Berkshire hathaway (warren buffett’s company) is having their annual meeting over this weekend. This meeting is called the woodstock of capitalists. I have been reading and following buffett for the last 10 years and tend to read his every interview, speech and the Q&A session of the annual meetings.
You can find a great compilation of everything buffett here
His letter to shareholder are a must read and I would recommend reading them multiple times.
Berkshire declared their quarterly results and reported a 65% drop in profits. Although as an indian investor, we cannot invest in this company, I would recommend reading the letter to shareholders and analysing the company to learn how a great company works and what it means to be shareholder oriented (the company is a gold standard).
I cannot explain the company in detail here. However if you have been following the company and have an idea about it, below is my analysis of the cause of the drop in profits.
Buffett has called derivatives as financial weapons of mass destruction and has cautioned against them. I am pretty sure that media, seeing a drop in profits due to derivatives, would crow about how the world’s greatest investor has himself got burnt by the same. However one has to understand that though buffett has warned against using derivatives if the company cannot understand the risks behind it, he himself understands them better than most and clearly knows what he is doing.
The quarter’s loss have been due to mark to market loss on the put options and CDS written by buffett. The put option buffett has written is similar to supercat insurance written by the company. The company gets a premium and insures a low probability event. if the event occurs then the company has to pay the insured amount. now over the years buffett has indicated the they could lose money on specific policies, but over a long term , they work with the odds on their side and would make a profit.
In case of the put, although we do not have the specific details, i would assume a similar approach. In addition buffett has indicated that he looks at the exposure also (total max loss) and no matter what the odds would never risk a huge amount. The puts are deep puts and the odds of the markets being lower 20 years later is low (we dont know what is the strike price of the puts, but they are based on the index and not on a company).
Berkshire accounts for MTM losses or profits which are accounting or book keeping losses/ profits if the options are closed today (unlikely to happen). So the company gets to keep the premium, invest it and get a good return from it for the next 20 years. This is on a low probability event that the market would be way lower 20 years later, in which case the company may well exercise the put and buy the index at the ultra-low valuations.
You would think that if the above is such a good deal, then why are other companies not doing it?
It is explained in the current year’s letter to shareholder and I can think of the following reasons
- The accounting as we can see in this quarter is very volatile. There are almost no companies which would risk a billion dollar hit to their results via such derivatives. The CEO would lose his job for such results
- There is counter party risk too. The buyer of the put option should believe that the company writing the put will be around 20 years later to pay up. Very few companies can do that
ofcourse media is going to make a show about this drop as they dont understand the company or how the options in this case are different from the one's written by banks and other financial institutions.
Saturday, May 03, 2008
Berkshire hathaway annual meeting and quarterly results
Berkshire hathaway (warren buffett’s company) is having their annual meeting over this weekend. This meeting is called the woodstock of capitalists. I have been reading and following buffett for the last 10 years and tend to read his every interview, speech and the Q&A session of the annual meetings.
You can find a great compilation of everything buffett here
His letter to shareholder are a must read and I would recommend reading them multiple times.
Berkshire declared their quarterly results and reported a 65% drop in profits. Although as an indian investor, we cannot invest in this company, I would recommend reading the letter to shareholders and analysing the company to learn how a great company works and what it means to be shareholder oriented (the company is a gold standard).
I cannot explain the company in detail here. However if you have been following the company and have an idea about it, below is my analysis of the cause of the drop in profits.
Buffett has called derivatives as financial weapons of mass destruction and has cautioned against them. I am pretty sure that media, seeing a drop in profits due to derivatives, would crow about how the world’s greatest investor has himself got burnt by the same. However one has to understand that though buffett has warned against using derivatives if the company cannot understand the risks behind it, he himself understands them better than most and clearly knows what he is doing.
The quarter’s loss have been due to mark to market loss on the put options and CDS written by buffett. The put option buffett has written is similar to supercat insurance written by the company. The company gets a premium and insures a low probability event. if the event occurs then the company has to pay the insured amount. now over the years buffett has indicated the they could lose money on specific policies, but over a long term , they work with the odds on their side and would make a profit.
In case of the put, although we do not have the specific details, i would assume a similar approach. In addition buffett has indicated that he looks at the exposure also (total max loss) and no matter what the odds would never risk a huge amount. The puts are deep puts and the odds of the markets being lower 20 years later is low (we dont know what is the strike price of the puts, but they are based on the index and not on a company).
Berkshire accounts for MTM losses or profits which are accounting or book keeping losses/ profits if the options are closed today (unlikely to happen). So the company gets to keep the premium, invest it and get a good return from it for the next 20 years. This is on a low probability event that the market would be way lower 20 years later, in which case the company may well exercise the put and buy the index at the ultra-low valuations.
You would think that if the above is such a good deal, then why are other companies not doing it?
It is explained in the current year’s letter to shareholder and I can think of the following reasons
- The accounting as we can see in this quarter is very volatile. There are almost no companies which would risk a billion dollar hit to their results via such derivatives. The CEO would lose his job for such results
- There is counter party risk too. The buyer of the put option should believe that the company writing the put will be around 20 years later to pay up. Very few companies can do that
ofcourse media is going to make a show about this drop as they dont understand the company or how the options in this case are different from the one's written by banks and other financial institutions.
You can find a great compilation of everything buffett here
His letter to shareholder are a must read and I would recommend reading them multiple times.
Berkshire declared their quarterly results and reported a 65% drop in profits. Although as an indian investor, we cannot invest in this company, I would recommend reading the letter to shareholders and analysing the company to learn how a great company works and what it means to be shareholder oriented (the company is a gold standard).
I cannot explain the company in detail here. However if you have been following the company and have an idea about it, below is my analysis of the cause of the drop in profits.
