Note: The analysis below is dated end of march – beginning of april. The stock has had a major jump since I started analysing the company. In interest of disclosure, I have a position in the stock. So please take this as a biased analysis. In addition I do not know if the jump in price is temporary and the price will fall again or it will continue rising. So as usual, please do your own analysis, read my disclaimer below and don’t blame me if your decision is based on my analysis alone. In summary – I am not recommending anyone to buy or sell the stock.
About
NIIT technologies is a 900 Crs company. It is a spinoff from NIIT ltd and is in the business of ITES and BPO. The company has 50% of revenue from Europe, around 30% from US and the rest from Asia, and other parts of the world
The company has a focus on a few key verticals such as BFSI (more in insurance), Transportation and retail services. The company has done a few targeted accquisition (such as ROOM solutions) in the above verticals in the last few years. In addition the company has signed a few JV’s too in the past. The company thus seems to be following an organic and in-organic path to growth
Financials
The company has done well in the past few years with ROE increasing from 17% to 30%+ in 2006. This has been driven by improvement in margins from 6% to around 12-14% in the recent years.
The revenue has also grown from around 500 Crs in 2004 to around 1000 odd crores in 2008 (expected). This translates into a revenue growth of around 18% p.a. The Net profit has grown from 33 Crs to around 110 Crs in 2007.
Positives
The company has a cash balance of almost 250 Crs (2007) which could rise to 350 odd crs (approximate). This would account for more than 60% of the market cap of the company.The company has almost 50% revenue from europe and thus is less exposed to the dollar risk and recession in the US.
In addition the company seems to be growing well, improving margins and increasing scale. At the same time the revenue from top 10 clients as a % of total revenue seems to be coming down, which is a good thing.
The company has a repeat business of almost 89% which shows good stability of revenue.
Risks
The obvious ones – US dollar, global slowdown etc etc.
The non obvious – The company is mid-tier ITES company. It still does not have the scale of the tier I vendor. However if the company focusses on the specific verticals and scales up in those verticals, then this disadvantage could be eliminated
In addition the company is pursuing accquisitions also. This is always a riskier way to grow.
Competitive analysis
The ITES business depends on the following key factors
a) scale : NIIT seems to be building scale in specific verticals. This would be the key to the company’s future
b) Customer lock in: This seems to be working for the company as the repeat business is fairly high
The other factors such cost advantage, overall scale etc is no longer a key differentiator as all ITES companies have this advantage and it is now considered as a minimum requirement in this business.
Valuation
The company sells at 1-2 times Net profit (Net profit is equal to free cash flow here) if you take out cash. The market is pricing NIIT tech with a view that the company will be out of business by 2010.
Conclusion
Short the company shutting down by 2010, it cannot think of any other justification for such valuations.
Dollar depreciation, US slowdown and increase in taxation rate can hurt margins. However ITES companies have some flexibility and control on the net margins through variable pay, utilization etc. So even if the margins drop by 50% to around 6-7%, the company will still sell at 4-5 times PE which is still quite low.
In summary, the market is pricing NIIT tech to be out of business in the next 1-2 years. That is a very low probability event in my view
Wednesday, April 09, 2008
Friday, April 04, 2008
Prof Greenwald's valueinvesting talk
Prof Bakshi co-hosted a valueinvesting talk by Prof greenwald and has uploaded the presentation on his website here
I have read prof greenwald’s book on competitive analysis twice and have found his book very useful. You can see the usage of the concepts in my valuation templates too.
My notes on the presentation
- A lot of analysts consider only equity value in the valuation. Debt is also important
- On valuation basis a number of companies especially midcaps are priced at or below asset value. The market assumes these companies are worth more dead than as a going concern
- Most valuation approaches for PE are based on growth. As prof greenwald rightly points out, PE depends on multiple factors such as cost of capital, cyclical position, management etc too. Important to adopt multiple valuation approaches rather than a single simplistic approach based on PE alone.
- Looking back, my most successful investments were in companies selling below asset value, but having a moderate growth and a certain amount of competitive advantage. The returns were realised when the market revalued the company to reflect the true value (for ex : asian paints, blue star, concor, Guj gas, pidilite, ICICI bank etc)
- Great section on barriers to entry (see here for academic understanding of demand supply curves). I had an idea of the demand supply curves and other concepts of competitive advantage. This is the first time I have been able to get an understanding of how these two concepts interact – great learning.
- Slide 27-33 has great explaination of how competitive advantage concepts can be combined with basic micro-economic theory.
- Slide 36 should be an eyeopener if you expect as a lot of market participants do, that the market should give an average of 25% returns per annum or higher. Even with the drop and shrinkage in PE, the prospective returns look like 10-11%.
- Slide 40 – A number of indian companies such real estate, capital goods are showing high ROE, high growth and hence high valuations. Is the growth and ROE sustainable? The high valuation will be justified only if they are sustainable. With competitive pressures, difficult to see how all companies in a sector can maintain high returns and high growth rates.
- Not able to understand the slide 42 completely. But it is interesting to apply the calculations to companies which are selling at PE’s of 40 or higher. Clearly lot of expectations from such companies.
I have read prof greenwald’s book on competitive analysis twice and have found his book very useful. You can see the usage of the concepts in my valuation templates too.
My notes on the presentation
- A lot of analysts consider only equity value in the valuation. Debt is also important
- On valuation basis a number of companies especially midcaps are priced at or below asset value. The market assumes these companies are worth more dead than as a going concern
- Most valuation approaches for PE are based on growth. As prof greenwald rightly points out, PE depends on multiple factors such as cost of capital, cyclical position, management etc too. Important to adopt multiple valuation approaches rather than a single simplistic approach based on PE alone.
- Looking back, my most successful investments were in companies selling below asset value, but having a moderate growth and a certain amount of competitive advantage. The returns were realised when the market revalued the company to reflect the true value (for ex : asian paints, blue star, concor, Guj gas, pidilite, ICICI bank etc)
- Great section on barriers to entry (see here for academic understanding of demand supply curves). I had an idea of the demand supply curves and other concepts of competitive advantage. This is the first time I have been able to get an understanding of how these two concepts interact – great learning.
- Slide 27-33 has great explaination of how competitive advantage concepts can be combined with basic micro-economic theory.
- Slide 36 should be an eyeopener if you expect as a lot of market participants do, that the market should give an average of 25% returns per annum or higher. Even with the drop and shrinkage in PE, the prospective returns look like 10-11%.
- Slide 40 – A number of indian companies such real estate, capital goods are showing high ROE, high growth and hence high valuations. Is the growth and ROE sustainable? The high valuation will be justified only if they are sustainable. With competitive pressures, difficult to see how all companies in a sector can maintain high returns and high growth rates.
- Not able to understand the slide 42 completely. But it is interesting to apply the calculations to companies which are selling at PE’s of 40 or higher. Clearly lot of expectations from such companies.
Prof Greenwald's valueinvesting talk
Prof Bakshi co-hosted a valueinvesting talk by Prof greenwald and has uploaded the presentation on his website here
I have read prof greenwald’s book on competitive analysis twice and have found his book very useful. You can see the usage of the concepts in my valuation templates too.
My notes on the presentation
- A lot of analysts consider only equity value in the valuation. Debt is also important
- On valuation basis a number of companies especially midcaps are priced at or below asset value. The market assumes these companies are worth more dead than as a going concern
- Most valuation approaches for PE are based on growth. As prof greenwald rightly points out, PE depends on multiple factors such as cost of capital, cyclical position, management etc too. Important to adopt multiple valuation approaches rather than a single simplistic approach based on PE alone.
- Looking back, my most successful investments were in companies selling below asset value, but having a moderate growth and a certain amount of competitive advantage. The returns were realised when the market revalued the company to reflect the true value (for ex : asian paints, blue star, concor, Guj gas, pidilite, ICICI bank etc)
- Great section on barriers to entry (see here for academic understanding of demand supply curves). I had an idea of the demand supply curves and other concepts of competitive advantage. This is the first time I have been able to get an understanding of how these two concepts interact – great learning.
- Slide 27-33 has great explaination of how competitive advantage concepts can be combined with basic micro-economic theory.
- Slide 36 should be an eyeopener if you expect as a lot of market participants do, that the market should give an average of 25% returns per annum or higher. Even with the drop and shrinkage in PE, the prospective returns look like 10-11%.
- Slide 40 – A number of indian companies such real estate, capital goods are showing high ROE, high growth and hence high valuations. Is the growth and ROE sustainable? The high valuation will be justified only if they are sustainable. With competitive pressures, difficult to see how all companies in a sector can maintain high returns and high growth rates.
- Not able to understand the slide 42 completely. But it is interesting to apply the calculations to companies which are selling at PE’s of 40 or higher. Clearly lot of expectations from such companies.
I have read prof greenwald’s book on competitive analysis twice and have found his book very useful. You can see the usage of the concepts in my valuation templates too.
My notes on the presentation
- A lot of analysts consider only equity value in the valuation. Debt is also important
- On valuation basis a number of companies especially midcaps are priced at or below asset value. The market assumes these companies are worth more dead than as a going concern
- Most valuation approaches for PE are based on growth. As prof greenwald rightly points out, PE depends on multiple factors such as cost of capital, cyclical position, management etc too. Important to adopt multiple valuation approaches rather than a single simplistic approach based on PE alone.
- Looking back, my most successful investments were in companies selling below asset value, but having a moderate growth and a certain amount of competitive advantage. The returns were realised when the market revalued the company to reflect the true value (for ex : asian paints, blue star, concor, Guj gas, pidilite, ICICI bank etc)
- Great section on barriers to entry (see here for academic understanding of demand supply curves). I had an idea of the demand supply curves and other concepts of competitive advantage. This is the first time I have been able to get an understanding of how these two concepts interact – great learning.
- Slide 27-33 has great explaination of how competitive advantage concepts can be combined with basic micro-economic theory.
- Slide 36 should be an eyeopener if you expect as a lot of market participants do, that the market should give an average of 25% returns per annum or higher. Even with the drop and shrinkage in PE, the prospective returns look like 10-11%.
- Slide 40 – A number of indian companies such real estate, capital goods are showing high ROE, high growth and hence high valuations. Is the growth and ROE sustainable? The high valuation will be justified only if they are sustainable. With competitive pressures, difficult to see how all companies in a sector can maintain high returns and high growth rates.
- Not able to understand the slide 42 completely. But it is interesting to apply the calculations to companies which are selling at PE’s of 40 or higher. Clearly lot of expectations from such companies.
Monday, March 31, 2008
Inflation, Rupee-dollar rate and impact on stocks
I generally avoid a macro view on stocks. It is quite difficult (for me) to analyse a macro event and then come to a stock specific conclusion.
However there seems to be broad trend of dollar depreciation (that not news :) ) due to variety of reasons – subprime, US current account deficit etc etc. A drop in the dollar does not always translate into a rise in the rupee as ours is a managed currency. However inflation and its impact on elections is a powerful motivation for the government to appreciate the currency (imports such as oil become cheaper).
Recently inflation hit 6%+ and it is quite likely that one of policy decision could be to allow the rupee to appreciate. Sudden or slow appreciation? I don’t know. However an appreciating rupee impacts my stock strategy as follows
- IT stocks could get hit further. I doesn’t matter that some are selling at 2-3 time PE and are being priced for bankruptcy. The market is not rational always. If IT stocks could sell for 100 times earnings, they could drop further.
- Oil companies could benefit ..the key word is could. For all you know, the government could drop the prices and pass the benefit of the rupee appreciation to the consumer.
- Export based industry such as textiles etc could be in for a tough time. Makes sense to find the strongest players and invest only in those companies which can pass some of the currency impact to the customers.
I am not changing my stock specific plan drastically. No moving out of export dependent companies and moving into import driven companies and all that. It is quite diffcult for me to figure out the exact impact of such macro factors in the long run.
I am not a contrarian by nature, but going against convential wisdom has been very profitable for me. So as it becomes an accepted wisdom that IT companies or other export driven companies and their stocks are doomed forever, I plan to look more closely at them (and buy if I find them attractive and oversold). and I will not blame you if you feel I am out of my mind to think of IT or export driven companies. I am now very used to that feedback :)
However there seems to be broad trend of dollar depreciation (that not news :) ) due to variety of reasons – subprime, US current account deficit etc etc. A drop in the dollar does not always translate into a rise in the rupee as ours is a managed currency. However inflation and its impact on elections is a powerful motivation for the government to appreciate the currency (imports such as oil become cheaper).
Recently inflation hit 6%+ and it is quite likely that one of policy decision could be to allow the rupee to appreciate. Sudden or slow appreciation? I don’t know. However an appreciating rupee impacts my stock strategy as follows
- IT stocks could get hit further. I doesn’t matter that some are selling at 2-3 time PE and are being priced for bankruptcy. The market is not rational always. If IT stocks could sell for 100 times earnings, they could drop further.
- Oil companies could benefit ..the key word is could. For all you know, the government could drop the prices and pass the benefit of the rupee appreciation to the consumer.
- Export based industry such as textiles etc could be in for a tough time. Makes sense to find the strongest players and invest only in those companies which can pass some of the currency impact to the customers.
I am not changing my stock specific plan drastically. No moving out of export dependent companies and moving into import driven companies and all that. It is quite diffcult for me to figure out the exact impact of such macro factors in the long run.
I am not a contrarian by nature, but going against convential wisdom has been very profitable for me. So as it becomes an accepted wisdom that IT companies or other export driven companies and their stocks are doomed forever, I plan to look more closely at them (and buy if I find them attractive and oversold). and I will not blame you if you feel I am out of my mind to think of IT or export driven companies. I am now very used to that feedback :)
Inflation, Rupee-dollar rate and impact on stocks
I generally avoid a macro view on stocks. It is quite difficult (for me) to analyse a macro event and then come to a stock specific conclusion.
However there seems to be broad trend of dollar depreciation (that not news :) ) due to variety of reasons – subprime, US current account deficit etc etc. A drop in the dollar does not always translate into a rise in the rupee as ours is a managed currency. However inflation and its impact on elections is a powerful motivation for the government to appreciate the currency (imports such as oil become cheaper).
