Found the following article on capitalideasonline (bold emphasis and italic comments are mine)
In an investment classic “Greatest Investing Stories”, there is a brilliant piece on Martin Whitman.
“We don’t carry a lot of excess baggage,” he says in the flatted vowels of his native Bronx. “A lot of what Wall Street does has nothing to do with the underlying value of a business. We deal in probabilities, not predictions.”
“The record entitles him to argue that “There are only two kinds of passive investing, value investing and speculative excess.” For the last two years, like 1928-1929 and 1972-1972,” continues Whitman, “we’ve had nothing but speculative excess.”
“These days, argues Whitman, management has to be appraised not only as operators of a going business, “but also as investors engaged in employing and redeploying assets.”
“As a long-term investor looking to a number of possible exit strategies, Whitman glories in the freedom to ignore near-term earnings predictions and results. Acidly, he argues that Wall Street spends far too much time “making predictions about unpredictable things.”
“His search is for companies backed by strong financials that will keep them going through hard times (“safe”), selling at a substantial discount below private business or takeover value (“cheap”). Buying quality assets cheap almost invariably means that the company’s near-term results are rocky enough to have turned off Wall Street. “Markets are too efficient for me to hope that I’d be able to get high-quality resources without the trade-off the near-term outlook not being great,” says Whitman. He chuckles and runs a hand through a fringe of white hair. “When the outlook stinks, you may not have to pay to play.”
“It’s a lot better than being called an indexer or an asset allocator,” he says, taking another poke at standard Wall Street dogma.”
“Whitman’s job is to sniff out what is wrong, and figure out the trade-offs against what is right, particularly in terms of some form of potential asset conversion.”
“Among the most common wrongs Whitman tries to avoid:
a) Attractive-seeming highly liquid cash positions that on inspection prove to be in the custody of managements too timid to put surplus assets to good use;
b) Seductively high rates of return on equity that often signal a relatively small asset base;
c) A combination of low returns on equity and high net asset value that may simply mean that asset values are overstated;
d) High net asset values that may point to a potentially sizable increase in earnings, but which just as often point to swollen over-head.
I have seen point b come up in several of my stock screens. Based purely on the screen, the company looks attractive. Digging deeper show some asset write offs which has artifically raised the return on equity.kind of highlights the risk of relying blindly on stock screen (I never do that though, generally using them to generate a finite list of companies to look at deeper)
“Whitman’s willingness to take on companies like the stereotypical “sick, lame, and lazy” he treated as a pharmacist’s mate – the old salt, in Navy slang, still thinks of himself as having been a “pecker checker” – is not unalloyed. Buying seeming trouble at a discount, Whitman ignores market risk (current price swings). Whitman worries all the time, though, about investment risk (the possibility he may have mis-judged a temporary illness that will prove terminal).”
“As smallish niche producers, often protected by proprietary techniques, the equipment manufacturers seemed less vulnerable to shake out, and had better "quality" assets. Unlike the far more capital-intensive chip makers, with their heavy investments in bricks and mortar, the equipment producers operate out of comparatively low-cost clean rooms, and buy, rather than make, most of their components. Research and development costs are high, but Whitman cannily focused on companies that expensed rather than capitalized them. Those running charges understated earnings, making them seem particularly weak in the down cycle. So much the worse for Wall Street.”
“Whitman continued to buy a cross section of equipment producers at quotes he regarded as "better than even first stage venture capitalists have to pay, and for companies already public and very, very cash rich."
“Whitman was averaging down, a key part of his strategy, but anathema to Wall Street's momentum players.”
Should be done only if one is sure of what he is doing and has strong reasons to believe that the market is wrong ( ‘I feel the stock will do better’ does not quality)
"Most," he thought, "ought to do okay and a few ought to be huge winners, but there would be a few strikeouts." The exit strategy for the strikeouts, in a consolidating industry, would almost certainly be acquisition.”
“Beyond diversification, Whitman protected himself by loading up on management that fit his two acid tests: good at day-to-day operations and equally good as asset managers.”
“Once again scoffing at market risk, Whitman underlines the comforts of being cushioned by strong financials. "When you're in well-capitalized companies, if they do start to dissipate, you get a chance to get out." "On the other hand," he continues, "when you're in poorly capitalized companies, you better watch the quarterly reports very closely."
“That's because he thinks in terms of multiple markets. What may seem to be a very rich price to an individual investor can be a perfectly reasonable one for control buyers looking to an acquisition. They can afford to stump up a premium because of the advantages control brings. Among them is the ability to finance a deal on easy terms with what Whitman calls "OPM" (Other People's Money) and "SOTT" (Something Off The Top) in the form of handsome salaries, options, and other goodies that come with general access to the corporate treasury.”
Read the book ‘Value Investing : A Balanced Approach’ for a better understanding of multiple market referred to by martin whitman.
“Shop depressed industries for strong financials going cheap and hang on. By strong financials Whitman means companies with little or no debt and plenty of cash. What's cheap? No hard and fast rules. "Low prices in terms of the resources you get," he generalizes.”
“Some of his other pricing rules of thumb:
a) For small cap, high-tech companies, a premium of no more than 60 percent over book - about what venture capitalists would pay on a first stage investment.
b) For banks, Whitman's limit is no more than 80 percent of book value.
c) For money managers, Whitman looks to assets under management (pay no more than two percent to three percent).
d) For real estate companies, he zeros in on discounted appraised values rather than book.”
Good reference point to look at when doing your own valuations for any of these type of companies
“Whitman, thumbing his nose at convention, has clearly established himself as an outside force on Wall Street. Despite the philosophical linkage, he even backs off from identification with what he calls Graham & Dodd Fundamentalists. The basic similarities are striking: long-term horizons, a rigorous analytic approach to the meaning behind reported numbers, and an unshakeable belief that probabilities favor those who buy quality at the lowest possible price. Like Ben Graham, Whitman scoffs at the academicians who hold that stock prices are set by a truly knowledgeable and efficient market. Acknowledging his debt to Graham, Whitman argues that his calculated exploitation of exit strategies has added a new dimension to value investing.”
“Whitman says, "I couldn't be a trader. I'm very slow with numbers. I have to understand what they mean."
"It's the art of the possible," he says. "The aim is not to maximize profits, but to be consistent at low risk. I never mind leaving something on the table."
“Whitman, look to a credit against the probability of a default. He looks beyond the credit to see what can be got when it does default-yet another variant on "safe and cheap."
“Whitman backs this contention with a notably unsentimental view of how Wall Street really works. He argues that heavy reliance on short-term earnings predictions as the key to market values makes trend players of money managers. Such linkages are the stuff of stock market columns. The Genesco shoe chain allows that fourth quarter earnings will "meet or exceed" analysts' estimates, and the stock pops with a gain of almost 25 percent. Sykes Enterprises, a call-center specialist, signals that earnings will be down, and the stock falls by a third.”
"Making forecasts about future general market levels," writes Whitman in Value Investing, "is much more in the realm of abnormal psychology than finance."
“Analysts who focus on earnings trends to the exclusion of asset values, continues Whitman, tend to think laterally. "The past is prologue; therefore, past growth will continue into the future, or even accelerate." Unfortunately, the "corporate world is rarely linear," and becomes a particularly dangerous place for trend players who leave no 'margin of safety in concentrating on high multiple growth stocks.”
“A bargain that stays a bargain isn't a bargain."
I think he is refering to a value trap. A company which stays cheap forever either due to poor management or because the intrinsic value is shrinking
Sunday, November 27, 2005
Thursday, November 24, 2005
Arithmetic return is what you see, geometric return is what you get
I am reading a fairly enjoyable book ‘A Mathematician plays the stock market’ (see section ‘currently reading’ under sidebar). Found the discussion on geometric mean v/s arithmetic mean (for returns) fairly relevant for an investor.
Let me explain
Arithmetic mean (or returns) is the simple average of returns over the time period being considered.
For ex: consider a stock X that has the following returns for the year
Week 1 : + 80 %
Week 2 : -60 %
The average return for a two week period is +10%. The ‘average’ return for the year would be 1.1^52 = 142 times the original investment. If average return is what an investor gets, then anyone can be fabulously rich in no time.
Geometric mean of the same stock will be derieved by the following formulae
Total return = (1+0.8)*(1-0.6)*(1+0.8)…….( for 52 weeks) = 0.000195
The scenario in the above formulae is that the investor makes a positive return the first week, followed by negative the next and then positive and so on. So the real return he/she actually gets is less than 1 % of capital invested
Another example
An investor is on the lookout for a hot mutual fund. He looks at the mutual fund rankings and sees a fund, which has returned 100 % last year. He invests his money in the fund. The hot fund promptly proceeds to lose 50% next year ( reversion to mean or maybe bad luck ).
The return the fund publicizes is 25 % (average for 2 years ). An investor who was invested for 2 years is lucky to get his money back. The performance chasing investor looses half his money. The fund manager and his company get their asset management fee and are able to show great performance at the same time.
Reminds me of a famous title of a book – ‘where are customer’s yatch?’
There is another interesting discussion happening on the BRK board on MSN (registration required ) on the same topic.
Let me explain
Arithmetic mean (or returns) is the simple average of returns over the time period being considered.
For ex: consider a stock X that has the following returns for the year
Week 1 : + 80 %
Week 2 : -60 %
The average return for a two week period is +10%. The ‘average’ return for the year would be 1.1^52 = 142 times the original investment. If average return is what an investor gets, then anyone can be fabulously rich in no time.
Geometric mean of the same stock will be derieved by the following formulae
Total return = (1+0.8)*(1-0.6)*(1+0.8)…….( for 52 weeks) = 0.000195
The scenario in the above formulae is that the investor makes a positive return the first week, followed by negative the next and then positive and so on. So the real return he/she actually gets is less than 1 % of capital invested
Another example
An investor is on the lookout for a hot mutual fund. He looks at the mutual fund rankings and sees a fund, which has returned 100 % last year. He invests his money in the fund. The hot fund promptly proceeds to lose 50% next year ( reversion to mean or maybe bad luck ).
The return the fund publicizes is 25 % (average for 2 years ). An investor who was invested for 2 years is lucky to get his money back. The performance chasing investor looses half his money. The fund manager and his company get their asset management fee and are able to show great performance at the same time.
Reminds me of a famous title of a book – ‘where are customer’s yatch?’
There is another interesting discussion happening on the BRK board on MSN (registration required ) on the same topic.
Arithmetic return is what you see, geometric return is what you get
I am reading a fairly enjoyable book ‘A Mathematician plays the stock market’ (see section ‘currently reading’ under sidebar). Found the discussion on geometric mean v/s arithmetic mean (for returns) fairly relevant for an investor.
Let me explain
Arithmetic mean (or returns) is the simple average of returns over the time period being considered.
For ex: consider a stock X that has the following returns for the year
Week 1 : + 80 %
Week 2 : -60 %
The average return for a two week period is +10%. The ‘average’ return for the year would be 1.1^52 = 142 times the original investment. If average return is what an investor gets, then anyone can be fabulously rich in no time.
Geometric mean of the same stock will be derieved by the following formulae
Total return = (1+0.8)*(1-0.6)*(1+0.8)…….( for 52 weeks) = 0.000195
The scenario in the above formulae is that the investor makes a positive return the first week, followed by negative the next and then positive and so on. So the real return he/she actually gets is less than 1 % of capital invested
Another example
An investor is on the lookout for a hot mutual fund. He looks at the mutual fund rankings and sees a fund, which has returned 100 % last year. He invests his money in the fund. The hot fund promptly proceeds to lose 50% next year ( reversion to mean or maybe bad luck ).
