Update 29th - I missed an important point when i posted on 28th. The data for the index is non-stationary. What it means that the underlying composition of the index is not fixed and the various other parameters such as interest rates, inflation are changing too. As a result the index of 1995 is not the same as the index of 2008. One must be careful from drawing too many conclusions from the data. It is good to analyse the data and have a perspective, but dangerous to make invest decision based on it alone. It easy to say the index is overvalued if the PE is above 30 or undervalued if it drops below 10. However it is not easy to arrive at a firm conclusion if the PE is 15 or 18 or similar such levels.
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I am not planning to make any forecast on where the forecast will be in the next few month. However I have done some analysis on the sensex and nifty index and uploaded it in the google groups. You can check here to download the file Quantitative calculation 2008.xls and check the first worksheet – market valuation.
The numbers for june 2008 are computed for both the sensex and the nifty. A few observations
1. The current PE for the sensex is around 16.8 and 17.7 for nifty. By historical standard ( history is few years back, not a few months) it is not too low. Just about towards the upper end of the PE band
2. The Return on equity (earnings/book) is still pretty high by historical standard. In the 90’s the numbers were generally low in 14-19% range. The last 3-4 years were actually an exception. We had a confluence of positive factors. Low interest rates, high demand growth and high capacity utilization all resulted in high returns. Companies had also re-structured and so net margins and ROE have been high in the past few years. The business cycle may be turning, with interest rates and inflation creeping up. We could revert to an average ROE of 18% (still higher by historical standards)
3. The Earnings growth has been 20%+ in the last few years. This has slowed down to around 10-12% in the current year.
Lets do some scenario analysis. For sake of assumption lets look at some probable scenarios on factors which are based on fundamentals
Book value is around 3540. An ROE of 18% which looks like a fair no. (look at the data for the entire 90s till 2003. I am still assuming a higher number). So normalized earnings is around 640 Rs which is lower than the current number of 820. What this means the earnings growth could slow down over the next few years as ROE reverts to the historical numbers. It is important to remember that ROE, unlike PE is not driven by market pschology. So the historical numbers do count in case of ROE.
For PE looks at the years 96-98. Interest rates were high and market PE ranged between 14-17.
Now for a juicy forecast – lets say earnings grow to around 900 in 2 years (book value will have to grow by 20% per annum and returns will drop to around 18% for that, so it is not impossible) and the PE is around 16-18, we are looking at a range of 14500- 16500.
Keep in mind that the assumptions in arriving at these numbers are still optimistic. We are still assuming reasonable growth in book values, moderate drop in ROE and fairly decent multiples. If things turn out better then we could have another bull market. But if we revert to historical levels, even on some variables such as ROE or PE or growth, then even the current market level is not too low.
Ofcourse other than the data, everything else in this post is a hypothesis. So my guess is as good as yours.
For an analysis of the index 2.5 years back see here
Friday, June 27, 2008
Where does the index stand ?
Update 29th - I missed an important point when i posted on 28th. The data for the index is non-stationary. What it means that the underlying composition of the index is not fixed and the various other parameters such as interest rates, inflation are changing too. As a result the index of 1995 is not the same as the index of 2008. One must be careful from drawing too many conclusions from the data. It is good to analyse the data and have a perspective, but dangerous to make invest decision based on it alone. It easy to say the index is overvalued if the PE is above 30 or undervalued if it drops below 10. However it is not easy to arrive at a firm conclusion if the PE is 15 or 18 or similar such levels.
----------------------------------------------------------------------------------
I am not planning to make any forecast on where the forecast will be in the next few month. However I have done some analysis on the sensex and nifty index and uploaded it in the google groups. You can check here to download the file Quantitative calculation 2008.xls and check the first worksheet – market valuation.