Recently inflation hit 6%+ and it is quite likely that one of policy decision could be to allow the rupee to appreciate. Sudden or slow appreciation? I don’t know. However an appreciating rupee impacts my stock strategy as follows
- IT stocks could get hit further. I doesn’t matter that some are selling at 2-3 time PE and are being priced for bankruptcy. The market is not rational always. If IT stocks could sell for 100 times earnings, they could drop further.
- Oil companies could benefit ..the key word is could. For all you know, the government could drop the prices and pass the benefit of the rupee appreciation to the consumer.
- Export based industry such as textiles etc could be in for a tough time. Makes sense to find the strongest players and invest only in those companies which can pass some of the currency impact to the customers.
I am not changing my stock specific plan drastically. No moving out of export dependent companies and moving into import driven companies and all that. It is quite diffcult for me to figure out the exact impact of such macro factors in the long run.
I am not a contrarian by nature, but going against convential wisdom has been very profitable for me. So as it becomes an accepted wisdom that IT companies or other export driven companies and their stocks are doomed forever, I plan to look more closely at them (and buy if I find them attractive and oversold). and I will not blame you if you feel I am out of my mind to think of IT or export driven companies. I am now very used to that feedback :)
However there seems to be broad trend of dollar depreciation (that not news :) ) due to variety of reasons – subprime, US current account deficit etc etc. A drop in the dollar does not always translate into a rise in the rupee as ours is a managed currency. However inflation and its impact on elections is a powerful motivation for the government to appreciate the currency (imports such as oil become cheaper).
Recently inflation hit 6%+ and it is quite likely that one of policy decision could be to allow the rupee to appreciate. Sudden or slow appreciation? I don’t know. However an appreciating rupee impacts my stock strategy as follows
- IT stocks could get hit further. I doesn’t matter that some are selling at 2-3 time PE and are being priced for bankruptcy. The market is not rational always. If IT stocks could sell for 100 times earnings, they could drop further.
- Oil companies could benefit ..the key word is could. For all you know, the government could drop the prices and pass the benefit of the rupee appreciation to the consumer.
- Export based industry such as textiles etc could be in for a tough time. Makes sense to find the strongest players and invest only in those companies which can pass some of the currency impact to the customers.
I am not changing my stock specific plan drastically. No moving out of export dependent companies and moving into import driven companies and all that. It is quite diffcult for me to figure out the exact impact of such macro factors in the long run.
I am not a contrarian by nature, but going against convential wisdom has been very profitable for me. So as it becomes an accepted wisdom that IT companies or other export driven companies and their stocks are doomed forever, I plan to look more closely at them (and buy if I find them attractive and oversold). and I will not blame you if you feel I am out of my mind to think of IT or export driven companies. I am now very used to that feedback :)
Wednesday, March 26, 2008
Mr Simpleton and Mr Hotshot Investor
Simpleton and hotshot investor are close friends. Simpleton is a small time businessman …doesn’t understand stock market much. But he knows cash is king. Hotshot is all into investing. Reads blogs like this, talks of DCF, PE, options, subprime and all that.
So one day Hotshot comes to meet simpleton and both get talking of business and stocks and all that.
Hotshot – how’s business?
Simpleton – ok …not too good though. You know that store I have. Used to do very well, but now with that new mall, business is not so good. Too much competition
Hotshot (all puffed) – So why don’t you sell it and put the money in stock market ? You know I made 5 times my money in the market in the last 3 years!!
Now this gets simpleton thinking ..here I am working hard and barely making 20% return every year and this cool dude is able to make so much money.
Simpleton – you study all this stock and business…you analyse all these big companies. How much should I sell my business for ?
Hotshot (opening his sleek laptop) – You know, I have analysed so many companies. I have this complicated spreadsheet. Just give me the numbers and I will tell you
Simpleton – let me see. Last year, I had sales of around 5,00,000 per month and I made around 50,000 per month after all expenses. I keep around 7,00,000 of inventory and I give some credit also. So I have a debt of around 3,00,000 per month. As of now I am having around 7,00,000 cash also in safe. Store is my own, so I don’t have to pay rent.
Hotshot – those are last year’s numbers. How much did you make year before that and last 5 years. I need all those numbers for my spreadsheet.
Simpleton – Around the same. I told you ..too much competition. But you know, I have some loyal customers, so last 5 years I have been making roughly the same. Maybe 3-4 % increase every year.
Hotshot (shaking his head) – not good, not good. No growth ..bad ..very bad. Why don’t you invest this cash some in high growth business
Simpleton – You know, I have not done any other business and I have been managing this store for last 15 years. So I don’t think I will be good at it. Actually, 5 years back I opened a chicken farm and lost all the money …you know bird flu !! . So whatever profit I make, I keep it as cash.
Hotshot (shaking his head even more now, lets out a sigh) – then you have to sell your business for 7,00,000. At best 10,00,000. See no growth, means no future
Simpleton (completely surprised) – what are you saying ? I have cash of 7,00,000. I have inventory, this store and all this good will !!
Hotshot (shutting down his laptop) – All that doesn’t matter. No growth …means no growth. If you cannot grow ..your business is worthless !! don’t believe me .. I will show big companies selling for peanuts because they cannot grow. I am not saying that …the stock market which has millions of intelligent people are saying that !
Simpleton cannot believe what hotshot is saying. How can it be true ? why should he sell his business for the cash he has in the safe ? If he sold his inventory and the store, he would make more money. But then he thinks ..the stock market must be smarter than him !!
So one day Hotshot comes to meet simpleton and both get talking of business and stocks and all that.
Hotshot – how’s business?
Simpleton – ok …not too good though. You know that store I have. Used to do very well, but now with that new mall, business is not so good. Too much competition
Hotshot (all puffed) – So why don’t you sell it and put the money in stock market ? You know I made 5 times my money in the market in the last 3 years!!
Now this gets simpleton thinking ..here I am working hard and barely making 20% return every year and this cool dude is able to make so much money.
Simpleton – you study all this stock and business…you analyse all these big companies. How much should I sell my business for ?
Hotshot (opening his sleek laptop) – You know, I have analysed so many companies. I have this complicated spreadsheet. Just give me the numbers and I will tell you
Simpleton – let me see. Last year, I had sales of around 5,00,000 per month and I made around 50,000 per month after all expenses. I keep around 7,00,000 of inventory and I give some credit also. So I have a debt of around 3,00,000 per month. As of now I am having around 7,00,000 cash also in safe. Store is my own, so I don’t have to pay rent.
Hotshot – those are last year’s numbers. How much did you make year before that and last 5 years. I need all those numbers for my spreadsheet.
Simpleton – Around the same. I told you ..too much competition. But you know, I have some loyal customers, so last 5 years I have been making roughly the same. Maybe 3-4 % increase every year.
Hotshot (shaking his head) – not good, not good. No growth ..bad ..very bad. Why don’t you invest this cash some in high growth business
Simpleton – You know, I have not done any other business and I have been managing this store for last 15 years. So I don’t think I will be good at it. Actually, 5 years back I opened a chicken farm and lost all the money …you know bird flu !! . So whatever profit I make, I keep it as cash.
Hotshot (shaking his head even more now, lets out a sigh) – then you have to sell your business for 7,00,000. At best 10,00,000. See no growth, means no future
Simpleton (completely surprised) – what are you saying ? I have cash of 7,00,000. I have inventory, this store and all this good will !!
Hotshot (shutting down his laptop) – All that doesn’t matter. No growth …means no growth. If you cannot grow ..your business is worthless !! don’t believe me .. I will show big companies selling for peanuts because they cannot grow. I am not saying that …the stock market which has millions of intelligent people are saying that !
Simpleton cannot believe what hotshot is saying. How can it be true ? why should he sell his business for the cash he has in the safe ? If he sold his inventory and the store, he would make more money. But then he thinks ..the stock market must be smarter than him !!
Mr Simpleton and Mr Hotshot Investor
Simpleton and hotshot investor are close friends. Simpleton is a small time businessman …doesn’t understand stock market much. But he knows cash is king. Hotshot is all into investing. Reads blogs like this, talks of DCF, PE, options, subprime and all that.
So one day Hotshot comes to meet simpleton and both get talking of business and stocks and all that.
Hotshot – how’s business?
Simpleton – ok …not too good though. You know that store I have. Used to do very well, but now with that new mall, business is not so good. Too much competition
Hotshot (all puffed) – So why don’t you sell it and put the money in stock market ? You know I made 5 times my money in the market in the last 3 years!!
Now this gets simpleton thinking ..here I am working hard and barely making 20% return every year and this cool dude is able to make so much money.
Simpleton – you study all this stock and business…you analyse all these big companies. How much should I sell my business for ?
Hotshot (opening his sleek laptop) – You know, I have analysed so many companies. I have this complicated spreadsheet. Just give me the numbers and I will tell you
Simpleton – let me see. Last year, I had sales of around 5,00,000 per month and I made around 50,000 per month after all expenses. I keep around 7,00,000 of inventory and I give some credit also. So I have a debt of around 3,00,000 per month. As of now I am having around 7,00,000 cash also in safe. Store is my own, so I don’t have to pay rent.
Hotshot – those are last year’s numbers. How much did you make year before that and last 5 years. I need all those numbers for my spreadsheet.
Simpleton – Around the same. I told you ..too much competition. But you know, I have some loyal customers, so last 5 years I have been making roughly the same. Maybe 3-4 % increase every year.
Hotshot (shaking his head) – not good, not good. No growth ..bad ..very bad. Why don’t you invest this cash some in high growth business
Simpleton – You know, I have not done any other business and I have been managing this store for last 15 years. So I don’t think I will be good at it. Actually, 5 years back I opened a chicken farm and lost all the money …you know bird flu !! . So whatever profit I make, I keep it as cash.
Hotshot (shaking his head even more now, lets out a sigh) – then you have to sell your business for 7,00,000. At best 10,00,000. See no growth, means no future
Simpleton (completely surprised) – what are you saying ? I have cash of 7,00,000. I have inventory, this store and all this good will !!
Hotshot (shutting down his laptop) – All that doesn’t matter. No growth …means no growth. If you cannot grow ..your business is worthless !! don’t believe me .. I will show big companies selling for peanuts because they cannot grow. I am not saying that …the stock market which has millions of intelligent people are saying that !
Simpleton cannot believe what hotshot is saying. How can it be true ? why should he sell his business for the cash he has in the safe ? If he sold his inventory and the store, he would make more money. But then he thinks ..the stock market must be smarter than him !!
So one day Hotshot comes to meet simpleton and both get talking of business and stocks and all that.
Hotshot – how’s business?
Simpleton – ok …not too good though. You know that store I have. Used to do very well, but now with that new mall, business is not so good. Too much competition
Hotshot (all puffed) – So why don’t you sell it and put the money in stock market ? You know I made 5 times my money in the market in the last 3 years!!
Now this gets simpleton thinking ..here I am working hard and barely making 20% return every year and this cool dude is able to make so much money.
Simpleton – you study all this stock and business…you analyse all these big companies. How much should I sell my business for ?
Hotshot (opening his sleek laptop) – You know, I have analysed so many companies. I have this complicated spreadsheet. Just give me the numbers and I will tell you
Simpleton – let me see. Last year, I had sales of around 5,00,000 per month and I made around 50,000 per month after all expenses. I keep around 7,00,000 of inventory and I give some credit also. So I have a debt of around 3,00,000 per month. As of now I am having around 7,00,000 cash also in safe. Store is my own, so I don’t have to pay rent.
Hotshot – those are last year’s numbers. How much did you make year before that and last 5 years. I need all those numbers for my spreadsheet.
Simpleton – Around the same. I told you ..too much competition. But you know, I have some loyal customers, so last 5 years I have been making roughly the same. Maybe 3-4 % increase every year.
Hotshot (shaking his head) – not good, not good. No growth ..bad ..very bad. Why don’t you invest this cash some in high growth business
Simpleton – You know, I have not done any other business and I have been managing this store for last 15 years. So I don’t think I will be good at it. Actually, 5 years back I opened a chicken farm and lost all the money …you know bird flu !! . So whatever profit I make, I keep it as cash.
Hotshot (shaking his head even more now, lets out a sigh) – then you have to sell your business for 7,00,000. At best 10,00,000. See no growth, means no future
Simpleton (completely surprised) – what are you saying ? I have cash of 7,00,000. I have inventory, this store and all this good will !!
Hotshot (shutting down his laptop) – All that doesn’t matter. No growth …means no growth. If you cannot grow ..your business is worthless !! don’t believe me .. I will show big companies selling for peanuts because they cannot grow. I am not saying that …the stock market which has millions of intelligent people are saying that !
Simpleton cannot believe what hotshot is saying. How can it be true ? why should he sell his business for the cash he has in the safe ? If he sold his inventory and the store, he would make more money. But then he thinks ..the stock market must be smarter than him !!
Thursday, March 20, 2008
Portfolio management and anchoring
A lot of energy is wasted around discussing the market levels. Short of buying an index, I think if you are focussing on a company, the market levels do not matter. If the company is overvalued in your opinion, the market level will not matter and vice versa. So all the decision is around the stock price and its relationship with the intrinsic value.
That said, it is not easy to ignore the noise. In order to so do, I have modified the way I manage my portfolio and track individual stocks. I have done this also to avoid anchoring to the price at which I buy the stock. To read on anchoring see here
The normal tendency is to look at how the stock has done v/s the price at which it was bought. So I used to get pained if it went below the buy price and happy when it went above. That can mislead us – this is how
Suppose the company you bought came out with results which are poorer than expected. You analyse the results and realize your estimate of the intrinsic value is off by 30%. What should you do ? If you are anchored to the purchase price and if the current price is higher, you tend to discount this information and may continue to hold on to the stock, when a good decision could be to sell.
This is how I currently try to avoid the problem –
I maintain a spreadsheet of all my holding with the following columns
Name
No. of stocks
Intrinsic value estimate
Buy price
Current price
Discount to intrinsic value (intrinsic value- current price / current price)
% gain/ loss
I am constantly looking at the discount to intrinsic value number. If the price drops and the discount is more than 50%, I start buying. If the discount is less than 50%, I sit pat.
After every quarterly/ annual results, I review the instrinic value estimates again and update this number. Check the discount again and buy if below 50%. In addition if I come across some information which I had not considered, I review the instrinsic value again.So the comparison is always to the intrinsic value (which is changing based on new information) and buy/hold or sell decisions are based on the discount to the intrinsic value.