The return the fund publicizes is 25 % (average for 2 years ). An investor who was invested for 2 years is lucky to get his money back. The performance chasing investor looses half his money. The fund manager and his company get their asset management fee and are able to show great performance at the same time.
Reminds me of a famous title of a book – ‘where are customer’s yatch?’
There is another interesting discussion happening on the BRK board on MSN (registration required ) on the same topic.
Let me explain
Arithmetic mean (or returns) is the simple average of returns over the time period being considered.
For ex: consider a stock X that has the following returns for the year
Week 1 : + 80 %
Week 2 : -60 %
The average return for a two week period is +10%. The ‘average’ return for the year would be 1.1^52 = 142 times the original investment. If average return is what an investor gets, then anyone can be fabulously rich in no time.
Geometric mean of the same stock will be derieved by the following formulae
Total return = (1+0.8)*(1-0.6)*(1+0.8)…….( for 52 weeks) = 0.000195
The scenario in the above formulae is that the investor makes a positive return the first week, followed by negative the next and then positive and so on. So the real return he/she actually gets is less than 1 % of capital invested
Another example
An investor is on the lookout for a hot mutual fund. He looks at the mutual fund rankings and sees a fund, which has returned 100 % last year. He invests his money in the fund. The hot fund promptly proceeds to lose 50% next year ( reversion to mean or maybe bad luck ).
The return the fund publicizes is 25 % (average for 2 years ). An investor who was invested for 2 years is lucky to get his money back. The performance chasing investor looses half his money. The fund manager and his company get their asset management fee and are able to show great performance at the same time.
Reminds me of a famous title of a book – ‘where are customer’s yatch?’
There is another interesting discussion happening on the BRK board on MSN (registration required ) on the same topic.
Tuesday, November 22, 2005
Concept of variant perception
I have been reading a book ‘No bull’ by Micheal steinhardt. He was hedge fund manager and was able to deliver around 30% returns for almost 30+ years.
I found his concept of variant perception useful. According to micheal, every investment idea should be explainable in 2 minutes and four points
For example, if there is a solid growth company which is expected by the market to grow at 20%, and as an investor my expectations are close to the same number, then I am not going to make more than the cost of equity if the actual numbers meet the expectations (for more detailed understanding of how to evaluate market expectation read the book Expectations investing)
I have used this concept of variant perception in some form although not exactly in the same manner as explained by micheal. Let me give an example
Marico in the year 2003-2004 was selling at around 10-12 time trailing earnings. A simple DCF would easily show that the market was discounting 2-3 years of competitive advantage period -CAP (for detailed understanding of CAP, please read this article) with growth in low teens. Now if one looks at the brands, the history of their New products and their distribution network and management,it is easy to see that this company could grow in low teens for considerably more than the market implied CAP of 2-3 years.
So basically my variant perception was not centred around the growth (which is the the usual variant perception generally given by most of the analysts) but around the CAP of the company.
Marico now sells for a much higher PE and the growth was also much higher than implied by the market (around 15% +).
To a certain extent, one can see the same kind variant perception being exploited by warren buffett, except that he is a genius at recognising such businesses with CAP much higher than implied by the market price (ex: coke, GIECO etc)
I found his concept of variant perception useful. According to micheal, every investment idea should be explainable in 2 minutes and four points
- The idea
- The consensus view around the idea
- The variant perception of the analyst
- The trigger event which would unlock the value
For example, if there is a solid growth company which is expected by the market to grow at 20%, and as an investor my expectations are close to the same number, then I am not going to make more than the cost of equity if the actual numbers meet the expectations (for more detailed understanding of how to evaluate market expectation read the book Expectations investing)
I have used this concept of variant perception in some form although not exactly in the same manner as explained by micheal. Let me give an example
Marico in the year 2003-2004 was selling at around 10-12 time trailing earnings. A simple DCF would easily show that the market was discounting 2-3 years of competitive advantage period -CAP (for detailed understanding of CAP, please read this article) with growth in low teens. Now if one looks at the brands, the history of their New products and their distribution network and management,it is easy to see that this company could grow in low teens for considerably more than the market implied CAP of 2-3 years.
So basically my variant perception was not centred around the growth (which is the the usual variant perception generally given by most of the analysts) but around the CAP of the company.
Marico now sells for a much higher PE and the growth was also much higher than implied by the market (around 15% +).
To a certain extent, one can see the same kind variant perception being exploited by warren buffett, except that he is a genius at recognising such businesses with CAP much higher than implied by the market price (ex: coke, GIECO etc)
Concept of variant perception
I have been reading a book ‘No bull’ by Micheal steinhardt. He was hedge fund manager and was able to deliver around 30% returns for almost 30+ years.
I found his concept of variant perception useful. According to micheal, every investment idea should be explainable in 2 minutes and four points
For example, if there is a solid growth company which is expected by the market to grow at 20%, and as an investor my expectations are close to the same number, then I am not going to make more than the cost of equity if the actual numbers meet the expectations (for more detailed understanding of how to evaluate market expectation read the book Expectations investing)
I have used this concept of variant perception in some form although not exactly in the same manner as explained by micheal. Let me give an example
Marico in the year 2003-2004 was selling at around 10-12 time trailing earnings. A simple DCF would easily show that the market was discounting 2-3 years of competitive advantage period -CAP (for detailed understanding of CAP, please read this article) with growth in low teens. Now if one looks at the brands, the history of their New products and their distribution network and management,it is easy to see that this company could grow in low teens for considerably more than the market implied CAP of 2-3 years.
So basically my variant perception was not centred around the growth (which is the the usual variant perception generally given by most of the analysts) but around the CAP of the company.
Marico now sells for a much higher PE and the growth was also much higher than implied by the market (around 15% +).
To a certain extent, one can see the same kind variant perception being exploited by warren buffett, except that he is a genius at recognising such businesses with CAP much higher than implied by the market price (ex: coke, GIECO etc)
I found his concept of variant perception useful. According to micheal, every investment idea should be explainable in 2 minutes and four points
- The idea
- The consensus view around the idea
- The variant perception of the analyst
- The trigger event which would unlock the value
For example, if there is a solid growth company which is expected by the market to grow at 20%, and as an investor my expectations are close to the same number, then I am not going to make more than the cost of equity if the actual numbers meet the expectations (for more detailed understanding of how to evaluate market expectation read the book Expectations investing)
I have used this concept of variant perception in some form although not exactly in the same manner as explained by micheal. Let me give an example
Marico in the year 2003-2004 was selling at around 10-12 time trailing earnings. A simple DCF would easily show that the market was discounting 2-3 years of competitive advantage period -CAP (for detailed understanding of CAP, please read this article) with growth in low teens. Now if one looks at the brands, the history of their New products and their distribution network and management,it is easy to see that this company could grow in low teens for considerably more than the market implied CAP of 2-3 years.
So basically my variant perception was not centred around the growth (which is the the usual variant perception generally given by most of the analysts) but around the CAP of the company.
Marico now sells for a much higher PE and the growth was also much higher than implied by the market (around 15% +).
To a certain extent, one can see the same kind variant perception being exploited by warren buffett, except that he is a genius at recognising such businesses with CAP much higher than implied by the market price (ex: coke, GIECO etc)
Friday, November 18, 2005
My problem with stock screens
Most of us know the problem with simple stock screens such as one’s based on low P/E ratio, low P/B ratio etc. A lot of stocks which get filtered through the screens are typically companies with poor economics. I have tried to overcome this problem by building a screen which has the following additional screening criteria
My concern is how these companies would fare once the cycle turns downwards. Let me explain using the example of shipping industry which I am analysing currently.
The main companies in the shipping industry which have filtered out through the screen are
any suggestions on improving the above screens ?
- An ROCE/ROE of atleast 13% or more
- No loss during the past 5 years
- Above average growth over 5 years in NP
- D/E < 2
- auto components
- bank
- cement
- Chemical
- Shipping
- Fertiliser
- Shipping
- Paper
- Textile
My concern is how these companies would fare once the cycle turns downwards. Let me explain using the example of shipping industry which I am analysing currently.
The main companies in the shipping industry which have filtered out through the screen are
- mercator lines : High asset addition recently through debt which has resulted in high earnings and high ROE. The risk to the business is high if the business cycle reverses as the company may be unable to service its debt
- Varun shipping / Shreyas shipping: high operating leverage, high debt and high growth in earnings in recent times due to high shipping rates. Earnings risk is high due to operating leverage
- Essar shipping : High earnings due high shipping rates. Also ROE is high to asset revaluations. This stock looks interesting and worth investigating further.
any suggestions on improving the above screens ?
My problem with stock screens
Most of us know the problem with simple stock screens such as one’s based on low P/E ratio, low P/B ratio etc. A lot of stocks which get filtered through the screens are typically companies with poor economics. I have tried to overcome this problem by building a screen which has the following additional screening criteria
My concern is how these companies would fare once the cycle turns downwards. Let me explain using the example of shipping industry which I am analysing currently.
The main companies in the shipping industry which have filtered out through the screen are
any suggestions on improving the above screens ?
- An ROCE/ROE of atleast 13% or more
- No loss during the past 5 years
- Above average growth over 5 years in NP
- D/E < 2
- auto components
- bank
- cement
- Chemical
- Shipping
- Fertiliser
- Shipping
- Paper
- Textile
My concern is how these companies would fare once the cycle turns downwards. Let me explain using the example of shipping industry which I am analysing currently.
The main companies in the shipping industry which have filtered out through the screen are
- mercator lines : High asset addition recently through debt which has resulted in high earnings and high ROE. The risk to the business is high if the business cycle reverses as the company may be unable to service its debt
- Varun shipping / Shreyas shipping: high operating leverage, high debt and high growth in earnings in recent times due to high shipping rates. Earnings risk is high due to operating leverage
- Essar shipping : High earnings due high shipping rates. Also ROE is high to asset revaluations. This stock looks interesting and worth investigating further.
any suggestions on improving the above screens ?
Sunday, November 13, 2005
Comparing performance when invested capital is low
Good article (free registration required) on mckinsey quarterly on how to evaluate performance, when the invested capital is low in a business (like IT services, FMCG, consulting services etc)
http://mckinseyquarterly.com/article_abstract.aspx?ar=1678&L2=5&L3=5
Some excerpts
A more useful way to measure performance is to divide annual economic profit by revenue.2 Grounded in the same logic as conventional ROIC and growth measures,3 this metric gives executives a clearer picture of absolute and relative value creation among companies, irrespective of a particular company's or business unit's absolute level of invested capital, which can distort more traditional metrics if it is very low or negative. As a result, executives are better able to evaluate the relative financial performance of businesses with different capital-investment strategies and to make sound judgments about where and how to spend investment dollars.
In application, this approach will vary from business to business, depending on what is defined as volume and margin. In a people business, such as accounting, the margin would likely best be broken down into the number of accountants multiplied by the economic profit per accountant. In a software business, however, it would be better calculated as the number of copies of software sold times the economic profit per copy of software; in this case, deriving the margin from the number of employees wouldn't make sense. But in all cases, this approach can provide a more nuanced understanding of performance across businesses or companies with divergent levels of capital intensity.