Buffett has called derivatives as financial weapons of mass destruction and has cautioned against them. I am pretty sure that media, seeing a drop in profits due to derivatives, would crow about how the world’s greatest investor has himself got burnt by the same. However one has to understand that though buffett has warned against using derivatives if the company cannot understand the risks behind it, he himself understands them better than most and clearly knows what he is doing.
The quarter’s loss have been due to mark to market loss on the put options and CDS written by buffett. The put option buffett has written is similar to supercat insurance written by the company. The company gets a premium and insures a low probability event. if the event occurs then the company has to pay the insured amount. now over the years buffett has indicated the they could lose money on specific policies, but over a long term , they work with the odds on their side and would make a profit.
In case of the put, although we do not have the specific details, i would assume a similar approach. In addition buffett has indicated that he looks at the exposure also (total max loss) and no matter what the odds would never risk a huge amount. The puts are deep puts and the odds of the markets being lower 20 years later is low (we dont know what is the strike price of the puts, but they are based on the index and not on a company).
Berkshire accounts for MTM losses or profits which are accounting or book keeping losses/ profits if the options are closed today (unlikely to happen). So the company gets to keep the premium, invest it and get a good return from it for the next 20 years. This is on a low probability event that the market would be way lower 20 years later, in which case the company may well exercise the put and buy the index at the ultra-low valuations.
You would think that if the above is such a good deal, then why are other companies not doing it?
It is explained in the current year’s letter to shareholder and I can think of the following reasons
- The accounting as we can see in this quarter is very volatile. There are almost no companies which would risk a billion dollar hit to their results via such derivatives. The CEO would lose his job for such results
- There is counter party risk too. The buyer of the put option should believe that the company writing the put will be around 20 years later to pay up. Very few companies can do that
ofcourse media is going to make a show about this drop as they dont understand the company or how the options in this case are different from the one's written by banks and other financial institutions.
Thursday, May 01, 2008
Business scalability and valuation
My pervious post was about business scalability, a term used by Rakesh jhunjhunwala frequently. I attempted to lay out my understanding of the term in that post.
Business scalability is a critical factor in valuation. As I detailed on my post on intrinsic value, the DCF formulae can be used to calculate this number. There are two key variables in the formuale – Free cash flow and the duration of the same before the terminal value is applied. This duration also referred to as CAP (competitive advantage period) is the time period during which the company is able to earn above its cost of capital. Beyond this period the company earns its cost of capital and hence is valued at its terminal value.
A company with a scalable business will be able to grow its free cash flow faster (higher growth) and also have a higher CAP at the same time. Now higher the growth and CAP, higher is the intrinsic value. If you can identify such a company much before the market does, as Rakesh jhunjhunwala and other top investors are able to, then the returns are very very high.
However identifying such companies is not easy. The most common error I have seen with analysts is that they identify the market opportunity, pick a company most likely to do well and stop at that. The analysis should also involve analysing the business model in detail, identifying the key drivers of performance and doing an assessment of these drivers. If this sounds complicated, then it is. The value is not easily apparent and requires quite a bit of analysis and digging around. All this has to be done before the market recognizes the company and bids up the price.
I think this approach to investing is a very advanced form of investing. It is not easy for a novice investor to practise this form of investing easily. One should have a keen understanding of business models, valuations, economics and other aspects of investing. Graham or deep value investing requires much lesser expertise and also has more diversification of risk. However this form of investing, where an investor can correctly identify a scalable business, is the key to long term riches.
Business scalability is a critical factor in valuation. As I detailed on my post on intrinsic value, the DCF formulae can be used to calculate this number. There are two key variables in the formuale – Free cash flow and the duration of the same before the terminal value is applied. This duration also referred to as CAP (competitive advantage period) is the time period during which the company is able to earn above its cost of capital. Beyond this period the company earns its cost of capital and hence is valued at its terminal value.
A company with a scalable business will be able to grow its free cash flow faster (higher growth) and also have a higher CAP at the same time. Now higher the growth and CAP, higher is the intrinsic value. If you can identify such a company much before the market does, as Rakesh jhunjhunwala and other top investors are able to, then the returns are very very high.
However identifying such companies is not easy. The most common error I have seen with analysts is that they identify the market opportunity, pick a company most likely to do well and stop at that. The analysis should also involve analysing the business model in detail, identifying the key drivers of performance and doing an assessment of these drivers. If this sounds complicated, then it is. The value is not easily apparent and requires quite a bit of analysis and digging around. All this has to be done before the market recognizes the company and bids up the price.
I think this approach to investing is a very advanced form of investing. It is not easy for a novice investor to practise this form of investing easily. One should have a keen understanding of business models, valuations, economics and other aspects of investing. Graham or deep value investing requires much lesser expertise and also has more diversification of risk. However this form of investing, where an investor can correctly identify a scalable business, is the key to long term riches.
Business scalability and valuation
My pervious post was about business scalability, a term used by Rakesh jhunjhunwala frequently. I attempted to lay out my understanding of the term in that post.
Business scalability is a critical factor in valuation. As I detailed on my post on intrinsic value, the DCF formulae can be used to calculate this number. There are two key variables in the formuale – Free cash flow and the duration of the same before the terminal value is applied. This duration also referred to as CAP (competitive advantage period) is the time period during which the company is able to earn above its cost of capital. Beyond this period the company earns its cost of capital and hence is valued at its terminal value.
A company with a scalable business will be able to grow its free cash flow faster (higher growth) and also have a higher CAP at the same time. Now higher the growth and CAP, higher is the intrinsic value. If you can identify such a company much before the market does, as Rakesh jhunjhunwala and other top investors are able to, then the returns are very very high.