The above ensures that I am not fixated to the current price or market level or what the analysts are saying – Ok I am joking about analysts, I never bother about their opinions (prefer to make my own blunders).
Next post : Adding, selling stocks and adjusting wieghtages
That said, it is not easy to ignore the noise. In order to so do, I have modified the way I manage my portfolio and track individual stocks. I have done this also to avoid anchoring to the price at which I buy the stock. To read on anchoring see here
The normal tendency is to look at how the stock has done v/s the price at which it was bought. So I used to get pained if it went below the buy price and happy when it went above. That can mislead us – this is how
Suppose the company you bought came out with results which are poorer than expected. You analyse the results and realize your estimate of the intrinsic value is off by 30%. What should you do ? If you are anchored to the purchase price and if the current price is higher, you tend to discount this information and may continue to hold on to the stock, when a good decision could be to sell.
This is how I currently try to avoid the problem –
I maintain a spreadsheet of all my holding with the following columns
Name
No. of stocks
Intrinsic value estimate
Buy price
Current price
Discount to intrinsic value (intrinsic value- current price / current price)
% gain/ loss
I am constantly looking at the discount to intrinsic value number. If the price drops and the discount is more than 50%, I start buying. If the discount is less than 50%, I sit pat.
After every quarterly/ annual results, I review the instrinic value estimates again and update this number. Check the discount again and buy if below 50%. In addition if I come across some information which I had not considered, I review the instrinsic value again.So the comparison is always to the intrinsic value (which is changing based on new information) and buy/hold or sell decisions are based on the discount to the intrinsic value.
The above ensures that I am not fixated to the current price or market level or what the analysts are saying – Ok I am joking about analysts, I never bother about their opinions (prefer to make my own blunders).
Next post : Adding, selling stocks and adjusting wieghtages
Portfolio management and anchoring
A lot of energy is wasted around discussing the market levels. Short of buying an index, I think if you are focussing on a company, the market levels do not matter. If the company is overvalued in your opinion, the market level will not matter and vice versa. So all the decision is around the stock price and its relationship with the intrinsic value.
That said, it is not easy to ignore the noise. In order to so do, I have modified the way I manage my portfolio and track individual stocks. I have done this also to avoid anchoring to the price at which I buy the stock. To read on anchoring see here
The normal tendency is to look at how the stock has done v/s the price at which it was bought. So I used to get pained if it went below the buy price and happy when it went above. That can mislead us – this is how
Suppose the company you bought came out with results which are poorer than expected. You analyse the results and realize your estimate of the intrinsic value is off by 30%. What should you do ? If you are anchored to the purchase price and if the current price is higher, you tend to discount this information and may continue to hold on to the stock, when a good decision could be to sell.
This is how I currently try to avoid the problem –
I maintain a spreadsheet of all my holding with the following columns
Name
No. of stocks
Intrinsic value estimate
Buy price
Current price
Discount to intrinsic value (intrinsic value- current price / current price)
% gain/ loss
I am constantly looking at the discount to intrinsic value number. If the price drops and the discount is more than 50%, I start buying. If the discount is less than 50%, I sit pat.
After every quarterly/ annual results, I review the instrinic value estimates again and update this number. Check the discount again and buy if below 50%. In addition if I come across some information which I had not considered, I review the instrinsic value again.So the comparison is always to the intrinsic value (which is changing based on new information) and buy/hold or sell decisions are based on the discount to the intrinsic value.
The above ensures that I am not fixated to the current price or market level or what the analysts are saying – Ok I am joking about analysts, I never bother about their opinions (prefer to make my own blunders).
Next post : Adding, selling stocks and adjusting wieghtages
That said, it is not easy to ignore the noise. In order to so do, I have modified the way I manage my portfolio and track individual stocks. I have done this also to avoid anchoring to the price at which I buy the stock. To read on anchoring see here
The normal tendency is to look at how the stock has done v/s the price at which it was bought. So I used to get pained if it went below the buy price and happy when it went above. That can mislead us – this is how
Suppose the company you bought came out with results which are poorer than expected. You analyse the results and realize your estimate of the intrinsic value is off by 30%. What should you do ? If you are anchored to the purchase price and if the current price is higher, you tend to discount this information and may continue to hold on to the stock, when a good decision could be to sell.
This is how I currently try to avoid the problem –
I maintain a spreadsheet of all my holding with the following columns
Name
No. of stocks
Intrinsic value estimate
Buy price
Current price
Discount to intrinsic value (intrinsic value- current price / current price)
% gain/ loss
I am constantly looking at the discount to intrinsic value number. If the price drops and the discount is more than 50%, I start buying. If the discount is less than 50%, I sit pat.
After every quarterly/ annual results, I review the instrinic value estimates again and update this number. Check the discount again and buy if below 50%. In addition if I come across some information which I had not considered, I review the instrinsic value again.So the comparison is always to the intrinsic value (which is changing based on new information) and buy/hold or sell decisions are based on the discount to the intrinsic value.
The above ensures that I am not fixated to the current price or market level or what the analysts are saying – Ok I am joking about analysts, I never bother about their opinions (prefer to make my own blunders).
Next post : Adding, selling stocks and adjusting wieghtages
Monday, March 17, 2008
Ouch !!
Jan 9th – Mar 17th – Returns = -27% and counting.
There is quite a bit of panic and fear in the markets now. It is amazing what difference 3-4 months can make.
It is easy to get preachy, especially if you don’t have skin in the game. But I am not in that position. My own portfolio shot up like a rocket from september and has come down since then. I have seen worse bear markets in the past where the index just kept sliding down for 2-3 years. Will it happen again now? There are enough forecasters and gurus out there forecasting. I don’t want to add to that noise further.
This is what I am doing .
1. Don’t panic – seriously!!
2. Stop watching the market, your portfolio and CNBC – I am half serious about this. This will only induce more panic
3. Don’t anchor – If you were watching a stock for sometime and it has dropped by 20 - 30% from the peak price, it does not mean that it is cheap. There is no point anchoring on the past price. The stock is cheap only if the current price is at a discount to its intrinsic value. So I would not rush out and start buying blindly just because the market has dropped
4. If you have been analysing and watching stocks for some time, a few stocks maybe dropping below the buy targets. It may be time to start buying. Will the stocks go down further …that’s possible. But if you think the stock is undervalued, I would ignore these fluctuations.
The above suggestions are valid if you have followed a long term investing strategy (where long term is more 1 year) and have not been a trader/ momentum player. For traders/ momentum players I have no suggestion as that is a different game, which I have no clue about.
Beyond this I don’t think there is much to do. Ofcourse I am assuming there is no leverage involved and you can psychologically handle the losses.
As I have said earlier and this becomes more and more evident as time goes by – It is close to impossible to predict the market. So I think no one can say whether the market will go up and start dropping again or resume its rise again. What we can do is to be rational about our investment approach and keep a margin of safety
There is quite a bit of panic and fear in the markets now. It is amazing what difference 3-4 months can make.
It is easy to get preachy, especially if you don’t have skin in the game. But I am not in that position. My own portfolio shot up like a rocket from september and has come down since then. I have seen worse bear markets in the past where the index just kept sliding down for 2-3 years. Will it happen again now? There are enough forecasters and gurus out there forecasting. I don’t want to add to that noise further.
This is what I am doing .
1. Don’t panic – seriously!!
2. Stop watching the market, your portfolio and CNBC – I am half serious about this. This will only induce more panic
3. Don’t anchor – If you were watching a stock for sometime and it has dropped by 20 - 30% from the peak price, it does not mean that it is cheap. There is no point anchoring on the past price. The stock is cheap only if the current price is at a discount to its intrinsic value. So I would not rush out and start buying blindly just because the market has dropped
4. If you have been analysing and watching stocks for some time, a few stocks maybe dropping below the buy targets. It may be time to start buying. Will the stocks go down further …that’s possible. But if you think the stock is undervalued, I would ignore these fluctuations.
The above suggestions are valid if you have followed a long term investing strategy (where long term is more 1 year) and have not been a trader/ momentum player. For traders/ momentum players I have no suggestion as that is a different game, which I have no clue about.
Beyond this I don’t think there is much to do. Ofcourse I am assuming there is no leverage involved and you can psychologically handle the losses.
As I have said earlier and this becomes more and more evident as time goes by – It is close to impossible to predict the market. So I think no one can say whether the market will go up and start dropping again or resume its rise again. What we can do is to be rational about our investment approach and keep a margin of safety
Ouch !!
Jan 9th – Mar 17th – Returns = -27% and counting.
There is quite a bit of panic and fear in the markets now. It is amazing what difference 3-4 months can make.
It is easy to get preachy, especially if you don’t have skin in the game. But I am not in that position. My own portfolio shot up like a rocket from september and has come down since then. I have seen worse bear markets in the past where the index just kept sliding down for 2-3 years. Will it happen again now? There are enough forecasters and gurus out there forecasting. I don’t want to add to that noise further.
This is what I am doing .
1. Don’t panic – seriously!!
2. Stop watching the market, your portfolio and CNBC – I am half serious about this. This will only induce more panic
3. Don’t anchor – If you were watching a stock for sometime and it has dropped by 20 - 30% from the peak price, it does not mean that it is cheap. There is no point anchoring on the past price. The stock is cheap only if the current price is at a discount to its intrinsic value. So I would not rush out and start buying blindly just because the market has dropped
4. If you have been analysing and watching stocks for some time, a few stocks maybe dropping below the buy targets. It may be time to start buying. Will the stocks go down further …that’s possible. But if you think the stock is undervalued, I would ignore these fluctuations.
The above suggestions are valid if you have followed a long term investing strategy (where long term is more 1 year) and have not been a trader/ momentum player. For traders/ momentum players I have no suggestion as that is a different game, which I have no clue about.
Beyond this I don’t think there is much to do. Ofcourse I am assuming there is no leverage involved and you can psychologically handle the losses.
As I have said earlier and this becomes more and more evident as time goes by – It is close to impossible to predict the market. So I think no one can say whether the market will go up and start dropping again or resume its rise again. What we can do is to be rational about our investment approach and keep a margin of safety
There is quite a bit of panic and fear in the markets now. It is amazing what difference 3-4 months can make.
It is easy to get preachy, especially if you don’t have skin in the game. But I am not in that position. My own portfolio shot up like a rocket from september and has come down since then. I have seen worse bear markets in the past where the index just kept sliding down for 2-3 years. Will it happen again now? There are enough forecasters and gurus out there forecasting. I don’t want to add to that noise further.
This is what I am doing .
1. Don’t panic – seriously!!
2. Stop watching the market, your portfolio and CNBC – I am half serious about this. This will only induce more panic
3. Don’t anchor – If you were watching a stock for sometime and it has dropped by 20 - 30% from the peak price, it does not mean that it is cheap. There is no point anchoring on the past price. The stock is cheap only if the current price is at a discount to its intrinsic value. So I would not rush out and start buying blindly just because the market has dropped
4. If you have been analysing and watching stocks for some time, a few stocks maybe dropping below the buy targets. It may be time to start buying. Will the stocks go down further …that’s possible. But if you think the stock is undervalued, I would ignore these fluctuations.
The above suggestions are valid if you have followed a long term investing strategy (where long term is more 1 year) and have not been a trader/ momentum player. For traders/ momentum players I have no suggestion as that is a different game, which I have no clue about.
Beyond this I don’t think there is much to do. Ofcourse I am assuming there is no leverage involved and you can psychologically handle the losses.
As I have said earlier and this becomes more and more evident as time goes by – It is close to impossible to predict the market. So I think no one can say whether the market will go up and start dropping again or resume its rise again. What we can do is to be rational about our investment approach and keep a margin of safety
Friday, March 14, 2008
Clusters of Investment ideas
I am finding more ideas in some sector/ sub-sectors than others. Such as,
- IT midcaps
- MNC Pharma
- Auto components
- Auto OEM
For some reason, valid or otherwise, most of the companies in these sectors have been beaten down. The reason range from genuine concerns (US recession, Rupee appreciation etc for IT sector) to investor apathy (MNC Pharma). My approach in such cases is to list all the companies in the cheap sector, filter the most attractive ones and invest in all of them.
For example, I can see the following attractive ideas in IT Mid cap space
- Patni computers
- NIIT technology
- Zensar
- Hexaware
- Sonata
- Aztec
I have not done a detailed analysis on these companies yet and may discard a few. However I do feel that there is too much pessimism around these sectors. It not surprising that the market has beaten down these sectors as during bull runs, most investors prefer high growth companies and avoid companies which show low growth (even if they have a high Return on capital)
High PE v/s Low PE stocks – Most of you must have noticed that stocks with high PE or high valuations are getting hit harder when the market drops. This does not mean that these companies are over-valued or will do badly. If the analysis is correct and the companies does well, then investors in these companies should do well in the long term. However you have to be comfortable with the high volatility in the stock price. In comparison the low PE stocks, of which not much is expected, don’t drop as much during market drops. However they do not gain as much during the rise too.
- IT midcaps
- MNC Pharma
- Auto components
- Auto OEM
For some reason, valid or otherwise, most of the companies in these sectors have been beaten down. The reason range from genuine concerns (US recession, Rupee appreciation etc for IT sector) to investor apathy (MNC Pharma). My approach in such cases is to list all the companies in the cheap sector, filter the most attractive ones and invest in all of them.
For example, I can see the following attractive ideas in IT Mid cap space
- Patni computers
- NIIT technology
- Zensar
- Hexaware
- Sonata
- Aztec
I have not done a detailed analysis on these companies yet and may discard a few. However I do feel that there is too much pessimism around these sectors. It not surprising that the market has beaten down these sectors as during bull runs, most investors prefer high growth companies and avoid companies which show low growth (even if they have a high Return on capital)
High PE v/s Low PE stocks – Most of you must have noticed that stocks with high PE or high valuations are getting hit harder when the market drops. This does not mean that these companies are over-valued or will do badly. If the analysis is correct and the companies does well, then investors in these companies should do well in the long term. However you have to be comfortable with the high volatility in the stock price. In comparison the low PE stocks, of which not much is expected, don’t drop as much during market drops. However they do not gain as much during the rise too.