Equally important, economic profit divided by revenue avoids the pitfalls of ROICs that are extremely high or meaningless as a result of very low or negative invested capital. Economic profit, in contrast, is positive for companies with negative invested capital and positive posttax operating margins, so it creates a meaningful measure. It is also less sensitive to changes in invested capital. If the services business mentioned previously doubled its capital to $20 million, its ROIC would be halved. But its economic profit would change only slightly and economic profit divided by revenue hardly at all (to 6.8 percent, from 6.9 percent), thus more accurately reflecting how small an effect this shift in capital would have on the value of the business.4
my thoughts : The above metric is not sufficient to evaluate. I would still consider a low capital intensive business superior compared to a capital intensive one , even if the above ratio is low , as a low capital intensive business could have higher free cash flow (provided both have similar competitive advantages ) and hence could be worth more.
The above metric is good to look at, but i would not base my decision on it (or any other single metric)
http://mckinseyquarterly.com/article_abstract.aspx?ar=1678&L2=5&L3=5
Some excerpts
A more useful way to measure performance is to divide annual economic profit by revenue.2 Grounded in the same logic as conventional ROIC and growth measures,3 this metric gives executives a clearer picture of absolute and relative value creation among companies, irrespective of a particular company's or business unit's absolute level of invested capital, which can distort more traditional metrics if it is very low or negative. As a result, executives are better able to evaluate the relative financial performance of businesses with different capital-investment strategies and to make sound judgments about where and how to spend investment dollars.
In application, this approach will vary from business to business, depending on what is defined as volume and margin. In a people business, such as accounting, the margin would likely best be broken down into the number of accountants multiplied by the economic profit per accountant. In a software business, however, it would be better calculated as the number of copies of software sold times the economic profit per copy of software; in this case, deriving the margin from the number of employees wouldn't make sense. But in all cases, this approach can provide a more nuanced understanding of performance across businesses or companies with divergent levels of capital intensity.
Equally important, economic profit divided by revenue avoids the pitfalls of ROICs that are extremely high or meaningless as a result of very low or negative invested capital. Economic profit, in contrast, is positive for companies with negative invested capital and positive posttax operating margins, so it creates a meaningful measure. It is also less sensitive to changes in invested capital. If the services business mentioned previously doubled its capital to $20 million, its ROIC would be halved. But its economic profit would change only slightly and economic profit divided by revenue hardly at all (to 6.8 percent, from 6.9 percent), thus more accurately reflecting how small an effect this shift in capital would have on the value of the business.4
my thoughts : The above metric is not sufficient to evaluate. I would still consider a low capital intensive business superior compared to a capital intensive one , even if the above ratio is low , as a low capital intensive business could have higher free cash flow (provided both have similar competitive advantages ) and hence could be worth more.
The above metric is good to look at, but i would not base my decision on it (or any other single metric)
Comparing performance when invested capital is low
Good article (free registration required) on mckinsey quarterly on how to evaluate performance, when the invested capital is low in a business (like IT services, FMCG, consulting services etc)
http://mckinseyquarterly.com/article_abstract.aspx?ar=1678&L2=5&L3=5
Some excerpts
A more useful way to measure performance is to divide annual economic profit by revenue.2 Grounded in the same logic as conventional ROIC and growth measures,3 this metric gives executives a clearer picture of absolute and relative value creation among companies, irrespective of a particular company's or business unit's absolute level of invested capital, which can distort more traditional metrics if it is very low or negative. As a result, executives are better able to evaluate the relative financial performance of businesses with different capital-investment strategies and to make sound judgments about where and how to spend investment dollars.
In application, this approach will vary from business to business, depending on what is defined as volume and margin. In a people business, such as accounting, the margin would likely best be broken down into the number of accountants multiplied by the economic profit per accountant. In a software business, however, it would be better calculated as the number of copies of software sold times the economic profit per copy of software; in this case, deriving the margin from the number of employees wouldn't make sense. But in all cases, this approach can provide a more nuanced understanding of performance across businesses or companies with divergent levels of capital intensity.
Equally important, economic profit divided by revenue avoids the pitfalls of ROICs that are extremely high or meaningless as a result of very low or negative invested capital. Economic profit, in contrast, is positive for companies with negative invested capital and positive posttax operating margins, so it creates a meaningful measure. It is also less sensitive to changes in invested capital. If the services business mentioned previously doubled its capital to $20 million, its ROIC would be halved. But its economic profit would change only slightly and economic profit divided by revenue hardly at all (to 6.8 percent, from 6.9 percent), thus more accurately reflecting how small an effect this shift in capital would have on the value of the business.4
my thoughts : The above metric is not sufficient to evaluate. I would still consider a low capital intensive business superior compared to a capital intensive one , even if the above ratio is low , as a low capital intensive business could have higher free cash flow (provided both have similar competitive advantages ) and hence could be worth more.
The above metric is good to look at, but i would not base my decision on it (or any other single metric)
http://mckinseyquarterly.com/article_abstract.aspx?ar=1678&L2=5&L3=5
Some excerpts
A more useful way to measure performance is to divide annual economic profit by revenue.2 Grounded in the same logic as conventional ROIC and growth measures,3 this metric gives executives a clearer picture of absolute and relative value creation among companies, irrespective of a particular company's or business unit's absolute level of invested capital, which can distort more traditional metrics if it is very low or negative. As a result, executives are better able to evaluate the relative financial performance of businesses with different capital-investment strategies and to make sound judgments about where and how to spend investment dollars.
In application, this approach will vary from business to business, depending on what is defined as volume and margin. In a people business, such as accounting, the margin would likely best be broken down into the number of accountants multiplied by the economic profit per accountant. In a software business, however, it would be better calculated as the number of copies of software sold times the economic profit per copy of software; in this case, deriving the margin from the number of employees wouldn't make sense. But in all cases, this approach can provide a more nuanced understanding of performance across businesses or companies with divergent levels of capital intensity.
Equally important, economic profit divided by revenue avoids the pitfalls of ROICs that are extremely high or meaningless as a result of very low or negative invested capital. Economic profit, in contrast, is positive for companies with negative invested capital and positive posttax operating margins, so it creates a meaningful measure. It is also less sensitive to changes in invested capital. If the services business mentioned previously doubled its capital to $20 million, its ROIC would be halved. But its economic profit would change only slightly and economic profit divided by revenue hardly at all (to 6.8 percent, from 6.9 percent), thus more accurately reflecting how small an effect this shift in capital would have on the value of the business.4
my thoughts : The above metric is not sufficient to evaluate. I would still consider a low capital intensive business superior compared to a capital intensive one , even if the above ratio is low , as a low capital intensive business could have higher free cash flow (provided both have similar competitive advantages ) and hence could be worth more.
The above metric is good to look at, but i would not base my decision on it (or any other single metric)
Saturday, November 12, 2005
Monday, November 07, 2005
The practise of giving price targets in research reports
I have always wondered why analysts give price targets, when it is extremely difficult to predict the price level of a security, which is dependent on a host of factors with a few of these factors related to the psychology of the market at a future date.
The typical research report ( at least the free ones which I typically read) usually starts off with a very brief background of the industry. It would then discuss the latest results with a brief analysis of the last 2-3 years. The next 2-3 years income statement and balance sheet is projected. The report would typically end with a price target with simplistic analysis which is typically based on the projected EPS and a PE no.
The more rigorous analyst would give his logic for the PE assumed(often based on the past PE of the company ). Most don’t bother to do even that.
PE as a measure is fairly flawed measure as it does not consider the ROE of the firm, its competitive advantage, impact of industry dynamics etc. At the same time the number used in backward looking (based on past PE, earning etc).I would assume a more rigorous mode of valuation would be based on DCF, with various scenarios being considered and valuation range being arrived at (with degree of confidence for this range).
But then the analyst is giving the consumer (the investor) what he wants – A precise price target (which would be hopefully achieved in the future) , a certainty, where none exists.
It’s not that all analyst reports are of a poor quality. Some do discuss the industry in depth and attempt to do a more thorough valuation exercise. But most are superficial and not worth reading. I have found the original source of the information – The annual reports, far more useful than the analyst reports and have never made a serious commitment of capital based on an analyst report.
Do we have any good source of analyst reports in India? If you are aware please email me.,
The typical research report ( at least the free ones which I typically read) usually starts off with a very brief background of the industry. It would then discuss the latest results with a brief analysis of the last 2-3 years. The next 2-3 years income statement and balance sheet is projected. The report would typically end with a price target with simplistic analysis which is typically based on the projected EPS and a PE no.
The more rigorous analyst would give his logic for the PE assumed(often based on the past PE of the company ). Most don’t bother to do even that.
PE as a measure is fairly flawed measure as it does not consider the ROE of the firm, its competitive advantage, impact of industry dynamics etc. At the same time the number used in backward looking (based on past PE, earning etc).I would assume a more rigorous mode of valuation would be based on DCF, with various scenarios being considered and valuation range being arrived at (with degree of confidence for this range).
But then the analyst is giving the consumer (the investor) what he wants – A precise price target (which would be hopefully achieved in the future) , a certainty, where none exists.
It’s not that all analyst reports are of a poor quality. Some do discuss the industry in depth and attempt to do a more thorough valuation exercise. But most are superficial and not worth reading. I have found the original source of the information – The annual reports, far more useful than the analyst reports and have never made a serious commitment of capital based on an analyst report.
Do we have any good source of analyst reports in India? If you are aware please email me.,
The practise of giving price targets in research reports
I have always wondered why analysts give price targets, when it is extremely difficult to predict the price level of a security, which is dependent on a host of factors with a few of these factors related to the psychology of the market at a future date.
The typical research report ( at least the free ones which I typically read) usually starts off with a very brief background of the industry. It would then discuss the latest results with a brief analysis of the last 2-3 years. The next 2-3 years income statement and balance sheet is projected. The report would typically end with a price target with simplistic analysis which is typically based on the projected EPS and a PE no.
The more rigorous analyst would give his logic for the PE assumed(often based on the past PE of the company ). Most don’t bother to do even that.
PE as a measure is fairly flawed measure as it does not consider the ROE of the firm, its competitive advantage, impact of industry dynamics etc. At the same time the number used in backward looking (based on past PE, earning etc).I would assume a more rigorous mode of valuation would be based on DCF, with various scenarios being considered and valuation range being arrived at (with degree of confidence for this range).
But then the analyst is giving the consumer (the investor) what he wants – A precise price target (which would be hopefully achieved in the future) , a certainty, where none exists.
It’s not that all analyst reports are of a poor quality. Some do discuss the industry in depth and attempt to do a more thorough valuation exercise. But most are superficial and not worth reading. I have found the original source of the information – The annual reports, far more useful than the analyst reports and have never made a serious commitment of capital based on an analyst report.
Do we have any good source of analyst reports in India? If you are aware please email me.,
The typical research report ( at least the free ones which I typically read) usually starts off with a very brief background of the industry. It would then discuss the latest results with a brief analysis of the last 2-3 years. The next 2-3 years income statement and balance sheet is projected. The report would typically end with a price target with simplistic analysis which is typically based on the projected EPS and a PE no.
The more rigorous analyst would give his logic for the PE assumed(often based on the past PE of the company ). Most don’t bother to do even that.