The numbers for june 2008 are computed for both the sensex and the nifty. A few observations
1. The current PE for the sensex is around 16.8 and 17.7 for nifty. By historical standard ( history is few years back, not a few months) it is not too low. Just about towards the upper end of the PE band
2. The Return on equity (earnings/book) is still pretty high by historical standard. In the 90’s the numbers were generally low in 14-19% range. The last 3-4 years were actually an exception. We had a confluence of positive factors. Low interest rates, high demand growth and high capacity utilization all resulted in high returns. Companies had also re-structured and so net margins and ROE have been high in the past few years. The business cycle may be turning, with interest rates and inflation creeping up. We could revert to an average ROE of 18% (still higher by historical standards)
3. The Earnings growth has been 20%+ in the last few years. This has slowed down to around 10-12% in the current year.
Lets do some scenario analysis. For sake of assumption lets look at some probable scenarios on factors which are based on fundamentals
Book value is around 3540. An ROE of 18% which looks like a fair no. (look at the data for the entire 90s till 2003. I am still assuming a higher number). So normalized earnings is around 640 Rs which is lower than the current number of 820. What this means the earnings growth could slow down over the next few years as ROE reverts to the historical numbers. It is important to remember that ROE, unlike PE is not driven by market pschology. So the historical numbers do count in case of ROE.
For PE looks at the years 96-98. Interest rates were high and market PE ranged between 14-17.
Now for a juicy forecast – lets say earnings grow to around 900 in 2 years (book value will have to grow by 20% per annum and returns will drop to around 18% for that, so it is not impossible) and the PE is around 16-18, we are looking at a range of 14500- 16500.
Keep in mind that the assumptions in arriving at these numbers are still optimistic. We are still assuming reasonable growth in book values, moderate drop in ROE and fairly decent multiples. If things turn out better then we could have another bull market. But if we revert to historical levels, even on some variables such as ROE or PE or growth, then even the current market level is not too low.
Ofcourse other than the data, everything else in this post is a hypothesis. So my guess is as good as yours.
For an analysis of the index 2.5 years back see here
----------------------------------------------------------------------------------
I am not planning to make any forecast on where the forecast will be in the next few month. However I have done some analysis on the sensex and nifty index and uploaded it in the google groups. You can check here to download the file Quantitative calculation 2008.xls and check the first worksheet – market valuation.
The numbers for june 2008 are computed for both the sensex and the nifty. A few observations
1. The current PE for the sensex is around 16.8 and 17.7 for nifty. By historical standard ( history is few years back, not a few months) it is not too low. Just about towards the upper end of the PE band
2. The Return on equity (earnings/book) is still pretty high by historical standard. In the 90’s the numbers were generally low in 14-19% range. The last 3-4 years were actually an exception. We had a confluence of positive factors. Low interest rates, high demand growth and high capacity utilization all resulted in high returns. Companies had also re-structured and so net margins and ROE have been high in the past few years. The business cycle may be turning, with interest rates and inflation creeping up. We could revert to an average ROE of 18% (still higher by historical standards)
3. The Earnings growth has been 20%+ in the last few years. This has slowed down to around 10-12% in the current year.
Lets do some scenario analysis. For sake of assumption lets look at some probable scenarios on factors which are based on fundamentals
Book value is around 3540. An ROE of 18% which looks like a fair no. (look at the data for the entire 90s till 2003. I am still assuming a higher number). So normalized earnings is around 640 Rs which is lower than the current number of 820. What this means the earnings growth could slow down over the next few years as ROE reverts to the historical numbers. It is important to remember that ROE, unlike PE is not driven by market pschology. So the historical numbers do count in case of ROE.
For PE looks at the years 96-98. Interest rates were high and market PE ranged between 14-17.
Now for a juicy forecast – lets say earnings grow to around 900 in 2 years (book value will have to grow by 20% per annum and returns will drop to around 18% for that, so it is not impossible) and the PE is around 16-18, we are looking at a range of 14500- 16500.
Keep in mind that the assumptions in arriving at these numbers are still optimistic. We are still assuming reasonable growth in book values, moderate drop in ROE and fairly decent multiples. If things turn out better then we could have another bull market. But if we revert to historical levels, even on some variables such as ROE or PE or growth, then even the current market level is not too low.
Ofcourse other than the data, everything else in this post is a hypothesis. So my guess is as good as yours.
For an analysis of the index 2.5 years back see here
Wednesday, June 25, 2008
A question on trading
06/27
some more observations from an outsider
- i have generally noticed that the younger crowd is more attracted to trading. that does not mean older people dont trade. just that if you talk to 100 young guys who are interested in stock market, a sizeable numbers would be into trading
- A lot of my friends who are into trading have a bias for action. There is the thrill of being right and knowing that pretty soon.
- there is more sense of company. you get to discuss about it with more people. value investing is pretty lonely. you buy ugly beaten down stocks. who wants to discuss companies no one has heard of ?