Clusters of Investment ideas
I am finding more ideas in some sector/ sub-sectors than others. Such as,
- IT midcaps
- MNC Pharma
- Auto components
- Auto OEM
For some reason, valid or otherwise, most of the companies in these sectors have been beaten down. The reason range from genuine concerns (US recession, Rupee appreciation etc for IT sector) to investor apathy (MNC Pharma). My approach in such cases is to list all the companies in the cheap sector, filter the most attractive ones and invest in all of them.
For example, I can see the following attractive ideas in IT Mid cap space
- Patni computers
- NIIT technology
- Zensar
- Hexaware
- Sonata
- Aztec
I have not done a detailed analysis on these companies yet and may discard a few. However I do feel that there is too much pessimism around these sectors. It not surprising that the market has beaten down these sectors as during bull runs, most investors prefer high growth companies and avoid companies which show low growth (even if they have a high Return on capital)
High PE v/s Low PE stocks – Most of you must have noticed that stocks with high PE or high valuations are getting hit harder when the market drops. This does not mean that these companies are over-valued or will do badly. If the analysis is correct and the companies does well, then investors in these companies should do well in the long term. However you have to be comfortable with the high volatility in the stock price. In comparison the low PE stocks, of which not much is expected, don’t drop as much during market drops. However they do not gain as much during the rise too.
- IT midcaps
- MNC Pharma
- Auto components
- Auto OEM
For some reason, valid or otherwise, most of the companies in these sectors have been beaten down. The reason range from genuine concerns (US recession, Rupee appreciation etc for IT sector) to investor apathy (MNC Pharma). My approach in such cases is to list all the companies in the cheap sector, filter the most attractive ones and invest in all of them.
For example, I can see the following attractive ideas in IT Mid cap space
- Patni computers
- NIIT technology
- Zensar
- Hexaware
- Sonata
- Aztec
I have not done a detailed analysis on these companies yet and may discard a few. However I do feel that there is too much pessimism around these sectors. It not surprising that the market has beaten down these sectors as during bull runs, most investors prefer high growth companies and avoid companies which show low growth (even if they have a high Return on capital)
High PE v/s Low PE stocks – Most of you must have noticed that stocks with high PE or high valuations are getting hit harder when the market drops. This does not mean that these companies are over-valued or will do badly. If the analysis is correct and the companies does well, then investors in these companies should do well in the long term. However you have to be comfortable with the high volatility in the stock price. In comparison the low PE stocks, of which not much is expected, don’t drop as much during market drops. However they do not gain as much during the rise too.
Sunday, March 09, 2008
Kothari products demerger – an arbitrage opportunity ?
Kothari products has announced the following de-merger plan
has approved the proposal for scheme of arrangement between the Company and Pan Pang India Ltd., for demerger of Pan Masala Division, Bevarages Division and Trading Division into Pan Parag India Ltd., subject to approval of the Stock Exchanges, its shareholders and the Hon'ble High Court and the necessary approvals under various statutes. Further the Company has informed that, the Board of Directors has also approved valuation report of M/s. Haresh Upendra & Co. Chartered Accountants, recommending exchange ratio of 1 Equity Share of Rs 10/- each of Pan Pang India Ltd for every 1 Equity Share of Rs 10/- each held by the shareholders in the Company. The Scheme of Arrangement provides for the exit to small Shareholders holding Equity Shares in Physical Form.
My earlier views on kothari products are here and here
Following is a comment from the 2007 Annual report – director’s report
In view of the risks associated with the Pan Masala Industry in the form of Governmental bans, the Company has decided to diversify into the business of Real Estate, constructions, builders etc. which is a booming business presently and which is growing at a very high speed. The market presents an attractive investment opportunity in the area by virtue of diversification. Your Company with requisite financial strength and proven managerial skills, stands in a position to seize the opportunity. To avoid any adverse impact on the growth of new business, management is considering various options for restructuring to seperate other businesses in a most efficient and transparent manner.
I am looking at kothari products as a short term arbitrage opportunity based on the following hypothesis – demerger would unlock the value in the company.
Kothari product would demerge the pan masala and other associated business from the parent company. The post de-merger company will be into real estate and construction business. The sum of value of kothari products (post merger) and pan parag ltd should be greater than Kothari products (pre-merger)
My question
1. Does the shareholders get 1 share of panparag and Kothari products (post de-merger) each based on 1 share of Kothari products (pre-demerger) ?
2. What happens to the Investments and cash on the books ?
Would appreciate any inputs on my questions ?
Please read disclaimer on the blog.
has approved the proposal for scheme of arrangement between the Company and Pan Pang India Ltd., for demerger of Pan Masala Division, Bevarages Division and Trading Division into Pan Parag India Ltd., subject to approval of the Stock Exchanges, its shareholders and the Hon'ble High Court and the necessary approvals under various statutes. Further the Company has informed that, the Board of Directors has also approved valuation report of M/s. Haresh Upendra & Co. Chartered Accountants, recommending exchange ratio of 1 Equity Share of Rs 10/- each of Pan Pang India Ltd for every 1 Equity Share of Rs 10/- each held by the shareholders in the Company. The Scheme of Arrangement provides for the exit to small Shareholders holding Equity Shares in Physical Form.
My earlier views on kothari products are here and here
Following is a comment from the 2007 Annual report – director’s report
In view of the risks associated with the Pan Masala Industry in the form of Governmental bans, the Company has decided to diversify into the business of Real Estate, constructions, builders etc. which is a booming business presently and which is growing at a very high speed. The market presents an attractive investment opportunity in the area by virtue of diversification. Your Company with requisite financial strength and proven managerial skills, stands in a position to seize the opportunity. To avoid any adverse impact on the growth of new business, management is considering various options for restructuring to seperate other businesses in a most efficient and transparent manner.
I am looking at kothari products as a short term arbitrage opportunity based on the following hypothesis – demerger would unlock the value in the company.
Kothari product would demerge the pan masala and other associated business from the parent company. The post de-merger company will be into real estate and construction business. The sum of value of kothari products (post merger) and pan parag ltd should be greater than Kothari products (pre-merger)
My question
1. Does the shareholders get 1 share of panparag and Kothari products (post de-merger) each based on 1 share of Kothari products (pre-demerger) ?
2. What happens to the Investments and cash on the books ?
Would appreciate any inputs on my questions ?
Please read disclaimer on the blog.
Kothari products demerger – an arbitrage opportunity ?
Kothari products has announced the following de-merger plan
has approved the proposal for scheme of arrangement between the Company and Pan Pang India Ltd., for demerger of Pan Masala Division, Bevarages Division and Trading Division into Pan Parag India Ltd., subject to approval of the Stock Exchanges, its shareholders and the Hon'ble High Court and the necessary approvals under various statutes. Further the Company has informed that, the Board of Directors has also approved valuation report of M/s. Haresh Upendra & Co. Chartered Accountants, recommending exchange ratio of 1 Equity Share of Rs 10/- each of Pan Pang India Ltd for every 1 Equity Share of Rs 10/- each held by the shareholders in the Company. The Scheme of Arrangement provides for the exit to small Shareholders holding Equity Shares in Physical Form.
My earlier views on kothari products are here and here
Following is a comment from the 2007 Annual report – director’s report
In view of the risks associated with the Pan Masala Industry in the form of Governmental bans, the Company has decided to diversify into the business of Real Estate, constructions, builders etc. which is a booming business presently and which is growing at a very high speed. The market presents an attractive investment opportunity in the area by virtue of diversification. Your Company with requisite financial strength and proven managerial skills, stands in a position to seize the opportunity. To avoid any adverse impact on the growth of new business, management is considering various options for restructuring to seperate other businesses in a most efficient and transparent manner.
I am looking at kothari products as a short term arbitrage opportunity based on the following hypothesis – demerger would unlock the value in the company.
Kothari product would demerge the pan masala and other associated business from the parent company. The post de-merger company will be into real estate and construction business. The sum of value of kothari products (post merger) and pan parag ltd should be greater than Kothari products (pre-merger)
My question
1. Does the shareholders get 1 share of panparag and Kothari products (post de-merger) each based on 1 share of Kothari products (pre-demerger) ?
2. What happens to the Investments and cash on the books ?
Would appreciate any inputs on my questions ?
Please read disclaimer on the blog.
has approved the proposal for scheme of arrangement between the Company and Pan Pang India Ltd., for demerger of Pan Masala Division, Bevarages Division and Trading Division into Pan Parag India Ltd., subject to approval of the Stock Exchanges, its shareholders and the Hon'ble High Court and the necessary approvals under various statutes. Further the Company has informed that, the Board of Directors has also approved valuation report of M/s. Haresh Upendra & Co. Chartered Accountants, recommending exchange ratio of 1 Equity Share of Rs 10/- each of Pan Pang India Ltd for every 1 Equity Share of Rs 10/- each held by the shareholders in the Company. The Scheme of Arrangement provides for the exit to small Shareholders holding Equity Shares in Physical Form.
My earlier views on kothari products are here and here
Following is a comment from the 2007 Annual report – director’s report
In view of the risks associated with the Pan Masala Industry in the form of Governmental bans, the Company has decided to diversify into the business of Real Estate, constructions, builders etc. which is a booming business presently and which is growing at a very high speed. The market presents an attractive investment opportunity in the area by virtue of diversification. Your Company with requisite financial strength and proven managerial skills, stands in a position to seize the opportunity. To avoid any adverse impact on the growth of new business, management is considering various options for restructuring to seperate other businesses in a most efficient and transparent manner.
I am looking at kothari products as a short term arbitrage opportunity based on the following hypothesis – demerger would unlock the value in the company.
Kothari product would demerge the pan masala and other associated business from the parent company. The post de-merger company will be into real estate and construction business. The sum of value of kothari products (post merger) and pan parag ltd should be greater than Kothari products (pre-merger)
My question
1. Does the shareholders get 1 share of panparag and Kothari products (post de-merger) each based on 1 share of Kothari products (pre-demerger) ?
2. What happens to the Investments and cash on the books ?
Would appreciate any inputs on my questions ?
Please read disclaimer on the blog.
Wednesday, March 05, 2008
ICICI bank news - some comments
Deepak has posted on the current news around ICICI.
See - ICICI's Disclosure See-Saws: Openly Making Fools Of Us
Following is my comment . You can read the discussion and all the comments on his blog
Deepak - Although it would be good to have more disclosure, it may be risky for a bank to do so also.
In addition the changes in the loss estimates seem to be consistent with what is happening in the market. For derivatives, accounting requires that the losses of mark to market are passed through the P&L even if the contracts are held to maturity (see this year's berkshire hathaway AR for some discussion on this)
So as the markets are deteriorating, the mark to market losses could increase and the bank will have to recognize them. This is also consistent with the banks claims that these are held to maturity and may not have losses (similar to a goverment bond portfolio where you may have mark to losses, but if you hold the bonds to maturity there may be no losses).
I am not saying that is case with icici, but it may be possible. Also icici may be communicating only required information, but i really doubt they can fudge the data without a serious consequence.
Regarding the solvency, the bank has a networth of almost 12bn USD. Even if they lose 50% of their derivatives portfolio, you are looking at a drop in the CAR from 15% to somewhere around 13-14%. Not good for the stock, but definitely not a solvency issue. In addition the bank has a lot of assets on the books at book value like their insurance subs, icici direct etc. so they do have some hidden assets too.
disclosure - i am neither long nor short this stock
Additional points
The above discussion does not mean that I think ICICI is a good investment or otherwise. A 250 Mn USD loss is still less than 1% of the asset base of the bank. The bank has a 1.47% Net NPA on its books. I am not sure if a 1% increase in NPA would have created such a hysteria.
On the contrary the bigger risk for the bank is the retail portfolio and NPA’s which can develop in the future or other hidden liabilities on the balance sheet.
See - ICICI's Disclosure See-Saws: Openly Making Fools Of Us
Following is my comment . You can read the discussion and all the comments on his blog
Deepak - Although it would be good to have more disclosure, it may be risky for a bank to do so also.
In addition the changes in the loss estimates seem to be consistent with what is happening in the market. For derivatives, accounting requires that the losses of mark to market are passed through the P&L even if the contracts are held to maturity (see this year's berkshire hathaway AR for some discussion on this)
So as the markets are deteriorating, the mark to market losses could increase and the bank will have to recognize them. This is also consistent with the banks claims that these are held to maturity and may not have losses (similar to a goverment bond portfolio where you may have mark to losses, but if you hold the bonds to maturity there may be no losses).
I am not saying that is case with icici, but it may be possible. Also icici may be communicating only required information, but i really doubt they can fudge the data without a serious consequence.
Regarding the solvency, the bank has a networth of almost 12bn USD. Even if they lose 50% of their derivatives portfolio, you are looking at a drop in the CAR from 15% to somewhere around 13-14%. Not good for the stock, but definitely not a solvency issue. In addition the bank has a lot of assets on the books at book value like their insurance subs, icici direct etc. so they do have some hidden assets too.
disclosure - i am neither long nor short this stock
Additional points
The above discussion does not mean that I think ICICI is a good investment or otherwise. A 250 Mn USD loss is still less than 1% of the asset base of the bank. The bank has a 1.47% Net NPA on its books. I am not sure if a 1% increase in NPA would have created such a hysteria.
On the contrary the bigger risk for the bank is the retail portfolio and NPA’s which can develop in the future or other hidden liabilities on the balance sheet.
ICICI bank news - some comments
Deepak has posted on the current news around ICICI.
See - ICICI's Disclosure See-Saws: Openly Making Fools Of Us
Following is my comment . You can read the discussion and all the comments on his blog
Deepak - Although it would be good to have more disclosure, it may be risky for a bank to do so also.
In addition the changes in the loss estimates seem to be consistent with what is happening in the market. For derivatives, accounting requires that the losses of mark to market are passed through the P&L even if the contracts are held to maturity (see this year's berkshire hathaway AR for some discussion on this)
So as the markets are deteriorating, the mark to market losses could increase and the bank will have to recognize them. This is also consistent with the banks claims that these are held to maturity and may not have losses (similar to a goverment bond portfolio where you may have mark to losses, but if you hold the bonds to maturity there may be no losses).