PE as a measure is fairly flawed measure as it does not consider the ROE of the firm, its competitive advantage, impact of industry dynamics etc. At the same time the number used in backward looking (based on past PE, earning etc).I would assume a more rigorous mode of valuation would be based on DCF, with various scenarios being considered and valuation range being arrived at (with degree of confidence for this range).
But then the analyst is giving the consumer (the investor) what he wants – A precise price target (which would be hopefully achieved in the future) , a certainty, where none exists.
It’s not that all analyst reports are of a poor quality. Some do discuss the industry in depth and attempt to do a more thorough valuation exercise. But most are superficial and not worth reading. I have found the original source of the information – The annual reports, far more useful than the analyst reports and have never made a serious commitment of capital based on an analyst report.
Do we have any good source of analyst reports in India? If you are aware please email me.,
Friday, November 04, 2005
Good post on ‘Understanding Risk & Fear of Consequence’
Saw a good post by arpit ranka who has a good blog on Value investing & Behaviorial finance.
This post reminded me of a comment by warren buffett on risk and tendency of investors to gamble everything on a single decision/ event ( The LTCM episode – where the hedge fund was full of these super brilliant guys, but still blew up)
from memory – ‘I have never understood why one would bet everything he has for something he does not need’
This post reminded me of a comment by warren buffett on risk and tendency of investors to gamble everything on a single decision/ event ( The LTCM episode – where the hedge fund was full of these super brilliant guys, but still blew up)
from memory – ‘I have never understood why one would bet everything he has for something he does not need’
Good post on ‘Understanding Risk & Fear of Consequence’
Saw a good post by arpit ranka who has a good blog on Value investing & Behaviorial finance.
This post reminded me of a comment by warren buffett on risk and tendency of investors to gamble everything on a single decision/ event ( The LTCM episode – where the hedge fund was full of these super brilliant guys, but still blew up)
from memory – ‘I have never understood why one would bet everything he has for something he does not need’
This post reminded me of a comment by warren buffett on risk and tendency of investors to gamble everything on a single decision/ event ( The LTCM episode – where the hedge fund was full of these super brilliant guys, but still blew up)
from memory – ‘I have never understood why one would bet everything he has for something he does not need’
Wednesday, November 02, 2005
Looking at exide industries
I came across a few research reports on exide industries and liked what I saw . In a nutshell
A few negatives
- Exide industries is in the business of Automotive batteries with brands such as Exide and Standard furukawa.
- Exide supplies to OEM customers in cars ( Maruti, Hyundai, Ford etc), 2 wheelers ( Bajaj, Honda etc ) and has now made an considerable in roads in the tractor segment too. It has a very high market share of around 80%+ in the OEM segment
- Exide has a dominant position in the replacement market ( 60%+) market share and a strong brand and extensive distribution network ( Read competitive advantage )
- Exide has a strong balance sheet with ROE in high teens and consistent topline and bottomline growth inspite of increases in lead prices ( lead account for around 65 % of Raw material costs )
- Exide seems to have a reasonable pricing power due to its strong brand and is a preferred vendor for a number of OEM customers
- The company is now expanding into the export market ( which accounts for only 5 % of the topline currently )
- The next few years look good for the company as the Automotive sector ( cars, CV and 2 wheelers) has seen good growth and as the replacement cycle is around 18-24 months, strong demand from the both the OEM segment and replacement segment should kick in.
A few negatives
- Lead pricing would have an important bearing on the margins going forward. However over the next 2-3 years the impact of higher lead prices could be reduced if Exide is able to pass through the cost increases.
- Valuation – The company is priced at around 15 times FY06 earnings. For me it is on the higher end of the price range. If I am able to get more comfortable and confident of the business (need to read about other companies in this industry), then 15 times FY06 earnings may have a margin of safety. But for the time being, I am still evaluating and trying to get my arms around it.
Looking at exide industries
I came across a few research reports on exide industries and liked what I saw . In a nutshell
A few negatives
- Exide industries is in the business of Automotive batteries with brands such as Exide and Standard furukawa.
- Exide supplies to OEM customers in cars ( Maruti, Hyundai, Ford etc), 2 wheelers ( Bajaj, Honda etc ) and has now made an considerable in roads in the tractor segment too. It has a very high market share of around 80%+ in the OEM segment
- Exide has a dominant position in the replacement market ( 60%+) market share and a strong brand and extensive distribution network ( Read competitive advantage )
- Exide has a strong balance sheet with ROE in high teens and consistent topline and bottomline growth inspite of increases in lead prices ( lead account for around 65 % of Raw material costs )
- Exide seems to have a reasonable pricing power due to its strong brand and is a preferred vendor for a number of OEM customers
- The company is now expanding into the export market ( which accounts for only 5 % of the topline currently )
- The next few years look good for the company as the Automotive sector ( cars, CV and 2 wheelers) has seen good growth and as the replacement cycle is around 18-24 months, strong demand from the both the OEM segment and replacement segment should kick in.
A few negatives
- Lead pricing would have an important bearing on the margins going forward. However over the next 2-3 years the impact of higher lead prices could be reduced if Exide is able to pass through the cost increases.
- Valuation – The company is priced at around 15 times FY06 earnings. For me it is on the higher end of the price range. If I am able to get more comfortable and confident of the business (need to read about other companies in this industry), then 15 times FY06 earnings may have a margin of safety. But for the time being, I am still evaluating and trying to get my arms around it.
Thursday, October 27, 2005
A good article on brands in fortune
For those interested in the discussion on brands and how strong, and powerful brands add value to a business, there is an article in fortune which discusses the top ten brands across the globe.
How to Build a Breakaway BrandHow ten companies, making products from drills to waffles, took good brands and made them much, much better.By Al Ehrbar
What do Gerber, Google, and Eggo have in common? They're all selling familiarity, trust, and quality—those intangible traits summed up by the word "brand." Right now that word is more important than ever before, because competitors are more instantly reactive and consumers more sophisticated than ever before. The Model T Ford was in production for 18 long years with little change; Sony's Cyber-shot digital cameras go out of production while the packaging is still crisp. And once upon a time shoppers pretty much believed the hype; these days Internet-powered bargain hunters are armed with accurate pricing and product information—and brutal in their search for value.
In this cutthroat marketplace, which brands have been most successful? To find out, FORTUNE turned to Landor Associates, a brand and design consultant in San Francisco. Landor mined a huge database of brand perceptions called the BrandAsset Valuator, or BAV, to identify ten products that scored the largest increases in brand strength from 2001 to 2004. (Landor is part of WPP Group's Young & Rubicam division, which owns the BAV.) Landor's partner, the New York consultancy BrandEconomics, then calculated the pop in economic value each of these breakaway brands gave their parent companies.
Here's how it works. First, Landor and BrandEconomics asked consumers—9,000 of them—what they thought of 2,500 U.S. brands. Then they looked at brand strength. This is a combination of two properties: differentiation and relevance. Differentiation is the degree to which a brand stands out. Relevance is the degree to which consumers believe a brand meets their needs. That all sounds rather obvious, but what's surprising is that the two factors don't necessarily go together. Rolls-Royce has stellar differentiation but hardly any relevance, since few people can pay $300,000 for four wheels. Kleenex is highly relevant but undifferentiated: Most tissues feel alike. The brands that do best are those that deliver on both counts.
In addition, the BAV measures a brand's stature, which can also be broken down into two components—esteem and knowledge. Esteem is how well regarded the brand is, while knowledge refers to whether the consumer understands it. And once again, those two qualities don't operate in lockstep. A high-esteem, low-knowledge profile may be a sign of a brand on the rise—the consumer's curiosity is piqued. A high-knowledge, low-esteem profile, on the other hand, is the consumer's way of dissing a brand: We know it, and it's nothing special (think Dodge or Coor's Lite).
Weakening brands tend to depend more on coupons and discounts; muscular ones can command a premium. How much does that matter? A lot. The intangible value of a company is its market value minus its tangible capital (i.e., property, plant, equipment, and net working capital). A BrandEconomics analysis found that companies with strong, well-regarded brands had an intangible value of 250% of annual sales; companies with listless brands had one of only 70%.
In important ways, though, the value of a brand is incalculable. A rising brand secures more customer loyalty, higher margins, greater pricing flexibility, and new opportunities for growth. And brands on the way up, BrandEconomics research shows, ride through economic downturns with less trauma. "The combination of faster growth with less risk," says Hayes Roth, vice president for global marketing at Landor, "is business nirvana." Here's a look at ten brands that are pretty close to paradise right now.
How to Build a Breakaway BrandHow ten companies, making products from drills to waffles, took good brands and made them much, much better.By Al Ehrbar
What do Gerber, Google, and Eggo have in common? They're all selling familiarity, trust, and quality—those intangible traits summed up by the word "brand." Right now that word is more important than ever before, because competitors are more instantly reactive and consumers more sophisticated than ever before. The Model T Ford was in production for 18 long years with little change; Sony's Cyber-shot digital cameras go out of production while the packaging is still crisp. And once upon a time shoppers pretty much believed the hype; these days Internet-powered bargain hunters are armed with accurate pricing and product information—and brutal in their search for value.
In this cutthroat marketplace, which brands have been most successful? To find out, FORTUNE turned to Landor Associates, a brand and design consultant in San Francisco. Landor mined a huge database of brand perceptions called the BrandAsset Valuator, or BAV, to identify ten products that scored the largest increases in brand strength from 2001 to 2004. (Landor is part of WPP Group's Young & Rubicam division, which owns the BAV.) Landor's partner, the New York consultancy BrandEconomics, then calculated the pop in economic value each of these breakaway brands gave their parent companies.
Here's how it works. First, Landor and BrandEconomics asked consumers—9,000 of them—what they thought of 2,500 U.S. brands. Then they looked at brand strength. This is a combination of two properties: differentiation and relevance. Differentiation is the degree to which a brand stands out. Relevance is the degree to which consumers believe a brand meets their needs. That all sounds rather obvious, but what's surprising is that the two factors don't necessarily go together. Rolls-Royce has stellar differentiation but hardly any relevance, since few people can pay $300,000 for four wheels. Kleenex is highly relevant but undifferentiated: Most tissues feel alike. The brands that do best are those that deliver on both counts.
In addition, the BAV measures a brand's stature, which can also be broken down into two components—esteem and knowledge. Esteem is how well regarded the brand is, while knowledge refers to whether the consumer understands it. And once again, those two qualities don't operate in lockstep. A high-esteem, low-knowledge profile may be a sign of a brand on the rise—the consumer's curiosity is piqued. A high-knowledge, low-esteem profile, on the other hand, is the consumer's way of dissing a brand: We know it, and it's nothing special (think Dodge or Coor's Lite).
Weakening brands tend to depend more on coupons and discounts; muscular ones can command a premium. How much does that matter? A lot. The intangible value of a company is its market value minus its tangible capital (i.e., property, plant, equipment, and net working capital). A BrandEconomics analysis found that companies with strong, well-regarded brands had an intangible value of 250% of annual sales; companies with listless brands had one of only 70%.
In important ways, though, the value of a brand is incalculable. A rising brand secures more customer loyalty, higher margins, greater pricing flexibility, and new opportunities for growth. And brands on the way up, BrandEconomics research shows, ride through economic downturns with less trauma. "The combination of faster growth with less risk," says Hayes Roth, vice president for global marketing at Landor, "is business nirvana." Here's a look at ten brands that are pretty close to paradise right now.