However identifying such companies is not easy. The most common error I have seen with analysts is that they identify the market opportunity, pick a company most likely to do well and stop at that. The analysis should also involve analysing the business model in detail, identifying the key drivers of performance and doing an assessment of these drivers. If this sounds complicated, then it is. The value is not easily apparent and requires quite a bit of analysis and digging around. All this has to be done before the market recognizes the company and bids up the price.
I think this approach to investing is a very advanced form of investing. It is not easy for a novice investor to practise this form of investing easily. One should have a keen understanding of business models, valuations, economics and other aspects of investing. Graham or deep value investing requires much lesser expertise and also has more diversification of risk. However this form of investing, where an investor can correctly identify a scalable business, is the key to long term riches.
Business scalability is a critical factor in valuation. As I detailed on my post on intrinsic value, the DCF formulae can be used to calculate this number. There are two key variables in the formuale – Free cash flow and the duration of the same before the terminal value is applied. This duration also referred to as CAP (competitive advantage period) is the time period during which the company is able to earn above its cost of capital. Beyond this period the company earns its cost of capital and hence is valued at its terminal value.
A company with a scalable business will be able to grow its free cash flow faster (higher growth) and also have a higher CAP at the same time. Now higher the growth and CAP, higher is the intrinsic value. If you can identify such a company much before the market does, as Rakesh jhunjhunwala and other top investors are able to, then the returns are very very high.
However identifying such companies is not easy. The most common error I have seen with analysts is that they identify the market opportunity, pick a company most likely to do well and stop at that. The analysis should also involve analysing the business model in detail, identifying the key drivers of performance and doing an assessment of these drivers. If this sounds complicated, then it is. The value is not easily apparent and requires quite a bit of analysis and digging around. All this has to be done before the market recognizes the company and bids up the price.
I think this approach to investing is a very advanced form of investing. It is not easy for a novice investor to practise this form of investing easily. One should have a keen understanding of business models, valuations, economics and other aspects of investing. Graham or deep value investing requires much lesser expertise and also has more diversification of risk. However this form of investing, where an investor can correctly identify a scalable business, is the key to long term riches.
Sunday, April 27, 2008
Business scalability
I received the following question from rathin and thought that this a good question which cannot be answered in a short comment.
Hi Rohit,Can you elaborate more on "Business scability"...Rakesh JhunJhunwala emphasises on that...Can you also give one practical example of a company??
Rakesh Jhunjhunwala empahsizes the term ‘business scalability’ a lot in his interviews and presentations. Let me try to give my understanding of of the term
I think business scalability should be analysed based on two key factors
1. Market opportunity – How big is the addressable market, the company is trying to target
2. Business model – How scalable is the business model in its ability to tap the above opportunity profitably
Let me expand further on the above two points via some examples
Lets take the example of Bharti or any other similar telecom company.
Market opportunity – The market opportunity is case of telecom is huge. Telecom services are still far below international level and even after years of hyper growth, there is still a large untapped market. Market opportunity is easier to identify and one can compare the indian market with other markets to get a sense of it. However the fallacy by most analysts is to take a direct linear estimation. For ex: for argument sake US consumes 20 Kg of choclate per capita per annum. India’s per capita consumption is say 100 gm. so the market opportunity is 200 times that of US.
This is a very simplistic approach and should be taken with a pinch of salt. There are far more variables involved in evaluating market opportunity and a range of values for most products and services should be considered.
Business model – This is far more complex to analyse. This is where the genius of investors such as Rakesh jhunjhunwala is apparent. They are able to evaluate the business model far in advance and are able to judge if the business model of the company can scale profitably.
For ex: In case of telecom, there is a huge upfront investment in the infrastructure, license, setting up the marketing infrastructure etc. However once these investments are done, incremental cost of gaining a Rupee of revenue is low. Such business models are far more scalable
To get technical – The marginal cost remains steady or reduces in scalable models. Such companies get more profitable as they grow.
In contrast lets look at IT companies. It is apparent that the market opportunity is large. However the business model is not as scalable as Telecom. Here the relationship of revenue and cost is at best linear. In some case there may be a disadvantage to the scale. As the company grows larger, you need to manage more employees, have more layers and there are other costs involved in managing such large organizations. The top tier IT companies now have 100000 employees . A 10% CAGR growth for next 10 years , which is not a high assumption , would take the employee strength to 1 million plus. So you are talking of model which is not as scalable as Telecom
Lets take an extreme example of a roadside eatry. The addressable market is big. However the business model is not scalable as the eatry can only serve limited geography and may be limited by the competency of its owner and the employees running it. However if the owner can develop a franchise and start licensing it, then the model is scalable. Alternatively if the owner can brand its product then it is scalable to a certain extent
Among the two factors discussed above, I think the more crucial aspect is the scalability of the business model and how competent would the management be in tapping the external opportunity.
Business scalability
I received the following question from rathin and thought that this a good question which cannot be answered in a short comment.
Hi Rohit,Can you elaborate more on "Business scability"...Rakesh JhunJhunwala emphasises on that...Can you also give one practical example of a company??
Rakesh Jhunjhunwala empahsizes the term ‘business scalability’ a lot in his interviews and presentations. Let me try to give my understanding of of the term
I think business scalability should be analysed based on two key factors
1. Market opportunity – How big is the addressable market, the company is trying to target
2. Business model – How scalable is the business model in its ability to tap the above opportunity profitably
Let me expand further on the above two points via some examples
Lets take the example of Bharti or any other similar telecom company.