I am not saying that is case with icici, but it may be possible. Also icici may be communicating only required information, but i really doubt they can fudge the data without a serious consequence.
Regarding the solvency, the bank has a networth of almost 12bn USD. Even if they lose 50% of their derivatives portfolio, you are looking at a drop in the CAR from 15% to somewhere around 13-14%. Not good for the stock, but definitely not a solvency issue. In addition the bank has a lot of assets on the books at book value like their insurance subs, icici direct etc. so they do have some hidden assets too.
disclosure - i am neither long nor short this stock
Additional points
The above discussion does not mean that I think ICICI is a good investment or otherwise. A 250 Mn USD loss is still less than 1% of the asset base of the bank. The bank has a 1.47% Net NPA on its books. I am not sure if a 1% increase in NPA would have created such a hysteria.
On the contrary the bigger risk for the bank is the retail portfolio and NPA’s which can develop in the future or other hidden liabilities on the balance sheet.
See - ICICI's Disclosure See-Saws: Openly Making Fools Of Us
Following is my comment . You can read the discussion and all the comments on his blog
Deepak - Although it would be good to have more disclosure, it may be risky for a bank to do so also.
In addition the changes in the loss estimates seem to be consistent with what is happening in the market. For derivatives, accounting requires that the losses of mark to market are passed through the P&L even if the contracts are held to maturity (see this year's berkshire hathaway AR for some discussion on this)
So as the markets are deteriorating, the mark to market losses could increase and the bank will have to recognize them. This is also consistent with the banks claims that these are held to maturity and may not have losses (similar to a goverment bond portfolio where you may have mark to losses, but if you hold the bonds to maturity there may be no losses).
I am not saying that is case with icici, but it may be possible. Also icici may be communicating only required information, but i really doubt they can fudge the data without a serious consequence.
Regarding the solvency, the bank has a networth of almost 12bn USD. Even if they lose 50% of their derivatives portfolio, you are looking at a drop in the CAR from 15% to somewhere around 13-14%. Not good for the stock, but definitely not a solvency issue. In addition the bank has a lot of assets on the books at book value like their insurance subs, icici direct etc. so they do have some hidden assets too.
disclosure - i am neither long nor short this stock
Additional points
The above discussion does not mean that I think ICICI is a good investment or otherwise. A 250 Mn USD loss is still less than 1% of the asset base of the bank. The bank has a 1.47% Net NPA on its books. I am not sure if a 1% increase in NPA would have created such a hysteria.
On the contrary the bigger risk for the bank is the retail portfolio and NPA’s which can develop in the future or other hidden liabilities on the balance sheet.
Monday, March 03, 2008
Allahabad bank – The risk materializes
update : 03/04
blog.rcfunds.com (referred to in the comment on this post) is also my website. I eventually plan to migrate this blog to that website. however my new website is still beta. I need to improve the look and feel of that website. As a result i have not publicized it, thinking no one will notice it. I guess i was wrong. Anyway, i will be posting my posts on both locations at the same time.
I had written on Allahabad bank earlier. I mentioned the following as a key risk
The biggest risk for the bank is political interference. As the majority shareholder is our government, you can never be sure what hairbrained scheme they will come up with. In the past there have been loan melas, loan writeoff etc. This has reduced in the last few years, but you never know.
Well, the risk has materialized. The FM has announced a loan waiver for small farmers to the tune of 60000 Crs. Forget about the fact that this money may never reach the farmers, a part of this money could come from PSU banks like Allahabad bank which has a 55% Government holding.
The bank has a 7000+ cr loan portfolio for the agricultre sector. The best case scenario is that the government would compensate the banks completely for this waiver, but I think that is unlikely. A probable scenario is some losses on this portfolio. A 10% loss on this portfolio would be a 20% hit to the Networth of the Bank. In addition PSU banks could get poor valuations going forward as the market will not trust that the government would not pull off a similar scheme again in the future.
This case is different from HPCL (see analysis here). In case of HPCL, the subsidy is priced into the stock. Any positive development such a moderate price hike would help the company. In case of allahabad bank, this risk is not priced into the stock.
As of now, I am not sure how this will play out. I generally do not concern myself with price movements. However a fundamental development such as the one above is different. I may be wrong on this one and this development in the short term, may not impact the company. However this is definitely a moral hazard for banks in the long run. Rural borowers may start expecting such writeoffs again in the future. Net Net, I am not interested in risking my capital to find out.
Disclosure : I have maintained a small position in the stock as the stock seemed undervalued, but not by a big margin. However I am now planning to exit the stock completely.
blog.rcfunds.com (referred to in the comment on this post) is also my website. I eventually plan to migrate this blog to that website. however my new website is still beta. I need to improve the look and feel of that website. As a result i have not publicized it, thinking no one will notice it. I guess i was wrong. Anyway, i will be posting my posts on both locations at the same time.
I had written on Allahabad bank earlier. I mentioned the following as a key risk
The biggest risk for the bank is political interference. As the majority shareholder is our government, you can never be sure what hairbrained scheme they will come up with. In the past there have been loan melas, loan writeoff etc. This has reduced in the last few years, but you never know.
Well, the risk has materialized. The FM has announced a loan waiver for small farmers to the tune of 60000 Crs. Forget about the fact that this money may never reach the farmers, a part of this money could come from PSU banks like Allahabad bank which has a 55% Government holding.
The bank has a 7000+ cr loan portfolio for the agricultre sector. The best case scenario is that the government would compensate the banks completely for this waiver, but I think that is unlikely. A probable scenario is some losses on this portfolio. A 10% loss on this portfolio would be a 20% hit to the Networth of the Bank. In addition PSU banks could get poor valuations going forward as the market will not trust that the government would not pull off a similar scheme again in the future.
This case is different from HPCL (see analysis here). In case of HPCL, the subsidy is priced into the stock. Any positive development such a moderate price hike would help the company. In case of allahabad bank, this risk is not priced into the stock.
As of now, I am not sure how this will play out. I generally do not concern myself with price movements. However a fundamental development such as the one above is different. I may be wrong on this one and this development in the short term, may not impact the company. However this is definitely a moral hazard for banks in the long run. Rural borowers may start expecting such writeoffs again in the future. Net Net, I am not interested in risking my capital to find out.
Disclosure : I have maintained a small position in the stock as the stock seemed undervalued, but not by a big margin. However I am now planning to exit the stock completely.
Allahabad bank – The risk materializes
update : 03/04
blog.rcfunds.com (referred to in the comment on this post) is also my website. I eventually plan to migrate this blog to that website. however my new website is still beta. I need to improve the look and feel of that website. As a result i have not publicized it, thinking no one will notice it. I guess i was wrong. Anyway, i will be posting my posts on both locations at the same time.
I had written on Allahabad bank earlier. I mentioned the following as a key risk
The biggest risk for the bank is political interference. As the majority shareholder is our government, you can never be sure what hairbrained scheme they will come up with. In the past there have been loan melas, loan writeoff etc. This has reduced in the last few years, but you never know.
Well, the risk has materialized. The FM has announced a loan waiver for small farmers to the tune of 60000 Crs. Forget about the fact that this money may never reach the farmers, a part of this money could come from PSU banks like Allahabad bank which has a 55% Government holding.
The bank has a 7000+ cr loan portfolio for the agricultre sector. The best case scenario is that the government would compensate the banks completely for this waiver, but I think that is unlikely. A probable scenario is some losses on this portfolio. A 10% loss on this portfolio would be a 20% hit to the Networth of the Bank. In addition PSU banks could get poor valuations going forward as the market will not trust that the government would not pull off a similar scheme again in the future.
This case is different from HPCL (see analysis here). In case of HPCL, the subsidy is priced into the stock. Any positive development such a moderate price hike would help the company. In case of allahabad bank, this risk is not priced into the stock.
As of now, I am not sure how this will play out. I generally do not concern myself with price movements. However a fundamental development such as the one above is different. I may be wrong on this one and this development in the short term, may not impact the company. However this is definitely a moral hazard for banks in the long run. Rural borowers may start expecting such writeoffs again in the future. Net Net, I am not interested in risking my capital to find out.
Disclosure : I have maintained a small position in the stock as the stock seemed undervalued, but not by a big margin. However I am now planning to exit the stock completely.
blog.rcfunds.com (referred to in the comment on this post) is also my website. I eventually plan to migrate this blog to that website. however my new website is still beta. I need to improve the look and feel of that website. As a result i have not publicized it, thinking no one will notice it. I guess i was wrong. Anyway, i will be posting my posts on both locations at the same time.
I had written on Allahabad bank earlier. I mentioned the following as a key risk
The biggest risk for the bank is political interference. As the majority shareholder is our government, you can never be sure what hairbrained scheme they will come up with. In the past there have been loan melas, loan writeoff etc. This has reduced in the last few years, but you never know.
Well, the risk has materialized. The FM has announced a loan waiver for small farmers to the tune of 60000 Crs. Forget about the fact that this money may never reach the farmers, a part of this money could come from PSU banks like Allahabad bank which has a 55% Government holding.
The bank has a 7000+ cr loan portfolio for the agricultre sector. The best case scenario is that the government would compensate the banks completely for this waiver, but I think that is unlikely. A probable scenario is some losses on this portfolio. A 10% loss on this portfolio would be a 20% hit to the Networth of the Bank. In addition PSU banks could get poor valuations going forward as the market will not trust that the government would not pull off a similar scheme again in the future.
This case is different from HPCL (see analysis here). In case of HPCL, the subsidy is priced into the stock. Any positive development such a moderate price hike would help the company. In case of allahabad bank, this risk is not priced into the stock.
As of now, I am not sure how this will play out. I generally do not concern myself with price movements. However a fundamental development such as the one above is different. I may be wrong on this one and this development in the short term, may not impact the company. However this is definitely a moral hazard for banks in the long run. Rural borowers may start expecting such writeoffs again in the future. Net Net, I am not interested in risking my capital to find out.
Disclosure : I have maintained a small position in the stock as the stock seemed undervalued, but not by a big margin. However I am now planning to exit the stock completely.
Thursday, February 28, 2008
GSK consumer products
About
GSK consumer is a 1300 Cr consumer goods company with well known brands such as Horlicks, Boost, Maltova, Crocin etc. The company is a part of the Glaxo smithkline group which specialises in pharma products
Financials
The company has done well for the last 5 years after a dip in performance in 2001-2002. The company topline dropped by 12% in 2002 and the bottomline by 33%. The company has since then recovered the topline growth to around 10% per annum and Net profit growth to around 12-15% CAGR.
The RONW/ROCE have improved to 20%+ levels due to improvement in margins and Asset turns. The company has no debt and an approximate cash of 300 Crs.
Positives
The company has strong brands, well established distribution network and a high market share in its category (around 70%). In addition the company has cash of 300 Crs on its balance sheet.
The management has been a rational allocator of capital. They have maintained a dividend payout of almost 35%. In addition the management executed a buyback in 2006 of around 125Crs using up the excess cash. The current cash on the Balance sheet is for acquisitions and to grow the business.
The company plans to introduce 2-3 of its international brands in the couple of years such as sensodyne, breathe right etc.
Risks
This is a single product company. Crocin and Iodex brands are not owned by it. The company only distributes it for the parent and gets a fee for it. As a result topline and bottom line is based on a single product category and it can get hit again as in the past by a drop in the demand or competition or both.
The company has plans to acquire new brands and businesses, but it remains to be seen how that will play out.
In addition it remains to be seen if the Global brands to be introduced in india would be successful or not.
Valuation
The company current sells at around a PE of 13.5 (after taking out the cash). A rough calculation (ROE = 20%, growth around 7-10% and CAP of 8-10 years) would give an intrinsic value of around 3000 Crs. This valuation does not include upside from Global brands or any accquisition. Those would be icing on the cake, but I would not value them as yet.
conclusion
The company seems to be undervalued by 20-30%. In addition the upside from introducing global brands or any acquisition is not included in the calculation. So that could be a positive upside (or a negative if it fails). I find the investment idea good, but not mouth watering. Would like to wait and watch
Disclaimer : I don’t hold the stock (as yet). In addition I may change my mind at any time on that and may not put that on the blog. So please look at the disclaimer below and take your own decision.
GSK consumer is a 1300 Cr consumer goods company with well known brands such as Horlicks, Boost, Maltova, Crocin etc. The company is a part of the Glaxo smithkline group which specialises in pharma products
Financials
The company has done well for the last 5 years after a dip in performance in 2001-2002. The company topline dropped by 12% in 2002 and the bottomline by 33%. The company has since then recovered the topline growth to around 10% per annum and Net profit growth to around 12-15% CAGR.
The RONW/ROCE have improved to 20%+ levels due to improvement in margins and Asset turns. The company has no debt and an approximate cash of 300 Crs.
Positives
The company has strong brands, well established distribution network and a high market share in its category (around 70%). In addition the company has cash of 300 Crs on its balance sheet.
The management has been a rational allocator of capital. They have maintained a dividend payout of almost 35%. In addition the management executed a buyback in 2006 of around 125Crs using up the excess cash. The current cash on the Balance sheet is for acquisitions and to grow the business.
The company plans to introduce 2-3 of its international brands in the couple of years such as sensodyne, breathe right etc.
Risks
This is a single product company. Crocin and Iodex brands are not owned by it. The company only distributes it for the parent and gets a fee for it. As a result topline and bottom line is based on a single product category and it can get hit again as in the past by a drop in the demand or competition or both.
The company has plans to acquire new brands and businesses, but it remains to be seen how that will play out.
In addition it remains to be seen if the Global brands to be introduced in india would be successful or not.
Valuation
The company current sells at around a PE of 13.5 (after taking out the cash). A rough calculation (ROE = 20%, growth around 7-10% and CAP of 8-10 years) would give an intrinsic value of around 3000 Crs. This valuation does not include upside from Global brands or any accquisition. Those would be icing on the cake, but I would not value them as yet.
conclusion
The company seems to be undervalued by 20-30%. In addition the upside from introducing global brands or any acquisition is not included in the calculation. So that could be a positive upside (or a negative if it fails). I find the investment idea good, but not mouth watering. Would like to wait and watch
Disclaimer : I don’t hold the stock (as yet). In addition I may change my mind at any time on that and may not put that on the blog. So please look at the disclaimer below and take your own decision.