A good article on brands in fortune
For those interested in the discussion on brands and how strong, and powerful brands add value to a business, there is an article in fortune which discusses the top ten brands across the globe.
How to Build a Breakaway BrandHow ten companies, making products from drills to waffles, took good brands and made them much, much better.By Al Ehrbar
What do Gerber, Google, and Eggo have in common? They're all selling familiarity, trust, and quality—those intangible traits summed up by the word "brand." Right now that word is more important than ever before, because competitors are more instantly reactive and consumers more sophisticated than ever before. The Model T Ford was in production for 18 long years with little change; Sony's Cyber-shot digital cameras go out of production while the packaging is still crisp. And once upon a time shoppers pretty much believed the hype; these days Internet-powered bargain hunters are armed with accurate pricing and product information—and brutal in their search for value.
In this cutthroat marketplace, which brands have been most successful? To find out, FORTUNE turned to Landor Associates, a brand and design consultant in San Francisco. Landor mined a huge database of brand perceptions called the BrandAsset Valuator, or BAV, to identify ten products that scored the largest increases in brand strength from 2001 to 2004. (Landor is part of WPP Group's Young & Rubicam division, which owns the BAV.) Landor's partner, the New York consultancy BrandEconomics, then calculated the pop in economic value each of these breakaway brands gave their parent companies.
Here's how it works. First, Landor and BrandEconomics asked consumers—9,000 of them—what they thought of 2,500 U.S. brands. Then they looked at brand strength. This is a combination of two properties: differentiation and relevance. Differentiation is the degree to which a brand stands out. Relevance is the degree to which consumers believe a brand meets their needs. That all sounds rather obvious, but what's surprising is that the two factors don't necessarily go together. Rolls-Royce has stellar differentiation but hardly any relevance, since few people can pay $300,000 for four wheels. Kleenex is highly relevant but undifferentiated: Most tissues feel alike. The brands that do best are those that deliver on both counts.
In addition, the BAV measures a brand's stature, which can also be broken down into two components—esteem and knowledge. Esteem is how well regarded the brand is, while knowledge refers to whether the consumer understands it. And once again, those two qualities don't operate in lockstep. A high-esteem, low-knowledge profile may be a sign of a brand on the rise—the consumer's curiosity is piqued. A high-knowledge, low-esteem profile, on the other hand, is the consumer's way of dissing a brand: We know it, and it's nothing special (think Dodge or Coor's Lite).
Weakening brands tend to depend more on coupons and discounts; muscular ones can command a premium. How much does that matter? A lot. The intangible value of a company is its market value minus its tangible capital (i.e., property, plant, equipment, and net working capital). A BrandEconomics analysis found that companies with strong, well-regarded brands had an intangible value of 250% of annual sales; companies with listless brands had one of only 70%.
In important ways, though, the value of a brand is incalculable. A rising brand secures more customer loyalty, higher margins, greater pricing flexibility, and new opportunities for growth. And brands on the way up, BrandEconomics research shows, ride through economic downturns with less trauma. "The combination of faster growth with less risk," says Hayes Roth, vice president for global marketing at Landor, "is business nirvana." Here's a look at ten brands that are pretty close to paradise right now.
How to Build a Breakaway BrandHow ten companies, making products from drills to waffles, took good brands and made them much, much better.By Al Ehrbar
What do Gerber, Google, and Eggo have in common? They're all selling familiarity, trust, and quality—those intangible traits summed up by the word "brand." Right now that word is more important than ever before, because competitors are more instantly reactive and consumers more sophisticated than ever before. The Model T Ford was in production for 18 long years with little change; Sony's Cyber-shot digital cameras go out of production while the packaging is still crisp. And once upon a time shoppers pretty much believed the hype; these days Internet-powered bargain hunters are armed with accurate pricing and product information—and brutal in their search for value.
In this cutthroat marketplace, which brands have been most successful? To find out, FORTUNE turned to Landor Associates, a brand and design consultant in San Francisco. Landor mined a huge database of brand perceptions called the BrandAsset Valuator, or BAV, to identify ten products that scored the largest increases in brand strength from 2001 to 2004. (Landor is part of WPP Group's Young & Rubicam division, which owns the BAV.) Landor's partner, the New York consultancy BrandEconomics, then calculated the pop in economic value each of these breakaway brands gave their parent companies.
Here's how it works. First, Landor and BrandEconomics asked consumers—9,000 of them—what they thought of 2,500 U.S. brands. Then they looked at brand strength. This is a combination of two properties: differentiation and relevance. Differentiation is the degree to which a brand stands out. Relevance is the degree to which consumers believe a brand meets their needs. That all sounds rather obvious, but what's surprising is that the two factors don't necessarily go together. Rolls-Royce has stellar differentiation but hardly any relevance, since few people can pay $300,000 for four wheels. Kleenex is highly relevant but undifferentiated: Most tissues feel alike. The brands that do best are those that deliver on both counts.
In addition, the BAV measures a brand's stature, which can also be broken down into two components—esteem and knowledge. Esteem is how well regarded the brand is, while knowledge refers to whether the consumer understands it. And once again, those two qualities don't operate in lockstep. A high-esteem, low-knowledge profile may be a sign of a brand on the rise—the consumer's curiosity is piqued. A high-knowledge, low-esteem profile, on the other hand, is the consumer's way of dissing a brand: We know it, and it's nothing special (think Dodge or Coor's Lite).
Weakening brands tend to depend more on coupons and discounts; muscular ones can command a premium. How much does that matter? A lot. The intangible value of a company is its market value minus its tangible capital (i.e., property, plant, equipment, and net working capital). A BrandEconomics analysis found that companies with strong, well-regarded brands had an intangible value of 250% of annual sales; companies with listless brands had one of only 70%.
In important ways, though, the value of a brand is incalculable. A rising brand secures more customer loyalty, higher margins, greater pricing flexibility, and new opportunities for growth. And brands on the way up, BrandEconomics research shows, ride through economic downturns with less trauma. "The combination of faster growth with less risk," says Hayes Roth, vice president for global marketing at Landor, "is business nirvana." Here's a look at ten brands that are pretty close to paradise right now.
It is easy to know what will happen in the market, but difficult to know when
The above comment is from warren buffet. He has also written in the annual letters that he prices the market, rather than time the market. The difference is substantial between the two approaches. The first one, is based on valuation and understanding when the market price is way above the intrinsic value and then going ahead and selling the overvalued security.
The second approach of timing the market is based on psychology of the market and is very difficult (at least for me) to do consistently. People try technical analysis, charts etc to time the market and there could some investors out there who could be good at it. But I have never tried it, as it is too difficult and not really productive for me.
The approach in ‘pricing’ the market works in areas beyond the stock market too. Let me give a personal example
Interest rates in India have fallen for quite some time. From a 10% in 2001 to around 6-7 % by 2004. This was the time to be an investor in debt as debt funds gave good returns. In 2004 I was looking at a housing loan and had an offer of 7.75 % fixed versus 7.25 % Variable. The loan officer ofcourse was very enthusiastic about the variable loan and kept pushing it. I however was keen on the fixed loan and had worked the following math (with assumptions)
Long-term inflation – 5-6 % (assumption on the lower end, can be higher)
NPA – 0.5-1 %
Cost of loan servicing for an HFC – 0.25 – 0.5 %
Return on asset – 1.5 % (for an HFC to earn a reasonable return on equity)
The effective cost (rate an HFC should charge me) should be around 7.5 % - 9 %. So with all the optimistic assumptions built into the ‘value’ of the funds, it should not be priced below 7.5%.
As the bank was offering 7.75 % fixed for a tenure of 20 years, I felt the loan was underpriced and opted for a fixed rate loan.
I could be wrong in my decision if
But the odds are that over a 20-year period, we could have periods of high inflation and high NPA. So I went ahead with the fixed rate loan. At the same time I moved out of debt funds and into floating rate funds.
I found the approach of pricing (and working on odds) the market much more productive. I am not right immediately and so there is no instant gratification (all my friends in 2004 kept saying that floating rate is the way to go). But if my logic is correct and I make a rational, informed decision, it has worked out for me.
Please share any such experiences you would have had
The second approach of timing the market is based on psychology of the market and is very difficult (at least for me) to do consistently. People try technical analysis, charts etc to time the market and there could some investors out there who could be good at it. But I have never tried it, as it is too difficult and not really productive for me.
The approach in ‘pricing’ the market works in areas beyond the stock market too. Let me give a personal example
Interest rates in India have fallen for quite some time. From a 10% in 2001 to around 6-7 % by 2004. This was the time to be an investor in debt as debt funds gave good returns. In 2004 I was looking at a housing loan and had an offer of 7.75 % fixed versus 7.25 % Variable. The loan officer ofcourse was very enthusiastic about the variable loan and kept pushing it. I however was keen on the fixed loan and had worked the following math (with assumptions)
Long-term inflation – 5-6 % (assumption on the lower end, can be higher)
NPA – 0.5-1 %
Cost of loan servicing for an HFC – 0.25 – 0.5 %
Return on asset – 1.5 % (for an HFC to earn a reasonable return on equity)
The effective cost (rate an HFC should charge me) should be around 7.5 % - 9 %. So with all the optimistic assumptions built into the ‘value’ of the funds, it should not be priced below 7.5%.
As the bank was offering 7.75 % fixed for a tenure of 20 years, I felt the loan was underpriced and opted for a fixed rate loan.
I could be wrong in my decision if
- Inflation for next 20 years remains below 5 %
- NPA for most of the HFC are below 0.5 %
But the odds are that over a 20-year period, we could have periods of high inflation and high NPA. So I went ahead with the fixed rate loan. At the same time I moved out of debt funds and into floating rate funds.
I found the approach of pricing (and working on odds) the market much more productive. I am not right immediately and so there is no instant gratification (all my friends in 2004 kept saying that floating rate is the way to go). But if my logic is correct and I make a rational, informed decision, it has worked out for me.
Please share any such experiences you would have had
It is easy to know what will happen in the market, but difficult to know when
The above comment is from warren buffet. He has also written in the annual letters that he prices the market, rather than time the market. The difference is substantial between the two approaches. The first one, is based on valuation and understanding when the market price is way above the intrinsic value and then going ahead and selling the overvalued security.
The second approach of timing the market is based on psychology of the market and is very difficult (at least for me) to do consistently. People try technical analysis, charts etc to time the market and there could some investors out there who could be good at it. But I have never tried it, as it is too difficult and not really productive for me.
The approach in ‘pricing’ the market works in areas beyond the stock market too. Let me give a personal example
Interest rates in India have fallen for quite some time. From a 10% in 2001 to around 6-7 % by 2004. This was the time to be an investor in debt as debt funds gave good returns. In 2004 I was looking at a housing loan and had an offer of 7.75 % fixed versus 7.25 % Variable. The loan officer ofcourse was very enthusiastic about the variable loan and kept pushing it. I however was keen on the fixed loan and had worked the following math (with assumptions)
Long-term inflation – 5-6 % (assumption on the lower end, can be higher)
NPA – 0.5-1 %
Cost of loan servicing for an HFC – 0.25 – 0.5 %
Return on asset – 1.5 % (for an HFC to earn a reasonable return on equity)
The effective cost (rate an HFC should charge me) should be around 7.5 % - 9 %. So with all the optimistic assumptions built into the ‘value’ of the funds, it should not be priced below 7.5%.