Market opportunity – The market opportunity is case of telecom is huge. Telecom services are still far below international level and even after years of hyper growth, there is still a large untapped market. Market opportunity is easier to identify and one can compare the indian market with other markets to get a sense of it. However the fallacy by most analysts is to take a direct linear estimation. For ex: for argument sake US consumes 20 Kg of choclate per capita per annum. India’s per capita consumption is say 100 gm. so the market opportunity is 200 times that of US.
This is a very simplistic approach and should be taken with a pinch of salt. There are far more variables involved in evaluating market opportunity and a range of values for most products and services should be considered.
Business model – This is far more complex to analyse. This is where the genius of investors such as Rakesh jhunjhunwala is apparent. They are able to evaluate the business model far in advance and are able to judge if the business model of the company can scale profitably.
For ex: In case of telecom, there is a huge upfront investment in the infrastructure, license, setting up the marketing infrastructure etc. However once these investments are done, incremental cost of gaining a Rupee of revenue is low. Such business models are far more scalable
To get technical – The marginal cost remains steady or reduces in scalable models. Such companies get more profitable as they grow.
In contrast lets look at IT companies. It is apparent that the market opportunity is large. However the business model is not as scalable as Telecom. Here the relationship of revenue and cost is at best linear. In some case there may be a disadvantage to the scale. As the company grows larger, you need to manage more employees, have more layers and there are other costs involved in managing such large organizations. The top tier IT companies now have 100000 employees . A 10% CAGR growth for next 10 years , which is not a high assumption , would take the employee strength to 1 million plus. So you are talking of model which is not as scalable as Telecom
Lets take an extreme example of a roadside eatry. The addressable market is big. However the business model is not scalable as the eatry can only serve limited geography and may be limited by the competency of its owner and the employees running it. However if the owner can develop a franchise and start licensing it, then the model is scalable. Alternatively if the owner can brand its product then it is scalable to a certain extent
Among the two factors discussed above, I think the more crucial aspect is the scalability of the business model and how competent would the management be in tapping the external opportunity.
Wednesday, April 23, 2008
What is intrinsic value ?
In all my posts on investment ideas, I typically refer to the instrinsic value of the company. Although the definition and the concept is deceptively simple, application takes a lifetime.
What is intrinsic value – It is the total free cash flow the company will produce from now to closure of the firm. Discounting these cash flows gives the intrinsic value.
I will not be able to give a complete rundown on the DCF (discounted cash flow) computation. That could be another post, when I am really in mood to bore everyone to tears :). However the formuale for the computations is present in my valuation template – see the tab ‘DCF’
You can find the formulae here. The key parameters are free cash flow, discount rate, terminal values and growth rate. There are volumes written on each parameter and I will not get into the pros and cons of it. Let me give you how I calculate each. You can find the mechanics for each in my worksheets for companies.
Free cash flow = Net profit (after adjusting for all one time gains / losses) + depreciation – maintenance capex
Discount rate = around 12-13 %. That’s the hurdle rate for me. I don’t use any risk premium above that. Discount rate is a research topic in itself. I prefer to use a rough approach though and not tie myself up in academic acrobatics.
Growth – self-explainatory
Terminal value – It is the value of the company from the nth year ( n-1 year are the no. of CAP years) onwards. I would suggest looking at some textbook for more details as it is difficult to explain it in a short post.
I take it as 12 times Free cash flow of the previous year. Simple formulae for terminal value is NOPAT (net operating profit after tax)/ WACC (weighted average cost of capital). However let me warn you that the DCF calculations are very sensitive to the terminal value and it is important to be conservative on this parameter.
Once you have worked these numbers, you can plug them into a spreadsheet and get the intrinsic value. As you can see all these numbers are estimate and hence intrinsic value is an estimate too. The trick is in the assumptions you make. You have to be careful in making conservative assumptions, otherwise the DCF calculation could give you inflated numbers. That’s why a good valuation requires an indepth understanding of the company and its economics.
Discounted cash flow (DCF) analysis is the most fundamental way of calculating the instrinsic value. The other approaches such as PE, relative valuation which depends on comparing the valuation with other companies in the same industry etc are indirect valuation approaches. They can be used an input into the valuation process, but should not be the sole approach
What is intrinsic value – It is the total free cash flow the company will produce from now to closure of the firm. Discounting these cash flows gives the intrinsic value.
I will not be able to give a complete rundown on the DCF (discounted cash flow) computation. That could be another post, when I am really in mood to bore everyone to tears :). However the formuale for the computations is present in my valuation template – see the tab ‘DCF’
You can find the formulae here. The key parameters are free cash flow, discount rate, terminal values and growth rate. There are volumes written on each parameter and I will not get into the pros and cons of it. Let me give you how I calculate each. You can find the mechanics for each in my worksheets for companies.
Free cash flow = Net profit (after adjusting for all one time gains / losses) + depreciation – maintenance capex
Discount rate = around 12-13 %. That’s the hurdle rate for me. I don’t use any risk premium above that. Discount rate is a research topic in itself. I prefer to use a rough approach though and not tie myself up in academic acrobatics.
Growth – self-explainatory
Terminal value – It is the value of the company from the nth year ( n-1 year are the no. of CAP years) onwards. I would suggest looking at some textbook for more details as it is difficult to explain it in a short post.
I take it as 12 times Free cash flow of the previous year. Simple formulae for terminal value is NOPAT (net operating profit after tax)/ WACC (weighted average cost of capital). However let me warn you that the DCF calculations are very sensitive to the terminal value and it is important to be conservative on this parameter.
Once you have worked these numbers, you can plug them into a spreadsheet and get the intrinsic value. As you can see all these numbers are estimate and hence intrinsic value is an estimate too. The trick is in the assumptions you make. You have to be careful in making conservative assumptions, otherwise the DCF calculation could give you inflated numbers. That’s why a good valuation requires an indepth understanding of the company and its economics.