GSK consumer products
About
GSK consumer is a 1300 Cr consumer goods company with well known brands such as Horlicks, Boost, Maltova, Crocin etc. The company is a part of the Glaxo smithkline group which specialises in pharma products
Financials
The company has done well for the last 5 years after a dip in performance in 2001-2002. The company topline dropped by 12% in 2002 and the bottomline by 33%. The company has since then recovered the topline growth to around 10% per annum and Net profit growth to around 12-15% CAGR.
The RONW/ROCE have improved to 20%+ levels due to improvement in margins and Asset turns. The company has no debt and an approximate cash of 300 Crs.
Positives
The company has strong brands, well established distribution network and a high market share in its category (around 70%). In addition the company has cash of 300 Crs on its balance sheet.
The management has been a rational allocator of capital. They have maintained a dividend payout of almost 35%. In addition the management executed a buyback in 2006 of around 125Crs using up the excess cash. The current cash on the Balance sheet is for acquisitions and to grow the business.
The company plans to introduce 2-3 of its international brands in the couple of years such as sensodyne, breathe right etc.
Risks
This is a single product company. Crocin and Iodex brands are not owned by it. The company only distributes it for the parent and gets a fee for it. As a result topline and bottom line is based on a single product category and it can get hit again as in the past by a drop in the demand or competition or both.
The company has plans to acquire new brands and businesses, but it remains to be seen how that will play out.
In addition it remains to be seen if the Global brands to be introduced in india would be successful or not.
Valuation
The company current sells at around a PE of 13.5 (after taking out the cash). A rough calculation (ROE = 20%, growth around 7-10% and CAP of 8-10 years) would give an intrinsic value of around 3000 Crs. This valuation does not include upside from Global brands or any accquisition. Those would be icing on the cake, but I would not value them as yet.
conclusion
The company seems to be undervalued by 20-30%. In addition the upside from introducing global brands or any acquisition is not included in the calculation. So that could be a positive upside (or a negative if it fails). I find the investment idea good, but not mouth watering. Would like to wait and watch
Disclaimer : I don’t hold the stock (as yet). In addition I may change my mind at any time on that and may not put that on the blog. So please look at the disclaimer below and take your own decision.
GSK consumer is a 1300 Cr consumer goods company with well known brands such as Horlicks, Boost, Maltova, Crocin etc. The company is a part of the Glaxo smithkline group which specialises in pharma products
Financials
The company has done well for the last 5 years after a dip in performance in 2001-2002. The company topline dropped by 12% in 2002 and the bottomline by 33%. The company has since then recovered the topline growth to around 10% per annum and Net profit growth to around 12-15% CAGR.
The RONW/ROCE have improved to 20%+ levels due to improvement in margins and Asset turns. The company has no debt and an approximate cash of 300 Crs.
Positives
The company has strong brands, well established distribution network and a high market share in its category (around 70%). In addition the company has cash of 300 Crs on its balance sheet.
The management has been a rational allocator of capital. They have maintained a dividend payout of almost 35%. In addition the management executed a buyback in 2006 of around 125Crs using up the excess cash. The current cash on the Balance sheet is for acquisitions and to grow the business.
The company plans to introduce 2-3 of its international brands in the couple of years such as sensodyne, breathe right etc.
Risks
This is a single product company. Crocin and Iodex brands are not owned by it. The company only distributes it for the parent and gets a fee for it. As a result topline and bottom line is based on a single product category and it can get hit again as in the past by a drop in the demand or competition or both.
The company has plans to acquire new brands and businesses, but it remains to be seen how that will play out.
In addition it remains to be seen if the Global brands to be introduced in india would be successful or not.
Valuation
The company current sells at around a PE of 13.5 (after taking out the cash). A rough calculation (ROE = 20%, growth around 7-10% and CAP of 8-10 years) would give an intrinsic value of around 3000 Crs. This valuation does not include upside from Global brands or any accquisition. Those would be icing on the cake, but I would not value them as yet.
conclusion
The company seems to be undervalued by 20-30%. In addition the upside from introducing global brands or any acquisition is not included in the calculation. So that could be a positive upside (or a negative if it fails). I find the investment idea good, but not mouth watering. Would like to wait and watch
Disclaimer : I don’t hold the stock (as yet). In addition I may change my mind at any time on that and may not put that on the blog. So please look at the disclaimer below and take your own decision.
Sunday, February 24, 2008
Reverse engineering the L&T stock price
I got the following comment from abhishek
Hi Rohit,
Using the same concept, dont u think L&T is a very expensive stock trading at PE of above 70.
To sustain this PE, how much growth it must show in the future?
Does this PE look sustainable?
If no, could u please help us understand this calculation by using L&T as an example?
Following is a very brief unpacking or analysis of the expectations embedded in the stock price. Is the stock undervalued?…that is your call
Caution: I have done a quick analysis and hence there are a lot of assumptions (such as net profit = Free cash flow) and shortcuts. i have not done a detailed analysis as the company does not pass my initial selection criteria
The stock sells at a PE of around 30 (assuming consolidated profits of around 3000 crs for the year. LY was 2250 Crs).
The ROE is around 30%+ and Debt equity is around 1:1 based on 2007 Balance sheet.
You can plug the following numbers in the spreadsheet – quantitative calculation – ROC and PE to calculate the embedded expectations
1. ROE = 30% (approximate). Use the DCF calcluations on line 88
2. Growth ~ 20% ( 5 year average growth was 50% per annum). This is clearly an assumption and one can play around with it
3. CAP – Take as 10 years. Again an assumption. Increase or decrease based on your assesment of competition and industry
4. Free cash flow = Net profit
If you plug the above numbers, the model throws a PE of around 36 (close enough!)
So the expectations seem to be
- Company will maintain an ROE of 30% or more
- Growth for the 10 years would be 20%. If you are more optimistic, increase the number and you will find the company is undervalued (as expected).
- After 10 years , L&T would be a 40 bn dollar company! , with net profit of 4.5 bn dollars (19000 crore)
So the stock market is discounting the above performance. If you think the company is undervalued you are saying
The ROE of the company will be higher than 30%
Growth with higher than 20% and hence 10 years later the company would be a much larger company, making the same margins and profits.
Suggestion: I have not done this, but look around for such EPC companies worldwide and check the size, growth and PE for these companies. That could give a hint how large and profitable L&T can get.
Reverse engineering the L&T stock price
I got the following comment from abhishek
Hi Rohit,
Using the same concept, dont u think L&T is a very expensive stock trading at PE of above 70.
To sustain this PE, how much growth it must show in the future?
Does this PE look sustainable?
If no, could u please help us understand this calculation by using L&T as an example?
Following is a very brief unpacking or analysis of the expectations embedded in the stock price. Is the stock undervalued?…that is your call
Caution: I have done a quick analysis and hence there are a lot of assumptions (such as net profit = Free cash flow) and shortcuts. i have not done a detailed analysis as the company does not pass my initial selection criteria
The stock sells at a PE of around 30 (assuming consolidated profits of around 3000 crs for the year. LY was 2250 Crs).
The ROE is around 30%+ and Debt equity is around 1:1 based on 2007 Balance sheet.
You can plug the following numbers in the spreadsheet – quantitative calculation – ROC and PE to calculate the embedded expectations
1. ROE = 30% (approximate). Use the DCF calcluations on line 88
2. Growth ~ 20% ( 5 year average growth was 50% per annum). This is clearly an assumption and one can play around with it
3. CAP – Take as 10 years. Again an assumption. Increase or decrease based on your assesment of competition and industry
4. Free cash flow = Net profit
If you plug the above numbers, the model throws a PE of around 36 (close enough!)
So the expectations seem to be
- Company will maintain an ROE of 30% or more
- Growth for the 10 years would be 20%. If you are more optimistic, increase the number and you will find the company is undervalued (as expected).
- After 10 years , L&T would be a 40 bn dollar company! , with net profit of 4.5 bn dollars (19000 crore)
So the stock market is discounting the above performance. If you think the company is undervalued you are saying
The ROE of the company will be higher than 30%
Growth with higher than 20% and hence 10 years later the company would be a much larger company, making the same margins and profits.
Suggestion: I have not done this, but look around for such EPC companies worldwide and check the size, growth and PE for these companies. That could give a hint how large and profitable L&T can get.
Wednesday, February 20, 2008
Correction to the post : valuation – reverse engineering the stock price
There was an error in the analysis of crisil in the post . I had looked at the standalone numbers only and not the consolidated numbers (as an anonymous reader has pointed out in the comments)
So crisil may not be a good example of over valuation. I am not sure how undervalued the company is. It sells at a PE of 33 (approximate Net profit of 100 odd crs for 2007). I have analysed the company earlier here …and I have underestimated the competitive advantage of this company and its ability to keep increasing its instrinsic value.
That said, if I were make my point in the post again, I would replace crisil with any of the Real estate companies or capital goods company which have a high performance hurdle to cross (due to their high PE) to deliver good returns to investors in the future.
The post was however was not an analysis of CRISL. The key point is this – A good company may not be a good stock and vice versa (important word is ‘may’) . That depends on whether the stock price fully discounts the future performance of the company or not. If one has to make money in such high PE stocks, then the actual performance has to be better than what is implied by the stock
Low PE or low valuation stocks have low expectations built in and hence a small improvement in the company performance can deliver good returns. High PE or stocks selling at high valuations are stars of the Stock market. If they stumble even a bit, the stock price can get butchered. So one has to be confident and sure that the company will meet the high expectations well into the distant future.
I have personal experience of seeing a stock drop 90% when the company was not able to meet its high expectations (see here).
Ofcourse you can say that I am not as dumb as rohit and will not make a mistake like him :)
Feb 23 :
Following quote from peter lynch is very relevant to the topic of this post
“It’s a real tragedy when you buy a stock that’s overpriced; the company is a big success and you still don’t make any money.” Peter Lynch, “One Up on Wall Street,” New York, Penguin Books, 1989, p. 244.
I am a big fan of Mohnish Pabrai. He is a very succesful investment manager and has recently written a great book - dhandho investor.
Following article from mohnish explains the key point of the post - A good company may not be a good stock and vice versa in a great (and much better) way.
Valuation by intrinsic value.
In addition you can find the links for a lot of mohnish's articles here. I strongly recommend reading each article
So crisil may not be a good example of over valuation. I am not sure how undervalued the company is. It sells at a PE of 33 (approximate Net profit of 100 odd crs for 2007). I have analysed the company earlier here …and I have underestimated the competitive advantage of this company and its ability to keep increasing its instrinsic value.
That said, if I were make my point in the post again, I would replace crisil with any of the Real estate companies or capital goods company which have a high performance hurdle to cross (due to their high PE) to deliver good returns to investors in the future.
The post was however was not an analysis of CRISL. The key point is this – A good company may not be a good stock and vice versa (important word is ‘may’) . That depends on whether the stock price fully discounts the future performance of the company or not. If one has to make money in such high PE stocks, then the actual performance has to be better than what is implied by the stock
Low PE or low valuation stocks have low expectations built in and hence a small improvement in the company performance can deliver good returns. High PE or stocks selling at high valuations are stars of the Stock market. If they stumble even a bit, the stock price can get butchered. So one has to be confident and sure that the company will meet the high expectations well into the distant future.
I have personal experience of seeing a stock drop 90% when the company was not able to meet its high expectations (see here).
Ofcourse you can say that I am not as dumb as rohit and will not make a mistake like him :)
Feb 23 :
Following quote from peter lynch is very relevant to the topic of this post
“It’s a real tragedy when you buy a stock that’s overpriced; the company is a big success and you still don’t make any money.” Peter Lynch, “One Up on Wall Street,” New York, Penguin Books, 1989, p. 244.
I am a big fan of Mohnish Pabrai. He is a very succesful investment manager and has recently written a great book - dhandho investor.
Following article from mohnish explains the key point of the post - A good company may not be a good stock and vice versa in a great (and much better) way.
Valuation by intrinsic value.
In addition you can find the links for a lot of mohnish's articles here. I strongly recommend reading each article
Correction to the post : valuation – reverse engineering the stock price
There was an error in the analysis of crisil in the post . I had looked at the standalone numbers only and not the consolidated numbers (as an anonymous reader has pointed out in the comments)
So crisil may not be a good example of over valuation. I am not sure how undervalued the company is. It sells at a PE of 33 (approximate Net profit of 100 odd crs for 2007). I have analysed the company earlier here …and I have underestimated the competitive advantage of this company and its ability to keep increasing its instrinsic value.
That said, if I were make my point in the post again, I would replace crisil with any of the Real estate companies or capital goods company which have a high performance hurdle to cross (due to their high PE) to deliver good returns to investors in the future.
The post was however was not an analysis of CRISL. The key point is this – A good company may not be a good stock and vice versa (important word is ‘may’) . That depends on whether the stock price fully discounts the future performance of the company or not. If one has to make money in such high PE stocks, then the actual performance has to be better than what is implied by the stock
Low PE or low valuation stocks have low expectations built in and hence a small improvement in the company performance can deliver good returns. High PE or stocks selling at high valuations are stars of the Stock market. If they stumble even a bit, the stock price can get butchered. So one has to be confident and sure that the company will meet the high expectations well into the distant future.
I have personal experience of seeing a stock drop 90% when the company was not able to meet its high expectations (see here).
Ofcourse you can say that I am not as dumb as rohit and will not make a mistake like him :)
Feb 23 :
Following quote from peter lynch is very relevant to the topic of this post
“It’s a real tragedy when you buy a stock that’s overpriced; the company is a big success and you still don’t make any money.” Peter Lynch, “One Up on Wall Street,” New York, Penguin Books, 1989, p. 244.
I am a big fan of Mohnish Pabrai. He is a very succesful investment manager and has recently written a great book - dhandho investor.
Following article from mohnish explains the key point of the post - A good company may not be a good stock and vice versa in a great (and much better) way.
Valuation by intrinsic value.
In addition you can find the links for a lot of mohnish's articles here. I strongly recommend reading each article
So crisil may not be a good example of over valuation. I am not sure how undervalued the company is. It sells at a PE of 33 (approximate Net profit of 100 odd crs for 2007). I have analysed the company earlier here …and I have underestimated the competitive advantage of this company and its ability to keep increasing its instrinsic value.