As the bank was offering 7.75 % fixed for a tenure of 20 years, I felt the loan was underpriced and opted for a fixed rate loan.
I could be wrong in my decision if
But the odds are that over a 20-year period, we could have periods of high inflation and high NPA. So I went ahead with the fixed rate loan. At the same time I moved out of debt funds and into floating rate funds.
I found the approach of pricing (and working on odds) the market much more productive. I am not right immediately and so there is no instant gratification (all my friends in 2004 kept saying that floating rate is the way to go). But if my logic is correct and I make a rational, informed decision, it has worked out for me.
Please share any such experiences you would have had
The second approach of timing the market is based on psychology of the market and is very difficult (at least for me) to do consistently. People try technical analysis, charts etc to time the market and there could some investors out there who could be good at it. But I have never tried it, as it is too difficult and not really productive for me.
The approach in ‘pricing’ the market works in areas beyond the stock market too. Let me give a personal example
Interest rates in India have fallen for quite some time. From a 10% in 2001 to around 6-7 % by 2004. This was the time to be an investor in debt as debt funds gave good returns. In 2004 I was looking at a housing loan and had an offer of 7.75 % fixed versus 7.25 % Variable. The loan officer ofcourse was very enthusiastic about the variable loan and kept pushing it. I however was keen on the fixed loan and had worked the following math (with assumptions)
Long-term inflation – 5-6 % (assumption on the lower end, can be higher)
NPA – 0.5-1 %
Cost of loan servicing for an HFC – 0.25 – 0.5 %
Return on asset – 1.5 % (for an HFC to earn a reasonable return on equity)
The effective cost (rate an HFC should charge me) should be around 7.5 % - 9 %. So with all the optimistic assumptions built into the ‘value’ of the funds, it should not be priced below 7.5%.
As the bank was offering 7.75 % fixed for a tenure of 20 years, I felt the loan was underpriced and opted for a fixed rate loan.
I could be wrong in my decision if
- Inflation for next 20 years remains below 5 %
- NPA for most of the HFC are below 0.5 %
But the odds are that over a 20-year period, we could have periods of high inflation and high NPA. So I went ahead with the fixed rate loan. At the same time I moved out of debt funds and into floating rate funds.
I found the approach of pricing (and working on odds) the market much more productive. I am not right immediately and so there is no instant gratification (all my friends in 2004 kept saying that floating rate is the way to go). But if my logic is correct and I make a rational, informed decision, it has worked out for me.
Please share any such experiences you would have had
Wednesday, October 26, 2005
Pidilite industries - results and a change of opinion
Pidilite industries is one of the leading companies involved in adhesives, sealants and construction chemicals business. It has several top brands like fevicol, Fixit, M-seal etc.
I had looked at this company in 2001 and had made a small investment based on the following points
- Good ROC of 20 % +
- Sustaniable competitive advantage due to strong brands, extensive distribution network and high market share/ mindshare
- Consistent revenue and profit growth for last 10 years
What stopped me from committing myself more was the tendency of the management to do strange, under-related commitment of capital to businesses like windmills !. In addition they had some IT disputes. All this made me uncomfortable.
A few weeks back I looked at their latest annual report and liked what I saw. A few notable point
- Capital allocation has been rational and has added to the core business. Management has acquired brands like Mr Fixit, M-seal etc and have grown these brands after acquiring them
- No funny diversifications into stuff like windmills !!
- An increasing dividend flow indicating a willingness to return excess capital back to shareholders
- Focus on EVA / Return on capital ( The management discussion talks about these points which kind of indicates the managements commitment to it)
- Impressive growth in the core business of adhesives, sealants, construction chemicals
- Growth of the business to international markets
All in all, I am ready to re-think on the capital allocation attitude of management, which I feel is fairly pro-shareholder and rational. But the price is a bit higher than what I would like. So I guess, I would wait and watch for the price to be in happy zone before I take a swing
Pidilite industries - results and a change of opinion
Pidilite industries is one of the leading companies involved in adhesives, sealants and construction chemicals business. It has several top brands like fevicol, Fixit, M-seal etc.
I had looked at this company in 2001 and had made a small investment based on the following points
- Good ROC of 20 % +
- Sustaniable competitive advantage due to strong brands, extensive distribution network and high market share/ mindshare
- Consistent revenue and profit growth for last 10 years
What stopped me from committing myself more was the tendency of the management to do strange, under-related commitment of capital to businesses like windmills !. In addition they had some IT disputes. All this made me uncomfortable.
A few weeks back I looked at their latest annual report and liked what I saw. A few notable point
- Capital allocation has been rational and has added to the core business. Management has acquired brands like Mr Fixit, M-seal etc and have grown these brands after acquiring them
- No funny diversifications into stuff like windmills !!
- An increasing dividend flow indicating a willingness to return excess capital back to shareholders
- Focus on EVA / Return on capital ( The management discussion talks about these points which kind of indicates the managements commitment to it)
- Impressive growth in the core business of adhesives, sealants, construction chemicals
- Growth of the business to international markets
All in all, I am ready to re-think on the capital allocation attitude of management, which I feel is fairly pro-shareholder and rational. But the price is a bit higher than what I would like. So I guess, I would wait and watch for the price to be in happy zone before I take a swing
Monday, October 24, 2005
Is a strong brand a profitable franchise ? - comments / thoughts/ cases
I had posted my thoughts on the difference between a brand and franchise. Initially my understanding was that they are the same and a strong brand equates to a good franchise (franchise can be defined as a business which earns more than its cost of capital and has a sustainable competitive advantage).
However I have seen cases where the two are not the same ( ex : titan, Mercedes etc, general motor brands etc).
I put out a question asking for comments and got replies from bruce (see below) and from george who has put his thoughts on his website Fat Pitch Financials.
I am listing a few criteria which came to my mind after I got the comments from bruce and george
So here goes
A strong brand would equate to profitable franchise if price is not the key differentiator or is not key factor in the purchase decision. I can think of the following cases
Ofcourse the above are not sufficient for a strong brand to be a profitable franchise. Cost structures and other factors would also be important for the business to be a profitable franchise.
Now why go through all this in trying to distinguish between a franchise and good business (with or without a brand). If I remember correctly, warren buffett in his annual report has written about newspapers as very strong franchise with a kind of a toll bridge business model. Later with internet and other media, he commented that newspapers were still good businesses, but not bullet proof franchise. In the same section he also did a rough valuation exercise of a good franchise v/s good business and showed how strong franchises are worth more than good businesses.
Please share your thoughts on the above topic.
Comments :
Bruce said...
Here's my abstract opinion (there are a LOT of ways of looking at this one question). A brand/franchise/whatever is something which signals a contract with the customer. It's a popular solution to the prisoner's dilemma problem that plagues all economic transactions to some extent. Game theory deals with this subject very well.A vendor spends a great deal of time and money developing an easily recognizable public image that is protected by law (from having other vendors use the same image). That image slowly becomes a reputation, but it also signals a commitment from the vendor not to cheat the customer quickly and then run away. The average consumer must keep track of a very large and growing number of brands and franchises. They don't want to have to do the enormous work to validate a vendor every time they want to make an economic purchase. A brand/franchise allows them to make quick decisions, often in unknown places. So in a sense, a brand/franchise becomes a contract between the buyer and the vendor. The cost in establishing the brand (and also the value in not destroying it) is a fuzzy guarantee placed into the public by the vendor.When you have a comodity product or service, that brand becomes less important. Someone stands by the side of the road with a rock that you want to buy. They have no brand, but all you want is a rock which is easily verified during the purchase. Anyone spending lots of money to establish a brand is at a cost disadvantage to someone who just gathers rocks and stands at the side of the road. For that reason, comodity markets are won by whoever has the lowest cost. If the market demands 10,000 rocks, then you essentially line up the vendors from lowest cost to highest cost. You start with the lowest cost and work your way up until you buy 10,000 rocks (well, it's more complicated than that due to the supply/demand curve). The market price essentially becomes the highest cost rock among the 10,000.So call it a brand or franchise or whatever, it's really a sort of contract. It's very important that the law upholds the property rights of the brand or everything breaks down. In fact, it's always important for property rights to be upheld for economic activity to be efficient and effective. India has come a long way over the years and I suspect it will become a very major economic superpower so long as it continues on the path of free markets and property rights.
7:02 PM
Bruce said...
What makes a strong brand? Well, one view is covered very well in The 22 Immutable Laws of Marketing. But a better answer is to look at your own behavior and where you rely on brand. Buffett made some comments about Coca Cola that make a lot of sense. One type of very good brand is small, repeat purchases that are almost habit.When you look at what a brand is all about (a contract), then you can ask yourself when is that contract valuable from the vendor's perspective. One good thing is lots of confusion and doubt in the minds of customers. Another is a long delay before the customer finds out whether what they bought was good quality vs poor quality.
9:47 AM
George said...
This is a very interesting topic. I posted my comments about it over at my blog, Fat Pitch Financials. It would be nice to put together a set of criteria by which to gage how likely a brand will lead to a franchise.
8:04 PM
However I have seen cases where the two are not the same ( ex : titan, Mercedes etc, general motor brands etc).
I put out a question asking for comments and got replies from bruce (see below) and from george who has put his thoughts on his website Fat Pitch Financials.
I am listing a few criteria which came to my mind after I got the comments from bruce and george
So here goes
A strong brand would equate to profitable franchise if price is not the key differentiator or is not key factor in the purchase decision. I can think of the following cases
- Low value purchase v/s high value purchase (borrowed from george’s post on his website). I cannot think of anyone putting as much effort in buying a cola v/s buying a car. As a result a strong brand can charge more for a product
- A complex purchase decision requiring substantial information to asess the true price of a product. For ex: high end electronic products – A bose system ?
- Emotional association with the product – Disney products / Barbie dolls – try giving a child a regular lower price but equally good doll and you will understand what I mean
- Social proof / Association tendency – High prestige product which confer a social status on the owner . Ex : tiffany’s
Ofcourse the above are not sufficient for a strong brand to be a profitable franchise. Cost structures and other factors would also be important for the business to be a profitable franchise.
Now why go through all this in trying to distinguish between a franchise and good business (with or without a brand). If I remember correctly, warren buffett in his annual report has written about newspapers as very strong franchise with a kind of a toll bridge business model. Later with internet and other media, he commented that newspapers were still good businesses, but not bullet proof franchise. In the same section he also did a rough valuation exercise of a good franchise v/s good business and showed how strong franchises are worth more than good businesses.
Please share your thoughts on the above topic.
Comments :
Bruce said...