Discounted cash flow (DCF) analysis is the most fundamental way of calculating the instrinsic value. The other approaches such as PE, relative valuation which depends on comparing the valuation with other companies in the same industry etc are indirect valuation approaches. They can be used an input into the valuation process, but should not be the sole approach
What is intrinsic value ?
In all my posts on investment ideas, I typically refer to the instrinsic value of the company. Although the definition and the concept is deceptively simple, application takes a lifetime.
What is intrinsic value – It is the total free cash flow the company will produce from now to closure of the firm. Discounting these cash flows gives the intrinsic value.
I will not be able to give a complete rundown on the DCF (discounted cash flow) computation. That could be another post, when I am really in mood to bore everyone to tears :). However the formuale for the computations is present in my valuation template – see the tab ‘DCF’
You can find the formulae here. The key parameters are free cash flow, discount rate, terminal values and growth rate. There are volumes written on each parameter and I will not get into the pros and cons of it. Let me give you how I calculate each. You can find the mechanics for each in my worksheets for companies.
Free cash flow = Net profit (after adjusting for all one time gains / losses) + depreciation – maintenance capex
Discount rate = around 12-13 %. That’s the hurdle rate for me. I don’t use any risk premium above that. Discount rate is a research topic in itself. I prefer to use a rough approach though and not tie myself up in academic acrobatics.
Growth – self-explainatory
Terminal value – It is the value of the company from the nth year ( n-1 year are the no. of CAP years) onwards. I would suggest looking at some textbook for more details as it is difficult to explain it in a short post.
I take it as 12 times Free cash flow of the previous year. Simple formulae for terminal value is NOPAT (net operating profit after tax)/ WACC (weighted average cost of capital). However let me warn you that the DCF calculations are very sensitive to the terminal value and it is important to be conservative on this parameter.
Once you have worked these numbers, you can plug them into a spreadsheet and get the intrinsic value. As you can see all these numbers are estimate and hence intrinsic value is an estimate too. The trick is in the assumptions you make. You have to be careful in making conservative assumptions, otherwise the DCF calculation could give you inflated numbers. That’s why a good valuation requires an indepth understanding of the company and its economics.
Discounted cash flow (DCF) analysis is the most fundamental way of calculating the instrinsic value. The other approaches such as PE, relative valuation which depends on comparing the valuation with other companies in the same industry etc are indirect valuation approaches. They can be used an input into the valuation process, but should not be the sole approach
What is intrinsic value – It is the total free cash flow the company will produce from now to closure of the firm. Discounting these cash flows gives the intrinsic value.
I will not be able to give a complete rundown on the DCF (discounted cash flow) computation. That could be another post, when I am really in mood to bore everyone to tears :). However the formuale for the computations is present in my valuation template – see the tab ‘DCF’
You can find the formulae here. The key parameters are free cash flow, discount rate, terminal values and growth rate. There are volumes written on each parameter and I will not get into the pros and cons of it. Let me give you how I calculate each. You can find the mechanics for each in my worksheets for companies.
Free cash flow = Net profit (after adjusting for all one time gains / losses) + depreciation – maintenance capex
Discount rate = around 12-13 %. That’s the hurdle rate for me. I don’t use any risk premium above that. Discount rate is a research topic in itself. I prefer to use a rough approach though and not tie myself up in academic acrobatics.
Growth – self-explainatory
Terminal value – It is the value of the company from the nth year ( n-1 year are the no. of CAP years) onwards. I would suggest looking at some textbook for more details as it is difficult to explain it in a short post.
I take it as 12 times Free cash flow of the previous year. Simple formulae for terminal value is NOPAT (net operating profit after tax)/ WACC (weighted average cost of capital). However let me warn you that the DCF calculations are very sensitive to the terminal value and it is important to be conservative on this parameter.
Once you have worked these numbers, you can plug them into a spreadsheet and get the intrinsic value. As you can see all these numbers are estimate and hence intrinsic value is an estimate too. The trick is in the assumptions you make. You have to be careful in making conservative assumptions, otherwise the DCF calculation could give you inflated numbers. That’s why a good valuation requires an indepth understanding of the company and its economics.
Discounted cash flow (DCF) analysis is the most fundamental way of calculating the instrinsic value. The other approaches such as PE, relative valuation which depends on comparing the valuation with other companies in the same industry etc are indirect valuation approaches. They can be used an input into the valuation process, but should not be the sole approach
Friday, April 18, 2008
Change of Wind
US is in recession, Rupee is going to appreciate, wage cost is increasing, IT industry is doomed over,gone ..ok I am exaggerating. This was roughly the view just 1 month back.
I was running a few filters around that time and a lot of IT midcaps came up in the list. Some of these companies were 500 Crs+ companies selling at 2-3 times PE and 3-4 year lows. I listed a few ideas here. Since then there has been a complete change in the outlook.
The initial runup in the stocks seemed to be a correction of over-reaction in the prices. However as soon as Infosys and other results started coming out, there seems to be panic buying happening. Stocks like NIIT tech have gone up from 90 to 135, patni from 200 to around 280. So most of the IT midcaps have seen a 30-40% runup.
So whats the point, you may ask. Well I have always had a dilemma. Once I figure out that a sector or stock is undervalued, how fast should I react in building up a position ?
Based on this episode with IT midcaps, a big position,quickly would make sense. However that is a retrospective approach based on after the fact. Most of my picks go into a coma for quite some time and I typically analyse the stock further in detail for months together and build my position over the course of a few months. This approach helps as I am able to average down my cost, get a better understanding and build a decent position.