That said, if I were make my point in the post again, I would replace crisil with any of the Real estate companies or capital goods company which have a high performance hurdle to cross (due to their high PE) to deliver good returns to investors in the future.
The post was however was not an analysis of CRISL. The key point is this – A good company may not be a good stock and vice versa (important word is ‘may’) . That depends on whether the stock price fully discounts the future performance of the company or not. If one has to make money in such high PE stocks, then the actual performance has to be better than what is implied by the stock
Low PE or low valuation stocks have low expectations built in and hence a small improvement in the company performance can deliver good returns. High PE or stocks selling at high valuations are stars of the Stock market. If they stumble even a bit, the stock price can get butchered. So one has to be confident and sure that the company will meet the high expectations well into the distant future.
I have personal experience of seeing a stock drop 90% when the company was not able to meet its high expectations (see here).
Ofcourse you can say that I am not as dumb as rohit and will not make a mistake like him :)
Feb 23 :
Following quote from peter lynch is very relevant to the topic of this post
“It’s a real tragedy when you buy a stock that’s overpriced; the company is a big success and you still don’t make any money.” Peter Lynch, “One Up on Wall Street,” New York, Penguin Books, 1989, p. 244.
I am a big fan of Mohnish Pabrai. He is a very succesful investment manager and has recently written a great book - dhandho investor.
Following article from mohnish explains the key point of the post - A good company may not be a good stock and vice versa in a great (and much better) way.
Valuation by intrinsic value.
In addition you can find the links for a lot of mohnish's articles here. I strongly recommend reading each article
Thursday, February 14, 2008
Some Interesting ideas
I am analysing some of the following stocks in detail as these stock have passed my initial filters
Concor
Balmer Lawrie
GSK Smithline consumer
Disclosure – I have owned Concor and Balmer lawrie for the last few years and currently re-analysing the stocks. So my analysis could be biased. I would be posting the analysis soon.
In addition Mid-caps and some value stocks have now become even cheaper. Some companies now sell for almost or slightly less than cash on the balance sheet. I am now finding quite a few ideas to work on and hoping that the cheap would get cheaper.
In addition I am reading the following books and have found them to be good. I would definitely recommend reading both the books
More than you know by Michael J. Mauboussin
Margin of safety by seth Klarman
Concor
Balmer Lawrie
GSK Smithline consumer
Disclosure – I have owned Concor and Balmer lawrie for the last few years and currently re-analysing the stocks. So my analysis could be biased. I would be posting the analysis soon.
In addition Mid-caps and some value stocks have now become even cheaper. Some companies now sell for almost or slightly less than cash on the balance sheet. I am now finding quite a few ideas to work on and hoping that the cheap would get cheaper.
In addition I am reading the following books and have found them to be good. I would definitely recommend reading both the books
More than you know by Michael J. Mauboussin
Margin of safety by seth Klarman
Some Interesting ideas
I am analysing some of the following stocks in detail as these stock have passed my initial filters
Concor
Balmer Lawrie
GSK Smithline consumer
Disclosure – I have owned Concor and Balmer lawrie for the last few years and currently re-analysing the stocks. So my analysis could be biased. I would be posting the analysis soon.
In addition Mid-caps and some value stocks have now become even cheaper. Some companies now sell for almost or slightly less than cash on the balance sheet. I am now finding quite a few ideas to work on and hoping that the cheap would get cheaper.
In addition I am reading the following books and have found them to be good. I would definitely recommend reading both the books
More than you know by Michael J. Mauboussin
Margin of safety by seth Klarman
Concor
Balmer Lawrie
GSK Smithline consumer
Disclosure – I have owned Concor and Balmer lawrie for the last few years and currently re-analysing the stocks. So my analysis could be biased. I would be posting the analysis soon.
In addition Mid-caps and some value stocks have now become even cheaper. Some companies now sell for almost or slightly less than cash on the balance sheet. I am now finding quite a few ideas to work on and hoping that the cheap would get cheaper.
In addition I am reading the following books and have found them to be good. I would definitely recommend reading both the books
More than you know by Michael J. Mauboussin
Margin of safety by seth Klarman
Sunday, February 10, 2008
Using puts to reduce cost basis
A thought experiment -
Lets assume you find a stock which is undervalued and it is liquid (otherwise you may not get options on it). You buy the stock and would continue to buy if the price were to drop further (the critical point). In addition you sell puts for strike price say, 20% below the current price.
If the price does not drop, you keep the premium and reduce your cost basis. If the price drops by more than 20%, the put gets exercised and you buy the stock (which you any way planned to do so).
The key objections to this strategy could be
· Does not work with illiquid, lesser known stocks which are more likely to be undervalued
· if the price drops more than the strike price, say 30% then I am losing out on the additional 10% cost of the stock . In worst case scenario if I have mis-analysed the stock I could be in a lot of trouble as I may end up incurring huge losses in that scenario.
· Someone has to be ready to buy these puts (puts should be saleable)
· Stock has to be volatile enough to make the puts attractive and worth the effort
· Contract size – Does the contract size fit with the investment plan. May not work out for an investment plan of a few hundred shares in some cases
A few other cases
· Buying undervalued stock and sell calls at 60-70% above strike price
· Buying long term options on a stock (LEAPS in the US ..not sure if available in India)
I have analysed a few cases such as the above in the past. However once I have looked at the possible scenarios which can play out, done an expected value analysis and compared it with the cost, most of the cases turn out to be low in returns and moderate to high in risk.
Please feel free to comment on the above strategy or any better ones you may have tried.
Lets assume you find a stock which is undervalued and it is liquid (otherwise you may not get options on it). You buy the stock and would continue to buy if the price were to drop further (the critical point). In addition you sell puts for strike price say, 20% below the current price.
If the price does not drop, you keep the premium and reduce your cost basis. If the price drops by more than 20%, the put gets exercised and you buy the stock (which you any way planned to do so).
The key objections to this strategy could be
· Does not work with illiquid, lesser known stocks which are more likely to be undervalued
· if the price drops more than the strike price, say 30% then I am losing out on the additional 10% cost of the stock . In worst case scenario if I have mis-analysed the stock I could be in a lot of trouble as I may end up incurring huge losses in that scenario.
· Someone has to be ready to buy these puts (puts should be saleable)
· Stock has to be volatile enough to make the puts attractive and worth the effort
· Contract size – Does the contract size fit with the investment plan. May not work out for an investment plan of a few hundred shares in some cases
A few other cases
· Buying undervalued stock and sell calls at 60-70% above strike price
· Buying long term options on a stock (LEAPS in the US ..not sure if available in India)
I have analysed a few cases such as the above in the past. However once I have looked at the possible scenarios which can play out, done an expected value analysis and compared it with the cost, most of the cases turn out to be low in returns and moderate to high in risk.
Please feel free to comment on the above strategy or any better ones you may have tried.
Using puts to reduce cost basis
A thought experiment -
Lets assume you find a stock which is undervalued and it is liquid (otherwise you may not get options on it). You buy the stock and would continue to buy if the price were to drop further (the critical point). In addition you sell puts for strike price say, 20% below the current price.
If the price does not drop, you keep the premium and reduce your cost basis. If the price drops by more than 20%, the put gets exercised and you buy the stock (which you any way planned to do so).
The key objections to this strategy could be
· Does not work with illiquid, lesser known stocks which are more likely to be undervalued
· if the price drops more than the strike price, say 30% then I am losing out on the additional 10% cost of the stock . In worst case scenario if I have mis-analysed the stock I could be in a lot of trouble as I may end up incurring huge losses in that scenario.
· Someone has to be ready to buy these puts (puts should be saleable)
· Stock has to be volatile enough to make the puts attractive and worth the effort
· Contract size – Does the contract size fit with the investment plan. May not work out for an investment plan of a few hundred shares in some cases
A few other cases
· Buying undervalued stock and sell calls at 60-70% above strike price
· Buying long term options on a stock (LEAPS in the US ..not sure if available in India)
I have analysed a few cases such as the above in the past. However once I have looked at the possible scenarios which can play out, done an expected value analysis and compared it with the cost, most of the cases turn out to be low in returns and moderate to high in risk.
Please feel free to comment on the above strategy or any better ones you may have tried.
Lets assume you find a stock which is undervalued and it is liquid (otherwise you may not get options on it). You buy the stock and would continue to buy if the price were to drop further (the critical point). In addition you sell puts for strike price say, 20% below the current price.
If the price does not drop, you keep the premium and reduce your cost basis. If the price drops by more than 20%, the put gets exercised and you buy the stock (which you any way planned to do so).
The key objections to this strategy could be
· Does not work with illiquid, lesser known stocks which are more likely to be undervalued
· if the price drops more than the strike price, say 30% then I am losing out on the additional 10% cost of the stock . In worst case scenario if I have mis-analysed the stock I could be in a lot of trouble as I may end up incurring huge losses in that scenario.
· Someone has to be ready to buy these puts (puts should be saleable)
· Stock has to be volatile enough to make the puts attractive and worth the effort
· Contract size – Does the contract size fit with the investment plan. May not work out for an investment plan of a few hundred shares in some cases
A few other cases
· Buying undervalued stock and sell calls at 60-70% above strike price
· Buying long term options on a stock (LEAPS in the US ..not sure if available in India)
I have analysed a few cases such as the above in the past. However once I have looked at the possible scenarios which can play out, done an expected value analysis and compared it with the cost, most of the cases turn out to be low in returns and moderate to high in risk.
Please feel free to comment on the above strategy or any better ones you may have tried.
Wednesday, February 06, 2008
Futures, Options and hedging
If your first thought is – Options and value investing …what a combination? You are not alone. You will rarely find discussions on options and derivatives in books and articles on value investing. But then just because most value investors don’t talk about options, does not mean one should not even try to understand them.
That said, let me clarify – I am not an expert, heck not even a novice on options. I have read a few books on options and derivatives, bought a few here and there. However I am planning to read up more on options and understand them better – it would improve my understanding of probability.
Most of the discussions I have seen on options is around the strike price. A lot of investors look at options as leveraged bets on the stock price. It goes like this – Lets assume I am bullish on L&T (who isn’t :) !).
The current price is around 2500 (for argument sake). I expect it to rise by 20% in the next 6 months. So instead of investing 250000 and making 20% on that, I can invest buy 2500 contracts (for argument sake each contract is 100 Rs) and if the prices increases by 20%, then each contract is worth 500 Rs ( 2500*1.2- 2500). So I have made 5 times my investment. So I have leveraged my bet. The downside is that if price drops, I am out of the entire 250000
The above math is not accurate, but depicts the basic argument. The problem is that short of having a crystal ball, it is difficult to know what the future price would be. In addition to getting the price right, I need to get the timing right. If the contract expires in 6 months and the rise increases after that, I may be right but still lose money. Finally I am not sure how profitable this strategy is in the long term (net of all profits and losses) as one keeps losing money often and makes money in chunks a few times.
I think value investing principles, not in its traditional sense, are still relevant when investing in futures and options. Let me explain –
Options pricing is generally dependent on the following variables
- strike price
- time for expiration
- Interest rates
- Volatility
Value investing is about find undervalued securities which can include options. That would mean figuring out the option pricing based on the above variables and comparing it with the market prices. If the market prices are lower than the actual price, then it makes sense to buy the options. I have read about it, but have never tried it myself. In addition I think the options pricing is far more efficient and hence it is not easy to make money this way.
The second approach would be to look at options to help in hedging my portfolio. For example if I plan to sell part of my portfolio in the next couple of months as they seem to overvalued, I would like to buy put options to hedge those specific stocks. This however works only for specific stocks and is not useful as a general strategy.
The last approach is to buy long term call/put options on stocks which I think are undervalued. That would be equivalent of making a leveraged long term bet on a stock. However it suffers from the same, time related disadvantage I discussed earlier and also from the lack of such options in the Indian market (not sure if we have these options at all)
In summary I see options currently as an insurance against market crashes. However due the cost factor I need to still figure out if it is profitable to protect the portfolio against such crashes in the long term.
Ps: I would appreciate if anyone can suggest some good books on options and option pricing etc.
That said, let me clarify – I am not an expert, heck not even a novice on options. I have read a few books on options and derivatives, bought a few here and there. However I am planning to read up more on options and understand them better – it would improve my understanding of probability.
Most of the discussions I have seen on options is around the strike price. A lot of investors look at options as leveraged bets on the stock price. It goes like this – Lets assume I am bullish on L&T (who isn’t :) !).
The current price is around 2500 (for argument sake). I expect it to rise by 20% in the next 6 months. So instead of investing 250000 and making 20% on that, I can invest buy 2500 contracts (for argument sake each contract is 100 Rs) and if the prices increases by 20%, then each contract is worth 500 Rs ( 2500*1.2- 2500). So I have made 5 times my investment. So I have leveraged my bet. The downside is that if price drops, I am out of the entire 250000
The above math is not accurate, but depicts the basic argument. The problem is that short of having a crystal ball, it is difficult to know what the future price would be. In addition to getting the price right, I need to get the timing right. If the contract expires in 6 months and the rise increases after that, I may be right but still lose money. Finally I am not sure how profitable this strategy is in the long term (net of all profits and losses) as one keeps losing money often and makes money in chunks a few times.
I think value investing principles, not in its traditional sense, are still relevant when investing in futures and options. Let me explain –
Options pricing is generally dependent on the following variables
- strike price
- time for expiration
- Interest rates
- Volatility
Value investing is about find undervalued securities which can include options. That would mean figuring out the option pricing based on the above variables and comparing it with the market prices. If the market prices are lower than the actual price, then it makes sense to buy the options. I have read about it, but have never tried it myself. In addition I think the options pricing is far more efficient and hence it is not easy to make money this way.
The second approach would be to look at options to help in hedging my portfolio. For example if I plan to sell part of my portfolio in the next couple of months as they seem to overvalued, I would like to buy put options to hedge those specific stocks. This however works only for specific stocks and is not useful as a general strategy.
The last approach is to buy long term call/put options on stocks which I think are undervalued. That would be equivalent of making a leveraged long term bet on a stock. However it suffers from the same, time related disadvantage I discussed earlier and also from the lack of such options in the Indian market (not sure if we have these options at all)
In summary I see options currently as an insurance against market crashes. However due the cost factor I need to still figure out if it is profitable to protect the portfolio against such crashes in the long term.