Here's my abstract opinion (there are a LOT of ways of looking at this one question). A brand/franchise/whatever is something which signals a contract with the customer. It's a popular solution to the prisoner's dilemma problem that plagues all economic transactions to some extent. Game theory deals with this subject very well.A vendor spends a great deal of time and money developing an easily recognizable public image that is protected by law (from having other vendors use the same image). That image slowly becomes a reputation, but it also signals a commitment from the vendor not to cheat the customer quickly and then run away. The average consumer must keep track of a very large and growing number of brands and franchises. They don't want to have to do the enormous work to validate a vendor every time they want to make an economic purchase. A brand/franchise allows them to make quick decisions, often in unknown places. So in a sense, a brand/franchise becomes a contract between the buyer and the vendor. The cost in establishing the brand (and also the value in not destroying it) is a fuzzy guarantee placed into the public by the vendor.When you have a comodity product or service, that brand becomes less important. Someone stands by the side of the road with a rock that you want to buy. They have no brand, but all you want is a rock which is easily verified during the purchase. Anyone spending lots of money to establish a brand is at a cost disadvantage to someone who just gathers rocks and stands at the side of the road. For that reason, comodity markets are won by whoever has the lowest cost. If the market demands 10,000 rocks, then you essentially line up the vendors from lowest cost to highest cost. You start with the lowest cost and work your way up until you buy 10,000 rocks (well, it's more complicated than that due to the supply/demand curve). The market price essentially becomes the highest cost rock among the 10,000.So call it a brand or franchise or whatever, it's really a sort of contract. It's very important that the law upholds the property rights of the brand or everything breaks down. In fact, it's always important for property rights to be upheld for economic activity to be efficient and effective. India has come a long way over the years and I suspect it will become a very major economic superpower so long as it continues on the path of free markets and property rights.
7:02 PM
Bruce said...
What makes a strong brand? Well, one view is covered very well in The 22 Immutable Laws of Marketing. But a better answer is to look at your own behavior and where you rely on brand. Buffett made some comments about Coca Cola that make a lot of sense. One type of very good brand is small, repeat purchases that are almost habit.When you look at what a brand is all about (a contract), then you can ask yourself when is that contract valuable from the vendor's perspective. One good thing is lots of confusion and doubt in the minds of customers. Another is a long delay before the customer finds out whether what they bought was good quality vs poor quality.
9:47 AM
George said...
This is a very interesting topic. I posted my comments about it over at my blog, Fat Pitch Financials. It would be nice to put together a set of criteria by which to gage how likely a brand will lead to a franchise.
8:04 PM
Is a strong brand a profitable franchise ? - comments / thoughts/ cases
I had posted my thoughts on the difference between a brand and franchise. Initially my understanding was that they are the same and a strong brand equates to a good franchise (franchise can be defined as a business which earns more than its cost of capital and has a sustainable competitive advantage).
However I have seen cases where the two are not the same ( ex : titan, Mercedes etc, general motor brands etc).
I put out a question asking for comments and got replies from bruce (see below) and from george who has put his thoughts on his website Fat Pitch Financials.
I am listing a few criteria which came to my mind after I got the comments from bruce and george
So here goes
A strong brand would equate to profitable franchise if price is not the key differentiator or is not key factor in the purchase decision. I can think of the following cases
Ofcourse the above are not sufficient for a strong brand to be a profitable franchise. Cost structures and other factors would also be important for the business to be a profitable franchise.
Now why go through all this in trying to distinguish between a franchise and good business (with or without a brand). If I remember correctly, warren buffett in his annual report has written about newspapers as very strong franchise with a kind of a toll bridge business model. Later with internet and other media, he commented that newspapers were still good businesses, but not bullet proof franchise. In the same section he also did a rough valuation exercise of a good franchise v/s good business and showed how strong franchises are worth more than good businesses.
Please share your thoughts on the above topic.
Comments :
Bruce said...
Here's my abstract opinion (there are a LOT of ways of looking at this one question). A brand/franchise/whatever is something which signals a contract with the customer. It's a popular solution to the prisoner's dilemma problem that plagues all economic transactions to some extent. Game theory deals with this subject very well.A vendor spends a great deal of time and money developing an easily recognizable public image that is protected by law (from having other vendors use the same image). That image slowly becomes a reputation, but it also signals a commitment from the vendor not to cheat the customer quickly and then run away. The average consumer must keep track of a very large and growing number of brands and franchises. They don't want to have to do the enormous work to validate a vendor every time they want to make an economic purchase. A brand/franchise allows them to make quick decisions, often in unknown places. So in a sense, a brand/franchise becomes a contract between the buyer and the vendor. The cost in establishing the brand (and also the value in not destroying it) is a fuzzy guarantee placed into the public by the vendor.When you have a comodity product or service, that brand becomes less important. Someone stands by the side of the road with a rock that you want to buy. They have no brand, but all you want is a rock which is easily verified during the purchase. Anyone spending lots of money to establish a brand is at a cost disadvantage to someone who just gathers rocks and stands at the side of the road. For that reason, comodity markets are won by whoever has the lowest cost. If the market demands 10,000 rocks, then you essentially line up the vendors from lowest cost to highest cost. You start with the lowest cost and work your way up until you buy 10,000 rocks (well, it's more complicated than that due to the supply/demand curve). The market price essentially becomes the highest cost rock among the 10,000.So call it a brand or franchise or whatever, it's really a sort of contract. It's very important that the law upholds the property rights of the brand or everything breaks down. In fact, it's always important for property rights to be upheld for economic activity to be efficient and effective. India has come a long way over the years and I suspect it will become a very major economic superpower so long as it continues on the path of free markets and property rights.
7:02 PM
Bruce said...
What makes a strong brand? Well, one view is covered very well in The 22 Immutable Laws of Marketing. But a better answer is to look at your own behavior and where you rely on brand. Buffett made some comments about Coca Cola that make a lot of sense. One type of very good brand is small, repeat purchases that are almost habit.When you look at what a brand is all about (a contract), then you can ask yourself when is that contract valuable from the vendor's perspective. One good thing is lots of confusion and doubt in the minds of customers. Another is a long delay before the customer finds out whether what they bought was good quality vs poor quality.
9:47 AM
George said...
This is a very interesting topic. I posted my comments about it over at my blog, Fat Pitch Financials. It would be nice to put together a set of criteria by which to gage how likely a brand will lead to a franchise.
8:04 PM
However I have seen cases where the two are not the same ( ex : titan, Mercedes etc, general motor brands etc).
I put out a question asking for comments and got replies from bruce (see below) and from george who has put his thoughts on his website Fat Pitch Financials.
I am listing a few criteria which came to my mind after I got the comments from bruce and george
So here goes
A strong brand would equate to profitable franchise if price is not the key differentiator or is not key factor in the purchase decision. I can think of the following cases
- Low value purchase v/s high value purchase (borrowed from george’s post on his website). I cannot think of anyone putting as much effort in buying a cola v/s buying a car. As a result a strong brand can charge more for a product
- A complex purchase decision requiring substantial information to asess the true price of a product. For ex: high end electronic products – A bose system ?
- Emotional association with the product – Disney products / Barbie dolls – try giving a child a regular lower price but equally good doll and you will understand what I mean
- Social proof / Association tendency – High prestige product which confer a social status on the owner . Ex : tiffany’s
Ofcourse the above are not sufficient for a strong brand to be a profitable franchise. Cost structures and other factors would also be important for the business to be a profitable franchise.
Now why go through all this in trying to distinguish between a franchise and good business (with or without a brand). If I remember correctly, warren buffett in his annual report has written about newspapers as very strong franchise with a kind of a toll bridge business model. Later with internet and other media, he commented that newspapers were still good businesses, but not bullet proof franchise. In the same section he also did a rough valuation exercise of a good franchise v/s good business and showed how strong franchises are worth more than good businesses.
Please share your thoughts on the above topic.
Comments :
Bruce said...
Here's my abstract opinion (there are a LOT of ways of looking at this one question). A brand/franchise/whatever is something which signals a contract with the customer. It's a popular solution to the prisoner's dilemma problem that plagues all economic transactions to some extent. Game theory deals with this subject very well.A vendor spends a great deal of time and money developing an easily recognizable public image that is protected by law (from having other vendors use the same image). That image slowly becomes a reputation, but it also signals a commitment from the vendor not to cheat the customer quickly and then run away. The average consumer must keep track of a very large and growing number of brands and franchises. They don't want to have to do the enormous work to validate a vendor every time they want to make an economic purchase. A brand/franchise allows them to make quick decisions, often in unknown places. So in a sense, a brand/franchise becomes a contract between the buyer and the vendor. The cost in establishing the brand (and also the value in not destroying it) is a fuzzy guarantee placed into the public by the vendor.When you have a comodity product or service, that brand becomes less important. Someone stands by the side of the road with a rock that you want to buy. They have no brand, but all you want is a rock which is easily verified during the purchase. Anyone spending lots of money to establish a brand is at a cost disadvantage to someone who just gathers rocks and stands at the side of the road. For that reason, comodity markets are won by whoever has the lowest cost. If the market demands 10,000 rocks, then you essentially line up the vendors from lowest cost to highest cost. You start with the lowest cost and work your way up until you buy 10,000 rocks (well, it's more complicated than that due to the supply/demand curve). The market price essentially becomes the highest cost rock among the 10,000.So call it a brand or franchise or whatever, it's really a sort of contract. It's very important that the law upholds the property rights of the brand or everything breaks down. In fact, it's always important for property rights to be upheld for economic activity to be efficient and effective. India has come a long way over the years and I suspect it will become a very major economic superpower so long as it continues on the path of free markets and property rights.
7:02 PM
Bruce said...
What makes a strong brand? Well, one view is covered very well in The 22 Immutable Laws of Marketing. But a better answer is to look at your own behavior and where you rely on brand. Buffett made some comments about Coca Cola that make a lot of sense. One type of very good brand is small, repeat purchases that are almost habit.When you look at what a brand is all about (a contract), then you can ask yourself when is that contract valuable from the vendor's perspective. One good thing is lots of confusion and doubt in the minds of customers. Another is a long delay before the customer finds out whether what they bought was good quality vs poor quality.
9:47 AM
George said...
This is a very interesting topic. I posted my comments about it over at my blog, Fat Pitch Financials. It would be nice to put together a set of criteria by which to gage how likely a brand will lead to a franchise.
8:04 PM
Q&A with Warren buffett (Tuck school of business)
http://mba.tuck.dartmouth.edu/pages/clubs/investment/WarrenBuffett.html
Some excerpts from the Q&A
Q: In your letters you speak frequently of the importance of not over-complicating things. What are your secrets to keeping your life simple?A: When making investments, pretend in life you have a punch-card with only 20 boxes, and every time you make an investment you punch a slot. It will discipline you to only make investments you have extreme confidence in. Big money is made by obvious things. If using a discount rate of 8% vs. 10% is going to make or break an investment idea, it's probably not a good idea. Back in 1951 Moody's published thick handbooks by industry of every stock in circulation. I went through all of them, thousands of pages, motivated by the hope that a great idea was just on the next page. I found companies like National American Insurance and Western Insurance Securities Company that nobody was paying attention to that were trading for far less than their intrinsic values. Last year we found a steel company on the Korean Stock Exchange that had no analyst coverage, no research, but was the most profitable steel company in the world
Q: I have worked in various technologies businesses, but I understand that you do not typically invest in the technology sector. Why is that? How do you view technology as an individual and as an investor?A: Technology is clearly a boost to business productivity and a driver of better consumer products and the like, so as an individual I have a high appreciation for the power of technology. I have avoided technology sectors as an investor because in general I don't have a solid grasp of what differentiates many technology companies. I don't know how to spot durable competitive advantage in technology. To get rich, you find businesses with durable competitive advantage and you don't overpay for them. Technology is based on change; and change is really the enemy of the investor. Change is more rapid and unpredictable in technology relative to the broader economy. To me, all technology sectors look like 7-foot hurdles
Q: In many of your letters you speak about the importance of looking through the windshield and not the rearview mirror. What issues do you think people today are mistakenly looking at through the rearview mirror?A: Investors are always looking for the holy grail, the next great idea that will carry performance and pension returns for the several years. Right now its 'alternative investments' - private equity, hedge funds, the assets that have outperformed public equities for the past five years since the tech bubble burst. There's so much money chasing these ideas now that the returns in the future will probably not be as good. At some point, public equities will become good investments again and fewer people will be looking at them. At Berkshire, we look at a lot of "super-cat" (super catastrophe) insurance business that few firms will write. The challenge is determining when there's a paradigm shift, when the future will no longer look like the past. It's probable that the next hundred years of hurricane activity will not look like the past hundred years. Another example, we write a lot of D and O insurance, Directors and Officers liability. Post Enron, I feel strongly that juries will award much harsher penalties to victims of corporate fraud, etc. than they would have five years ago before the average juror watched hours of news stories about all the scandals. There's no model that can quantify that added risk, but it's a risk that won't be captured looking at historical data.