However this approach fails me in sudden runups. However in view of my overall time constraints and my need to do a detailed analysis, I prefer to take my time and build my positions. I would rather lose a few quick gains than compromise on my approach and repent later for the sloppy analysis.
In case you are wondering, I did build a position in NIIT tech and Patni computers around the major lows. This was however pure luck. It is quite possible that the opinion may change again and the prices may drop back again and i may get an opportunity to add to these positions or build new ones. Unfortunately I have no abilities to predict the future and do not follow an approach based on one. The downside to the run-up is that these stocks are no longer compelling no-brainers at current prices.
As an aside, I am seeing articles popping up saying capital goods and real estate sectors are overpriced and IT seems to be undervalued. Now you tell me !!
I was running a few filters around that time and a lot of IT midcaps came up in the list. Some of these companies were 500 Crs+ companies selling at 2-3 times PE and 3-4 year lows. I listed a few ideas here. Since then there has been a complete change in the outlook.
The initial runup in the stocks seemed to be a correction of over-reaction in the prices. However as soon as Infosys and other results started coming out, there seems to be panic buying happening. Stocks like NIIT tech have gone up from 90 to 135, patni from 200 to around 280. So most of the IT midcaps have seen a 30-40% runup.
So whats the point, you may ask. Well I have always had a dilemma. Once I figure out that a sector or stock is undervalued, how fast should I react in building up a position ?
Based on this episode with IT midcaps, a big position,quickly would make sense. However that is a retrospective approach based on after the fact. Most of my picks go into a coma for quite some time and I typically analyse the stock further in detail for months together and build my position over the course of a few months. This approach helps as I am able to average down my cost, get a better understanding and build a decent position.
However this approach fails me in sudden runups. However in view of my overall time constraints and my need to do a detailed analysis, I prefer to take my time and build my positions. I would rather lose a few quick gains than compromise on my approach and repent later for the sloppy analysis.
In case you are wondering, I did build a position in NIIT tech and Patni computers around the major lows. This was however pure luck. It is quite possible that the opinion may change again and the prices may drop back again and i may get an opportunity to add to these positions or build new ones. Unfortunately I have no abilities to predict the future and do not follow an approach based on one. The downside to the run-up is that these stocks are no longer compelling no-brainers at current prices.
As an aside, I am seeing articles popping up saying capital goods and real estate sectors are overpriced and IT seems to be undervalued. Now you tell me !!
Change of Wind
US is in recession, Rupee is going to appreciate, wage cost is increasing, IT industry is doomed over,gone ..ok I am exaggerating. This was roughly the view just 1 month back.
I was running a few filters around that time and a lot of IT midcaps came up in the list. Some of these companies were 500 Crs+ companies selling at 2-3 times PE and 3-4 year lows. I listed a few ideas here. Since then there has been a complete change in the outlook.
The initial runup in the stocks seemed to be a correction of over-reaction in the prices. However as soon as Infosys and other results started coming out, there seems to be panic buying happening. Stocks like NIIT tech have gone up from 90 to 135, patni from 200 to around 280. So most of the IT midcaps have seen a 30-40% runup.
So whats the point, you may ask. Well I have always had a dilemma. Once I figure out that a sector or stock is undervalued, how fast should I react in building up a position ?
Based on this episode with IT midcaps, a big position,quickly would make sense. However that is a retrospective approach based on after the fact. Most of my picks go into a coma for quite some time and I typically analyse the stock further in detail for months together and build my position over the course of a few months. This approach helps as I am able to average down my cost, get a better understanding and build a decent position.
However this approach fails me in sudden runups. However in view of my overall time constraints and my need to do a detailed analysis, I prefer to take my time and build my positions. I would rather lose a few quick gains than compromise on my approach and repent later for the sloppy analysis.
In case you are wondering, I did build a position in NIIT tech and Patni computers around the major lows. This was however pure luck. It is quite possible that the opinion may change again and the prices may drop back again and i may get an opportunity to add to these positions or build new ones. Unfortunately I have no abilities to predict the future and do not follow an approach based on one. The downside to the run-up is that these stocks are no longer compelling no-brainers at current prices.
As an aside, I am seeing articles popping up saying capital goods and real estate sectors are overpriced and IT seems to be undervalued. Now you tell me !!
I was running a few filters around that time and a lot of IT midcaps came up in the list. Some of these companies were 500 Crs+ companies selling at 2-3 times PE and 3-4 year lows. I listed a few ideas here. Since then there has been a complete change in the outlook.
The initial runup in the stocks seemed to be a correction of over-reaction in the prices. However as soon as Infosys and other results started coming out, there seems to be panic buying happening. Stocks like NIIT tech have gone up from 90 to 135, patni from 200 to around 280. So most of the IT midcaps have seen a 30-40% runup.
So whats the point, you may ask. Well I have always had a dilemma. Once I figure out that a sector or stock is undervalued, how fast should I react in building up a position ?
Based on this episode with IT midcaps, a big position,quickly would make sense. However that is a retrospective approach based on after the fact. Most of my picks go into a coma for quite some time and I typically analyse the stock further in detail for months together and build my position over the course of a few months. This approach helps as I am able to average down my cost, get a better understanding and build a decent position.
However this approach fails me in sudden runups. However in view of my overall time constraints and my need to do a detailed analysis, I prefer to take my time and build my positions. I would rather lose a few quick gains than compromise on my approach and repent later for the sloppy analysis.
In case you are wondering, I did build a position in NIIT tech and Patni computers around the major lows. This was however pure luck. It is quite possible that the opinion may change again and the prices may drop back again and i may get an opportunity to add to these positions or build new ones. Unfortunately I have no abilities to predict the future and do not follow an approach based on one. The downside to the run-up is that these stocks are no longer compelling no-brainers at current prices.