Ps: I would appreciate if anyone can suggest some good books on options and option pricing etc.
Futures, Options and hedging
If your first thought is – Options and value investing …what a combination? You are not alone. You will rarely find discussions on options and derivatives in books and articles on value investing. But then just because most value investors don’t talk about options, does not mean one should not even try to understand them.
That said, let me clarify – I am not an expert, heck not even a novice on options. I have read a few books on options and derivatives, bought a few here and there. However I am planning to read up more on options and understand them better – it would improve my understanding of probability.
Most of the discussions I have seen on options is around the strike price. A lot of investors look at options as leveraged bets on the stock price. It goes like this – Lets assume I am bullish on L&T (who isn’t :) !).
The current price is around 2500 (for argument sake). I expect it to rise by 20% in the next 6 months. So instead of investing 250000 and making 20% on that, I can invest buy 2500 contracts (for argument sake each contract is 100 Rs) and if the prices increases by 20%, then each contract is worth 500 Rs ( 2500*1.2- 2500). So I have made 5 times my investment. So I have leveraged my bet. The downside is that if price drops, I am out of the entire 250000
The above math is not accurate, but depicts the basic argument. The problem is that short of having a crystal ball, it is difficult to know what the future price would be. In addition to getting the price right, I need to get the timing right. If the contract expires in 6 months and the rise increases after that, I may be right but still lose money. Finally I am not sure how profitable this strategy is in the long term (net of all profits and losses) as one keeps losing money often and makes money in chunks a few times.
I think value investing principles, not in its traditional sense, are still relevant when investing in futures and options. Let me explain –
Options pricing is generally dependent on the following variables
- strike price
- time for expiration
- Interest rates
- Volatility
Value investing is about find undervalued securities which can include options. That would mean figuring out the option pricing based on the above variables and comparing it with the market prices. If the market prices are lower than the actual price, then it makes sense to buy the options. I have read about it, but have never tried it myself. In addition I think the options pricing is far more efficient and hence it is not easy to make money this way.
The second approach would be to look at options to help in hedging my portfolio. For example if I plan to sell part of my portfolio in the next couple of months as they seem to overvalued, I would like to buy put options to hedge those specific stocks. This however works only for specific stocks and is not useful as a general strategy.
The last approach is to buy long term call/put options on stocks which I think are undervalued. That would be equivalent of making a leveraged long term bet on a stock. However it suffers from the same, time related disadvantage I discussed earlier and also from the lack of such options in the Indian market (not sure if we have these options at all)
In summary I see options currently as an insurance against market crashes. However due the cost factor I need to still figure out if it is profitable to protect the portfolio against such crashes in the long term.
Ps: I would appreciate if anyone can suggest some good books on options and option pricing etc.
That said, let me clarify – I am not an expert, heck not even a novice on options. I have read a few books on options and derivatives, bought a few here and there. However I am planning to read up more on options and understand them better – it would improve my understanding of probability.
Most of the discussions I have seen on options is around the strike price. A lot of investors look at options as leveraged bets on the stock price. It goes like this – Lets assume I am bullish on L&T (who isn’t :) !).
The current price is around 2500 (for argument sake). I expect it to rise by 20% in the next 6 months. So instead of investing 250000 and making 20% on that, I can invest buy 2500 contracts (for argument sake each contract is 100 Rs) and if the prices increases by 20%, then each contract is worth 500 Rs ( 2500*1.2- 2500). So I have made 5 times my investment. So I have leveraged my bet. The downside is that if price drops, I am out of the entire 250000
The above math is not accurate, but depicts the basic argument. The problem is that short of having a crystal ball, it is difficult to know what the future price would be. In addition to getting the price right, I need to get the timing right. If the contract expires in 6 months and the rise increases after that, I may be right but still lose money. Finally I am not sure how profitable this strategy is in the long term (net of all profits and losses) as one keeps losing money often and makes money in chunks a few times.
I think value investing principles, not in its traditional sense, are still relevant when investing in futures and options. Let me explain –
Options pricing is generally dependent on the following variables
- strike price
- time for expiration
- Interest rates
- Volatility
Value investing is about find undervalued securities which can include options. That would mean figuring out the option pricing based on the above variables and comparing it with the market prices. If the market prices are lower than the actual price, then it makes sense to buy the options. I have read about it, but have never tried it myself. In addition I think the options pricing is far more efficient and hence it is not easy to make money this way.
The second approach would be to look at options to help in hedging my portfolio. For example if I plan to sell part of my portfolio in the next couple of months as they seem to overvalued, I would like to buy put options to hedge those specific stocks. This however works only for specific stocks and is not useful as a general strategy.
The last approach is to buy long term call/put options on stocks which I think are undervalued. That would be equivalent of making a leveraged long term bet on a stock. However it suffers from the same, time related disadvantage I discussed earlier and also from the lack of such options in the Indian market (not sure if we have these options at all)
In summary I see options currently as an insurance against market crashes. However due the cost factor I need to still figure out if it is profitable to protect the portfolio against such crashes in the long term.
Ps: I would appreciate if anyone can suggest some good books on options and option pricing etc.
Friday, February 01, 2008
Seesaw markets,my plans, a good book and market crisis
The month of jan was a complete rollcoaster. Initially the market shotup, then crashed and now seems to go one step forward and one step backward.
One could have made a killing shorting the market or by buying puts. I however did none of that. I personally need to do more homework in that area to venture into it. However I do see puts as a decent option to hedge the portfolio. The part I still need to work out is this -
Most options expire worthless. The reason is that the options market is fairly efficient, definitely more than straight equity. So is it possible to buy puts over the long term, make money a few times only and still have a decent return after all the costs ?
Some of my own holdings, some of which I have discussed (and some not), have declined below 50% of intrinsic value. Earlier I would get mixed feeling – pained by the decline and excited by the opportunity to buy more. Now I get more excited than pained. I however try to re-analyse the position and check if I have missed something which the market is discounting. In the past my key mistake was not putting more money into such ideas – Blue star, concor, Pidilite etc.
I just finished reading the book – A demon of our own design. I am not going ga ga over it. However it is a good book. This book came out 6-8 months back and is fairly presceint of the current subprime crisis. The book discusses the past crises like the 1987 US market crash and the LTCM collapse. One key point the author makes is that the main cause of the market crises is tight coupling and complexity.
Complexity in the markets is mainly due to the complex instruments such as CDO, derivatives etc which very few understand. In addition these instruments are non linear and it is diffcult to model them. That’s why a lot of the companies holding these instruments are not able to compute their value and appear clueless. By tight coupling the author means is refering to the linkages between companies and markets. That is easy to see even in India. 10 years back a subprime crisis would not have affected the Indian markets. However inspite of no direct exposure, indirect linkages via hedge funds and FII are causing these wild swings in the market. All in all a decent book.
I am a big fan of warren buffett and have read his annual reports several times. He purchased a company called GenRe in 1999 and wound down their derivative operations over 3-4 years. This was done during normal times and by one of the smartest investors around. Inspite of that the company took 400Mn or higher writedowns. Buffett noted in his letter then (2002 I think) that inspite of such orderly and planned unwinding, they faced such losses for such a small derivative operation. The larger banks (read citi, JP morgan and others) may face much higher losses if they have to unwind their derivatives during a market crisis (now).
So personally I think market problems are far from over and we may get more buying opportunities in the future. Will the market crash or will it be a bear market?? ..i don’t know. Either way I think it would be good to keep some cash around to take advantage of opportunities as they come up.
One could have made a killing shorting the market or by buying puts. I however did none of that. I personally need to do more homework in that area to venture into it. However I do see puts as a decent option to hedge the portfolio. The part I still need to work out is this -
Most options expire worthless. The reason is that the options market is fairly efficient, definitely more than straight equity. So is it possible to buy puts over the long term, make money a few times only and still have a decent return after all the costs ?
Some of my own holdings, some of which I have discussed (and some not), have declined below 50% of intrinsic value. Earlier I would get mixed feeling – pained by the decline and excited by the opportunity to buy more. Now I get more excited than pained. I however try to re-analyse the position and check if I have missed something which the market is discounting. In the past my key mistake was not putting more money into such ideas – Blue star, concor, Pidilite etc.
I just finished reading the book – A demon of our own design. I am not going ga ga over it. However it is a good book. This book came out 6-8 months back and is fairly presceint of the current subprime crisis. The book discusses the past crises like the 1987 US market crash and the LTCM collapse. One key point the author makes is that the main cause of the market crises is tight coupling and complexity.
Complexity in the markets is mainly due to the complex instruments such as CDO, derivatives etc which very few understand. In addition these instruments are non linear and it is diffcult to model them. That’s why a lot of the companies holding these instruments are not able to compute their value and appear clueless. By tight coupling the author means is refering to the linkages between companies and markets. That is easy to see even in India. 10 years back a subprime crisis would not have affected the Indian markets. However inspite of no direct exposure, indirect linkages via hedge funds and FII are causing these wild swings in the market. All in all a decent book.
I am a big fan of warren buffett and have read his annual reports several times. He purchased a company called GenRe in 1999 and wound down their derivative operations over 3-4 years. This was done during normal times and by one of the smartest investors around. Inspite of that the company took 400Mn or higher writedowns. Buffett noted in his letter then (2002 I think) that inspite of such orderly and planned unwinding, they faced such losses for such a small derivative operation. The larger banks (read citi, JP morgan and others) may face much higher losses if they have to unwind their derivatives during a market crisis (now).
So personally I think market problems are far from over and we may get more buying opportunities in the future. Will the market crash or will it be a bear market?? ..i don’t know. Either way I think it would be good to keep some cash around to take advantage of opportunities as they come up.
Seesaw markets,my plans, a good book and market crisis
The month of jan was a complete rollcoaster. Initially the market shotup, then crashed and now seems to go one step forward and one step backward.
One could have made a killing shorting the market or by buying puts. I however did none of that. I personally need to do more homework in that area to venture into it. However I do see puts as a decent option to hedge the portfolio. The part I still need to work out is this -
Most options expire worthless. The reason is that the options market is fairly efficient, definitely more than straight equity. So is it possible to buy puts over the long term, make money a few times only and still have a decent return after all the costs ?
Some of my own holdings, some of which I have discussed (and some not), have declined below 50% of intrinsic value. Earlier I would get mixed feeling – pained by the decline and excited by the opportunity to buy more. Now I get more excited than pained. I however try to re-analyse the position and check if I have missed something which the market is discounting. In the past my key mistake was not putting more money into such ideas – Blue star, concor, Pidilite etc.
I just finished reading the book – A demon of our own design. I am not going ga ga over it. However it is a good book. This book came out 6-8 months back and is fairly presceint of the current subprime crisis. The book discusses the past crises like the 1987 US market crash and the LTCM collapse. One key point the author makes is that the main cause of the market crises is tight coupling and complexity.
Complexity in the markets is mainly due to the complex instruments such as CDO, derivatives etc which very few understand. In addition these instruments are non linear and it is diffcult to model them. That’s why a lot of the companies holding these instruments are not able to compute their value and appear clueless. By tight coupling the author means is refering to the linkages between companies and markets. That is easy to see even in India. 10 years back a subprime crisis would not have affected the Indian markets. However inspite of no direct exposure, indirect linkages via hedge funds and FII are causing these wild swings in the market. All in all a decent book.
I am a big fan of warren buffett and have read his annual reports several times. He purchased a company called GenRe in 1999 and wound down their derivative operations over 3-4 years. This was done during normal times and by one of the smartest investors around. Inspite of that the company took 400Mn or higher writedowns. Buffett noted in his letter then (2002 I think) that inspite of such orderly and planned unwinding, they faced such losses for such a small derivative operation. The larger banks (read citi, JP morgan and others) may face much higher losses if they have to unwind their derivatives during a market crisis (now).
So personally I think market problems are far from over and we may get more buying opportunities in the future. Will the market crash or will it be a bear market?? ..i don’t know. Either way I think it would be good to keep some cash around to take advantage of opportunities as they come up.
One could have made a killing shorting the market or by buying puts. I however did none of that. I personally need to do more homework in that area to venture into it. However I do see puts as a decent option to hedge the portfolio. The part I still need to work out is this -
Most options expire worthless. The reason is that the options market is fairly efficient, definitely more than straight equity. So is it possible to buy puts over the long term, make money a few times only and still have a decent return after all the costs ?
Some of my own holdings, some of which I have discussed (and some not), have declined below 50% of intrinsic value. Earlier I would get mixed feeling – pained by the decline and excited by the opportunity to buy more. Now I get more excited than pained. I however try to re-analyse the position and check if I have missed something which the market is discounting. In the past my key mistake was not putting more money into such ideas – Blue star, concor, Pidilite etc.
I just finished reading the book – A demon of our own design. I am not going ga ga over it. However it is a good book. This book came out 6-8 months back and is fairly presceint of the current subprime crisis. The book discusses the past crises like the 1987 US market crash and the LTCM collapse. One key point the author makes is that the main cause of the market crises is tight coupling and complexity.
Complexity in the markets is mainly due to the complex instruments such as CDO, derivatives etc which very few understand. In addition these instruments are non linear and it is diffcult to model them. That’s why a lot of the companies holding these instruments are not able to compute their value and appear clueless. By tight coupling the author means is refering to the linkages between companies and markets. That is easy to see even in India. 10 years back a subprime crisis would not have affected the Indian markets. However inspite of no direct exposure, indirect linkages via hedge funds and FII are causing these wild swings in the market. All in all a decent book.
I am a big fan of warren buffett and have read his annual reports several times. He purchased a company called GenRe in 1999 and wound down their derivative operations over 3-4 years. This was done during normal times and by one of the smartest investors around. Inspite of that the company took 400Mn or higher writedowns. Buffett noted in his letter then (2002 I think) that inspite of such orderly and planned unwinding, they faced such losses for such a small derivative operation. The larger banks (read citi, JP morgan and others) may face much higher losses if they have to unwind their derivatives during a market crisis (now).
So personally I think market problems are far from over and we may get more buying opportunities in the future. Will the market crash or will it be a bear market?? ..i don’t know. Either way I think it would be good to keep some cash around to take advantage of opportunities as they come up.
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