My thought - The last Q&A throws up an interesting question for Indian investors. After 3 years of great returns, are we as investors also operating with a rear mirror view? Any thoughts ?
Some excerpts from the Q&A
Q: In your letters you speak frequently of the importance of not over-complicating things. What are your secrets to keeping your life simple?A: When making investments, pretend in life you have a punch-card with only 20 boxes, and every time you make an investment you punch a slot. It will discipline you to only make investments you have extreme confidence in. Big money is made by obvious things. If using a discount rate of 8% vs. 10% is going to make or break an investment idea, it's probably not a good idea. Back in 1951 Moody's published thick handbooks by industry of every stock in circulation. I went through all of them, thousands of pages, motivated by the hope that a great idea was just on the next page. I found companies like National American Insurance and Western Insurance Securities Company that nobody was paying attention to that were trading for far less than their intrinsic values. Last year we found a steel company on the Korean Stock Exchange that had no analyst coverage, no research, but was the most profitable steel company in the world
Q: I have worked in various technologies businesses, but I understand that you do not typically invest in the technology sector. Why is that? How do you view technology as an individual and as an investor?A: Technology is clearly a boost to business productivity and a driver of better consumer products and the like, so as an individual I have a high appreciation for the power of technology. I have avoided technology sectors as an investor because in general I don't have a solid grasp of what differentiates many technology companies. I don't know how to spot durable competitive advantage in technology. To get rich, you find businesses with durable competitive advantage and you don't overpay for them. Technology is based on change; and change is really the enemy of the investor. Change is more rapid and unpredictable in technology relative to the broader economy. To me, all technology sectors look like 7-foot hurdles
Q: In many of your letters you speak about the importance of looking through the windshield and not the rearview mirror. What issues do you think people today are mistakenly looking at through the rearview mirror?A: Investors are always looking for the holy grail, the next great idea that will carry performance and pension returns for the several years. Right now its 'alternative investments' - private equity, hedge funds, the assets that have outperformed public equities for the past five years since the tech bubble burst. There's so much money chasing these ideas now that the returns in the future will probably not be as good. At some point, public equities will become good investments again and fewer people will be looking at them. At Berkshire, we look at a lot of "super-cat" (super catastrophe) insurance business that few firms will write. The challenge is determining when there's a paradigm shift, when the future will no longer look like the past. It's probable that the next hundred years of hurricane activity will not look like the past hundred years. Another example, we write a lot of D and O insurance, Directors and Officers liability. Post Enron, I feel strongly that juries will award much harsher penalties to victims of corporate fraud, etc. than they would have five years ago before the average juror watched hours of news stories about all the scandals. There's no model that can quantify that added risk, but it's a risk that won't be captured looking at historical data.
My thought - The last Q&A throws up an interesting question for Indian investors. After 3 years of great returns, are we as investors also operating with a rear mirror view? Any thoughts ?
Q&A with Warren buffett (Tuck school of business)
http://mba.tuck.dartmouth.edu/pages/clubs/investment/WarrenBuffett.html
Some excerpts from the Q&A
Q: In your letters you speak frequently of the importance of not over-complicating things. What are your secrets to keeping your life simple?A: When making investments, pretend in life you have a punch-card with only 20 boxes, and every time you make an investment you punch a slot. It will discipline you to only make investments you have extreme confidence in. Big money is made by obvious things. If using a discount rate of 8% vs. 10% is going to make or break an investment idea, it's probably not a good idea. Back in 1951 Moody's published thick handbooks by industry of every stock in circulation. I went through all of them, thousands of pages, motivated by the hope that a great idea was just on the next page. I found companies like National American Insurance and Western Insurance Securities Company that nobody was paying attention to that were trading for far less than their intrinsic values. Last year we found a steel company on the Korean Stock Exchange that had no analyst coverage, no research, but was the most profitable steel company in the world
Q: I have worked in various technologies businesses, but I understand that you do not typically invest in the technology sector. Why is that? How do you view technology as an individual and as an investor?A: Technology is clearly a boost to business productivity and a driver of better consumer products and the like, so as an individual I have a high appreciation for the power of technology. I have avoided technology sectors as an investor because in general I don't have a solid grasp of what differentiates many technology companies. I don't know how to spot durable competitive advantage in technology. To get rich, you find businesses with durable competitive advantage and you don't overpay for them. Technology is based on change; and change is really the enemy of the investor. Change is more rapid and unpredictable in technology relative to the broader economy. To me, all technology sectors look like 7-foot hurdles
Q: In many of your letters you speak about the importance of looking through the windshield and not the rearview mirror. What issues do you think people today are mistakenly looking at through the rearview mirror?A: Investors are always looking for the holy grail, the next great idea that will carry performance and pension returns for the several years. Right now its 'alternative investments' - private equity, hedge funds, the assets that have outperformed public equities for the past five years since the tech bubble burst. There's so much money chasing these ideas now that the returns in the future will probably not be as good. At some point, public equities will become good investments again and fewer people will be looking at them. At Berkshire, we look at a lot of "super-cat" (super catastrophe) insurance business that few firms will write. The challenge is determining when there's a paradigm shift, when the future will no longer look like the past. It's probable that the next hundred years of hurricane activity will not look like the past hundred years. Another example, we write a lot of D and O insurance, Directors and Officers liability. Post Enron, I feel strongly that juries will award much harsher penalties to victims of corporate fraud, etc. than they would have five years ago before the average juror watched hours of news stories about all the scandals. There's no model that can quantify that added risk, but it's a risk that won't be captured looking at historical data.
My thought - The last Q&A throws up an interesting question for Indian investors. After 3 years of great returns, are we as investors also operating with a rear mirror view? Any thoughts ?
Some excerpts from the Q&A
Q: In your letters you speak frequently of the importance of not over-complicating things. What are your secrets to keeping your life simple?A: When making investments, pretend in life you have a punch-card with only 20 boxes, and every time you make an investment you punch a slot. It will discipline you to only make investments you have extreme confidence in. Big money is made by obvious things. If using a discount rate of 8% vs. 10% is going to make or break an investment idea, it's probably not a good idea. Back in 1951 Moody's published thick handbooks by industry of every stock in circulation. I went through all of them, thousands of pages, motivated by the hope that a great idea was just on the next page. I found companies like National American Insurance and Western Insurance Securities Company that nobody was paying attention to that were trading for far less than their intrinsic values. Last year we found a steel company on the Korean Stock Exchange that had no analyst coverage, no research, but was the most profitable steel company in the world
Q: I have worked in various technologies businesses, but I understand that you do not typically invest in the technology sector. Why is that? How do you view technology as an individual and as an investor?A: Technology is clearly a boost to business productivity and a driver of better consumer products and the like, so as an individual I have a high appreciation for the power of technology. I have avoided technology sectors as an investor because in general I don't have a solid grasp of what differentiates many technology companies. I don't know how to spot durable competitive advantage in technology. To get rich, you find businesses with durable competitive advantage and you don't overpay for them. Technology is based on change; and change is really the enemy of the investor. Change is more rapid and unpredictable in technology relative to the broader economy. To me, all technology sectors look like 7-foot hurdles
Q: In many of your letters you speak about the importance of looking through the windshield and not the rearview mirror. What issues do you think people today are mistakenly looking at through the rearview mirror?A: Investors are always looking for the holy grail, the next great idea that will carry performance and pension returns for the several years. Right now its 'alternative investments' - private equity, hedge funds, the assets that have outperformed public equities for the past five years since the tech bubble burst. There's so much money chasing these ideas now that the returns in the future will probably not be as good. At some point, public equities will become good investments again and fewer people will be looking at them. At Berkshire, we look at a lot of "super-cat" (super catastrophe) insurance business that few firms will write. The challenge is determining when there's a paradigm shift, when the future will no longer look like the past. It's probable that the next hundred years of hurricane activity will not look like the past hundred years. Another example, we write a lot of D and O insurance, Directors and Officers liability. Post Enron, I feel strongly that juries will award much harsher penalties to victims of corporate fraud, etc. than they would have five years ago before the average juror watched hours of news stories about all the scandals. There's no model that can quantify that added risk, but it's a risk that won't be captured looking at historical data.
My thought - The last Q&A throws up an interesting question for Indian investors. After 3 years of great returns, are we as investors also operating with a rear mirror view? Any thoughts ?
Friday, October 21, 2005
Spreadsheet Link keeps breaking
I have uploaded the files in yahoo briefcase and provided the links here. However the link keeps breaking. Unfortunately I do not have better way of loading the files.
So if anyone wishes to have a look at the files please email me @ rohitc99@indiatimes.com. I will be glad to share the files.
So if anyone wishes to have a look at the files please email me @ rohitc99@indiatimes.com. I will be glad to share the files.
Spreadsheet Link keeps breaking
I have uploaded the files in yahoo briefcase and provided the links here. However the link keeps breaking. Unfortunately I do not have better way of loading the files.
So if anyone wishes to have a look at the files please email me @ rohitc99@indiatimes.com. I will be glad to share the files.
So if anyone wishes to have a look at the files please email me @ rohitc99@indiatimes.com. I will be glad to share the files.
Why do i blog ?
I have put this question to myself and have come up with two main reasons
I don’t think this blog is going to make me money directly (although it would not hurt), but hopefully would make me a better investor.
And what the heck ! , I am having fun putting my thoughts out and getting feedback/ suggestions/ clarifications from other. For me that is good enough.
- My blog is more like an online dairy. I try to put my thoughts on a regular basis. I try to read what I have posted in the past and try to see what I was thinking then and how has my thinking changed. Typically if something works out, I tend to think that it was my foresight (given time I will be become the new warren buffett !!) and luck had nothing to do with it. My blog ensures that when I look at my posts, I would be able to ‘recall’ what I was thinking and see if I can improve/ change it. At the same time if something does not work out, my earlier posts may prevent me from attributing my failure to bad luck.
- The second reason is to learn from others. Bruce, value architects and a few other visitors have commented or written personally to me in the past. It is good to have a different opinion or to get some inputs from others as it makes me rethink my assumptions or helps me in resolving some of my doubts.
I don’t think this blog is going to make me money directly (although it would not hurt), but hopefully would make me a better investor.
And what the heck ! , I am having fun putting my thoughts out and getting feedback/ suggestions/ clarifications from other. For me that is good enough.
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