As an aside, I am seeing articles popping up saying capital goods and real estate sectors are overpriced and IT seems to be undervalued. Now you tell me !!
Sunday, April 13, 2008
NIIT Tech – Few additional points
There has been quite a lot of discussion on this investment idea. You can check the comments for that.
A few key points in the valuation of the company are as follows. I have uploaded the valuation (valuationtemplatev3NIITtemp.xls) based on the factors below in google groups. Please note that this is a rough back of the envelope calculation (see net impacts section of the spreadsheet) and may be off by 10-20%.
Impact of ESOP – This can be computed and I have detailed my logic in the comments. It is not completely accurate. However considering that ESOP’s account for 6-8% of the company’s current Mcap, a 20% errror would not amount to more 2-3% error in the computation of the intrinsic value. That is an acceptable error for me (although you would flunk a derivatives class for that error) as It would not change my overall conclusions.
Tax impact – I do not have the exact numbers on what the changes are. However for NIIT the current tax rate is around 15%. The average tax rate for Corporate india is around 25%. I have assumed that NIIT would be paying the average rates from 2010 onwards. You can see the impact of the tax changes in valuation excel I have uploaded in google groups.
US slow down and dollar depreciation – cannot really compute the impact. The downside is limited due to the fact that NIIT tech has 30% revenue from US. However that does not mean than Europe and Rest of world are immune from a US recession. I have taken the impact of a slowdown and dollar depreciation by considering that the net margins will drop from 14.5% to around 7.5% in the next two years. It could drop below that too …although the probability is low (my guess is good as anyone else). As a result of this the net profit could drop from around 130 Crs in 2007 to 90 Crs in 2010.
Forex hedge – The company does not have large hedges. So I do not see any open risks from hedges (such as the one which hit hexaware). However one cannot rule out such a risk in the future
ESOP computations – See section ‘options’ in the uploaded excel
Basic logic is as follows (which differs from the text book approach). This approach may have flaws and I think it is overly conservative.
i do not consider just the granted options alone. I consider all options already granted and to be granted. As the options approved by the board will be granted in the future and that would then dilute the shareholder’s equity in the business
a) Adjusted mcap = current price * (all options+issued stock).
Options which lapse can be re-issued to new employees, so lapsed options should not be netted out.b) value lost due to free options to employees – The option price is given in balance sheet (ESOP are not free to shareholders)
so reduction from intrinsic value = total options to be issued or exercised* option pricenet intrisic value = DCF based intrinsic value - cost of optionsso based on above i now compare adj mcap with net instrinsic value. If the adj mcap is 50% or below Net intrinsic value, then it is a buy for me.
Finally a correction – As pointed by others in the comments, I have calculated the net cash incorrectly. Post accquisitions and net of debt the net cash could be around 200-250 Crs (what are a few crores here or there :) ?). Luckily that does not change the final conclusions much for me.
Please feel free to leave a comment for me if you find errors in my valuation.
Please read disclaimer at the bottom of the page. In addition I have a position in the stock.
A few key points in the valuation of the company are as follows. I have uploaded the valuation (valuationtemplatev3NIITtemp.xls) based on the factors below in google groups. Please note that this is a rough back of the envelope calculation (see net impacts section of the spreadsheet) and may be off by 10-20%.
Impact of ESOP – This can be computed and I have detailed my logic in the comments. It is not completely accurate. However considering that ESOP’s account for 6-8% of the company’s current Mcap, a 20% errror would not amount to more 2-3% error in the computation of the intrinsic value. That is an acceptable error for me (although you would flunk a derivatives class for that error) as It would not change my overall conclusions.
Tax impact – I do not have the exact numbers on what the changes are. However for NIIT the current tax rate is around 15%. The average tax rate for Corporate india is around 25%. I have assumed that NIIT would be paying the average rates from 2010 onwards. You can see the impact of the tax changes in valuation excel I have uploaded in google groups.
US slow down and dollar depreciation – cannot really compute the impact. The downside is limited due to the fact that NIIT tech has 30% revenue from US. However that does not mean than Europe and Rest of world are immune from a US recession. I have taken the impact of a slowdown and dollar depreciation by considering that the net margins will drop from 14.5% to around 7.5% in the next two years. It could drop below that too …although the probability is low (my guess is good as anyone else). As a result of this the net profit could drop from around 130 Crs in 2007 to 90 Crs in 2010.
Forex hedge – The company does not have large hedges. So I do not see any open risks from hedges (such as the one which hit hexaware). However one cannot rule out such a risk in the future
ESOP computations – See section ‘options’ in the uploaded excel
Basic logic is as follows (which differs from the text book approach). This approach may have flaws and I think it is overly conservative.
i do not consider just the granted options alone. I consider all options already granted and to be granted. As the options approved by the board will be granted in the future and that would then dilute the shareholder’s equity in the business
a) Adjusted mcap = current price * (all options+issued stock).
Options which lapse can be re-issued to new employees, so lapsed options should not be netted out.b) value lost due to free options to employees – The option price is given in balance sheet (ESOP are not free to shareholders)
so reduction from intrinsic value = total options to be issued or exercised* option pricenet intrisic value = DCF based intrinsic value - cost of optionsso based on above i now compare adj mcap with net instrinsic value. If the adj mcap is 50% or below Net intrinsic value, then it is a buy for me.
Finally a correction – As pointed by others in the comments, I have calculated the net cash incorrectly. Post accquisitions and net of debt the net cash could be around 200-250 Crs (what are a few crores here or there :) ?). Luckily that does not change the final conclusions much for me.
Please feel free to leave a comment for me if you find errors in my valuation.
Please read disclaimer at the bottom of the page. In addition I have a position in the stock.
