sum of parts.
Please feel free to leave a comment if you find something wrong in the spreadsheet.
Please use link - http://groups.google.com/group/valueinvestorindia to download the file. Please also see the disclaimer, as I am not recommending this stock. The spreadsheet analysis (correct or wrong) is my personal analysis of the company.
You can find the sum of the part analysis of the company under the tab – sum of parts.
Please feel free to leave a comment if you find something wrong in the spreadsheet.
Sundaram Finance Spreadsheet
I have uploaded the spreadsheet for sundaram finance in valueinvestor india google group.
Please use link - http://groups.google.com/group/valueinvestorindia to download the file. Please also see the disclaimer, as I am not recommending this stock. The spreadsheet analysis (correct or wrong) is my personal analysis of the company.
You can find the sum of the part analysis of the company under the tab – sum of parts.
Please feel free to leave a comment if you find something wrong in the spreadsheet.
Please use link - http://groups.google.com/group/valueinvestorindia to download the file. Please also see the disclaimer, as I am not recommending this stock. The spreadsheet analysis (correct or wrong) is my personal analysis of the company.
You can find the sum of the part analysis of the company under the tab – sum of parts.
Please feel free to leave a comment if you find something wrong in the spreadsheet.
Monday, October 29, 2007
Allahabad Bank
My notes on Allahabad bank
About
Allahabad bank is one of the oldest banks in India with over 2000 branches. The bank’s branch network is predominant in UP, Bihar and other northern parts of the country. The bank also has 47 specialised branches for various business activities such as Industrial finance, Collection service, Treasury management etc. The Bank is a PSU bank
The bank was a basket case a few years back. I was reading a research report when the bank came out with an IPO in 2002. The bank had NPA of 10.5% which was actually a reduction from 15.1% in 1998. So technically the bank had a zero networth till 2002. The bank has improved its performance since then.
Financials
The Bank has improved its financials substantially in the last few years. The following Key parameters of the Bank have shown improvements from 2002 to 2007
ROE – 11.2 % to 22%
CAR – From 10.5% to 13%
Net NPA – from 10.5% to 0.9%
ROA – From 0.6% to 1.3%
Absolute Net NPA – from 1160 Cr to 315 Cr
Credit deposit ratio – from 48% to 65%
Income growth has been 15%+ for the last 5 years
Net profit has also grown by 20%+ per annum over the last 5 years
The following financial numbers have remained stable or not shown much of an improvement
Other income as a percentage of total assets
Provision ratio has dropped to 70%
Yield on asset – In line with fall in rates over the past few years.
Positives
- The key indicators such NPA, ROE, CAR, ROA, Credit deposit ratio, income and netprofit growth are good for the bank.
- The bank has been expanding its branch network and also getting into the international markets. In addition the bank has kept its NPA’s low in percentage terms and absolute level.
- The bank is also increasing the other income component. The other income which comprises of fee income, trading etc has grown at a much faster rate this year as compared to the Net interest income.
- Operating costs as a percentage of total income has dropped mainly due to reduction in manpower costs. The bank has thus become more efficient in the past few years.
Risks
The biggest risk for the bank is political interference. As the majority shareholder is our government, you can never be sure what hairbrained scheme they will come up with. In the past there have been loan melas, loan writeoff etc. This has reduced in the last few years, but you never know.
In addition the NPA are controlled. However the bank operates in UP, bihar etc. There is a small risk of the rise in the NPA.
Comparitive Valuation
The bank is currently selling at a PE of around 5 and a P/B of around 0.9. On a comparitive basis SBI sells for a PE of around 17 and P/B ratio of around 2.5. SBI is a bigger bank, but on Key parameters such as ROE (around 18% ) , Growth rates (net profit around 8% for last 5 years) etc is not much better than Allahabad bank.
The other top notch bank HDFC is priced at around 35 time PE and P/B of around 6.5. On certain parameters such NPA and growth the bank is ahead of Allahabad bank, however ROE is higher for Allahabad bank. Finally the market recognizes the qualilty of HDFC bank’s management and performance and has priced it accordingly
Conclusion
Allahabad bank is one those non-glamorous, dull stocks. However key to investing is not how sexy the stock is or how much sizzle it has, but whether you can buy a stock at a discount to intrinsic value.
Personally I feel the stock is a bit undervalued, however I have yet to make up my mind on it . I don’t see an immediate catalyst to unlock the value, however if management continue to perform as it has in the past 4-5 years, the returns should be decent.
Please see disclaimer
About
Allahabad bank is one of the oldest banks in India with over 2000 branches. The bank’s branch network is predominant in UP, Bihar and other northern parts of the country. The bank also has 47 specialised branches for various business activities such as Industrial finance, Collection service, Treasury management etc. The Bank is a PSU bank
The bank was a basket case a few years back. I was reading a research report when the bank came out with an IPO in 2002. The bank had NPA of 10.5% which was actually a reduction from 15.1% in 1998. So technically the bank had a zero networth till 2002. The bank has improved its performance since then.
Financials
The Bank has improved its financials substantially in the last few years. The following Key parameters of the Bank have shown improvements from 2002 to 2007
ROE – 11.2 % to 22%
CAR – From 10.5% to 13%
Net NPA – from 10.5% to 0.9%
ROA – From 0.6% to 1.3%
Absolute Net NPA – from 1160 Cr to 315 Cr
Credit deposit ratio – from 48% to 65%
Income growth has been 15%+ for the last 5 years
Net profit has also grown by 20%+ per annum over the last 5 years
The following financial numbers have remained stable or not shown much of an improvement
Other income as a percentage of total assets
Provision ratio has dropped to 70%
Yield on asset – In line with fall in rates over the past few years.
Positives
- The key indicators such NPA, ROE, CAR, ROA, Credit deposit ratio, income and netprofit growth are good for the bank.
- The bank has been expanding its branch network and also getting into the international markets. In addition the bank has kept its NPA’s low in percentage terms and absolute level.
- The bank is also increasing the other income component. The other income which comprises of fee income, trading etc has grown at a much faster rate this year as compared to the Net interest income.
- Operating costs as a percentage of total income has dropped mainly due to reduction in manpower costs. The bank has thus become more efficient in the past few years.
Risks
The biggest risk for the bank is political interference. As the majority shareholder is our government, you can never be sure what hairbrained scheme they will come up with. In the past there have been loan melas, loan writeoff etc. This has reduced in the last few years, but you never know.
In addition the NPA are controlled. However the bank operates in UP, bihar etc. There is a small risk of the rise in the NPA.
Comparitive Valuation
The bank is currently selling at a PE of around 5 and a P/B of around 0.9. On a comparitive basis SBI sells for a PE of around 17 and P/B ratio of around 2.5. SBI is a bigger bank, but on Key parameters such as ROE (around 18% ) , Growth rates (net profit around 8% for last 5 years) etc is not much better than Allahabad bank.
The other top notch bank HDFC is priced at around 35 time PE and P/B of around 6.5. On certain parameters such NPA and growth the bank is ahead of Allahabad bank, however ROE is higher for Allahabad bank. Finally the market recognizes the qualilty of HDFC bank’s management and performance and has priced it accordingly
Conclusion
Allahabad bank is one those non-glamorous, dull stocks. However key to investing is not how sexy the stock is or how much sizzle it has, but whether you can buy a stock at a discount to intrinsic value.
Personally I feel the stock is a bit undervalued, however I have yet to make up my mind on it . I don’t see an immediate catalyst to unlock the value, however if management continue to perform as it has in the past 4-5 years, the returns should be decent.
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