NIIT Tech – Few additional points
There has been quite a lot of discussion on this investment idea. You can check the comments for that.
A few key points in the valuation of the company are as follows. I have uploaded the valuation (valuationtemplatev3NIITtemp.xls) based on the factors below in google groups. Please note that this is a rough back of the envelope calculation (see net impacts section of the spreadsheet) and may be off by 10-20%.
Impact of ESOP – This can be computed and I have detailed my logic in the comments. It is not completely accurate. However considering that ESOP’s account for 6-8% of the company’s current Mcap, a 20% errror would not amount to more 2-3% error in the computation of the intrinsic value. That is an acceptable error for me (although you would flunk a derivatives class for that error) as It would not change my overall conclusions.
Tax impact – I do not have the exact numbers on what the changes are. However for NIIT the current tax rate is around 15%. The average tax rate for Corporate india is around 25%. I have assumed that NIIT would be paying the average rates from 2010 onwards. You can see the impact of the tax changes in valuation excel I have uploaded in google groups.
US slow down and dollar depreciation – cannot really compute the impact. The downside is limited due to the fact that NIIT tech has 30% revenue from US. However that does not mean than Europe and Rest of world are immune from a US recession. I have taken the impact of a slowdown and dollar depreciation by considering that the net margins will drop from 14.5% to around 7.5% in the next two years. It could drop below that too …although the probability is low (my guess is good as anyone else). As a result of this the net profit could drop from around 130 Crs in 2007 to 90 Crs in 2010.
Forex hedge – The company does not have large hedges. So I do not see any open risks from hedges (such as the one which hit hexaware). However one cannot rule out such a risk in the future
ESOP computations – See section ‘options’ in the uploaded excel
Basic logic is as follows (which differs from the text book approach). This approach may have flaws and I think it is overly conservative.
i do not consider just the granted options alone. I consider all options already granted and to be granted. As the options approved by the board will be granted in the future and that would then dilute the shareholder’s equity in the business
a) Adjusted mcap = current price * (all options+issued stock).
Options which lapse can be re-issued to new employees, so lapsed options should not be netted out.b) value lost due to free options to employees – The option price is given in balance sheet (ESOP are not free to shareholders)
so reduction from intrinsic value = total options to be issued or exercised* option pricenet intrisic value = DCF based intrinsic value - cost of optionsso based on above i now compare adj mcap with net instrinsic value. If the adj mcap is 50% or below Net intrinsic value, then it is a buy for me.
Finally a correction – As pointed by others in the comments, I have calculated the net cash incorrectly. Post accquisitions and net of debt the net cash could be around 200-250 Crs (what are a few crores here or there :) ?). Luckily that does not change the final conclusions much for me.
Please feel free to leave a comment for me if you find errors in my valuation.
Please read disclaimer at the bottom of the page. In addition I have a position in the stock.
A few key points in the valuation of the company are as follows. I have uploaded the valuation (valuationtemplatev3NIITtemp.xls) based on the factors below in google groups. Please note that this is a rough back of the envelope calculation (see net impacts section of the spreadsheet) and may be off by 10-20%.
Impact of ESOP – This can be computed and I have detailed my logic in the comments. It is not completely accurate. However considering that ESOP’s account for 6-8% of the company’s current Mcap, a 20% errror would not amount to more 2-3% error in the computation of the intrinsic value. That is an acceptable error for me (although you would flunk a derivatives class for that error) as It would not change my overall conclusions.
Tax impact – I do not have the exact numbers on what the changes are. However for NIIT the current tax rate is around 15%. The average tax rate for Corporate india is around 25%. I have assumed that NIIT would be paying the average rates from 2010 onwards. You can see the impact of the tax changes in valuation excel I have uploaded in google groups.
US slow down and dollar depreciation – cannot really compute the impact. The downside is limited due to the fact that NIIT tech has 30% revenue from US. However that does not mean than Europe and Rest of world are immune from a US recession. I have taken the impact of a slowdown and dollar depreciation by considering that the net margins will drop from 14.5% to around 7.5% in the next two years. It could drop below that too …although the probability is low (my guess is good as anyone else). As a result of this the net profit could drop from around 130 Crs in 2007 to 90 Crs in 2010.
Forex hedge – The company does not have large hedges. So I do not see any open risks from hedges (such as the one which hit hexaware). However one cannot rule out such a risk in the future
ESOP computations – See section ‘options’ in the uploaded excel
Basic logic is as follows (which differs from the text book approach). This approach may have flaws and I think it is overly conservative.
i do not consider just the granted options alone. I consider all options already granted and to be granted. As the options approved by the board will be granted in the future and that would then dilute the shareholder’s equity in the business
a) Adjusted mcap = current price * (all options+issued stock).
Options which lapse can be re-issued to new employees, so lapsed options should not be netted out.b) value lost due to free options to employees – The option price is given in balance sheet (ESOP are not free to shareholders)
so reduction from intrinsic value = total options to be issued or exercised* option pricenet intrisic value = DCF based intrinsic value - cost of optionsso based on above i now compare adj mcap with net instrinsic value. If the adj mcap is 50% or below Net intrinsic value, then it is a buy for me.
Finally a correction – As pointed by others in the comments, I have calculated the net cash incorrectly. Post accquisitions and net of debt the net cash could be around 200-250 Crs (what are a few crores here or there :) ?). Luckily that does not change the final conclusions much for me.
Please feel free to leave a comment for me if you find errors in my valuation.
Please read disclaimer at the bottom of the page. In addition I have a position in the stock.
Wednesday, April 09, 2008
Analysis - NIIT Tech
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
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
Analysis - NIIT Tech
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
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
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.
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