- media and the environment like brokers also encourage trading. no one will recommend buying a stock and sleeping on it for 5 years.
if you are a trader, please do not take this as a criticism of trading. These are just neutral observations (maybe incorrect) of an outsider. I may have bias against trading, but not a bias against people who do trading.
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I have noticed in general that the number of people interested in trading are far more than those interested in long term investing or value investing. For ex: there are far more blogs on trading than say value investing. There could be an overlap between the two groups too. I however have no aptitude for trading and it does not fit my temprament. I have said so in the past.
I can understand why there are more folks interested in trading. Trading does have an element of excitement. You get to do something quite often, whereas value investing or long term investing is as exciting as watching grass grow or paint dry. So this is my question – What are the average non – leveraged returns experienced by traders over a multi year period ..say 5-6 years (including a bull or bear market) ?
I agree there are several trading strategies and so to lump all of them under ‘trading’ is not smart. But at the risk of sounding dumb (which I am in terms of trading), I was curious to know what kind of returns do most people get ?
some more observations from an outsider
- i have generally noticed that the younger crowd is more attracted to trading. that does not mean older people dont trade. just that if you talk to 100 young guys who are interested in stock market, a sizeable numbers would be into trading
- A lot of my friends who are into trading have a bias for action. There is the thrill of being right and knowing that pretty soon.
- there is more sense of company. you get to discuss about it with more people. value investing is pretty lonely. you buy ugly beaten down stocks. who wants to discuss companies no one has heard of ?
- media and the environment like brokers also encourage trading. no one will recommend buying a stock and sleeping on it for 5 years.
if you are a trader, please do not take this as a criticism of trading. These are just neutral observations (maybe incorrect) of an outsider. I may have bias against trading, but not a bias against people who do trading.
------------------------------------------------------------------------------------------------
I have noticed in general that the number of people interested in trading are far more than those interested in long term investing or value investing. For ex: there are far more blogs on trading than say value investing. There could be an overlap between the two groups too. I however have no aptitude for trading and it does not fit my temprament. I have said so in the past.
I can understand why there are more folks interested in trading. Trading does have an element of excitement. You get to do something quite often, whereas value investing or long term investing is as exciting as watching grass grow or paint dry. So this is my question – What are the average non – leveraged returns experienced by traders over a multi year period ..say 5-6 years (including a bull or bear market) ?
I agree there are several trading strategies and so to lump all of them under ‘trading’ is not smart. But at the risk of sounding dumb (which I am in terms of trading), I was curious to know what kind of returns do most people get ?
A question on trading
06/27
some more observations from an outsider
- i have generally noticed that the younger crowd is more attracted to trading. that does not mean older people dont trade. just that if you talk to 100 young guys who are interested in stock market, a sizeable numbers would be into trading
- A lot of my friends who are into trading have a bias for action. There is the thrill of being right and knowing that pretty soon.
- there is more sense of company. you get to discuss about it with more people. value investing is pretty lonely. you buy ugly beaten down stocks. who wants to discuss companies no one has heard of ?
- media and the environment like brokers also encourage trading. no one will recommend buying a stock and sleeping on it for 5 years.
if you are a trader, please do not take this as a criticism of trading. These are just neutral observations (maybe incorrect) of an outsider. I may have bias against trading, but not a bias against people who do trading.
------------------------------------------------------------------------------------------------
I have noticed in general that the number of people interested in trading are far more than those interested in long term investing or value investing. For ex: there are far more blogs on trading than say value investing. There could be an overlap between the two groups too. I however have no aptitude for trading and it does not fit my temprament. I have said so in the past.
I can understand why there are more folks interested in trading. Trading does have an element of excitement. You get to do something quite often, whereas value investing or long term investing is as exciting as watching grass grow or paint dry. So this is my question – What are the average non – leveraged returns experienced by traders over a multi year period ..say 5-6 years (including a bull or bear market) ?
I agree there are several trading strategies and so to lump all of them under ‘trading’ is not smart. But at the risk of sounding dumb (which I am in terms of trading), I was curious to know what kind of returns do most people get ?
some more observations from an outsider
- i have generally noticed that the younger crowd is more attracted to trading. that does not mean older people dont trade. just that if you talk to 100 young guys who are interested in stock market, a sizeable numbers would be into trading
- A lot of my friends who are into trading have a bias for action. There is the thrill of being right and knowing that pretty soon.
- there is more sense of company. you get to discuss about it with more people. value investing is pretty lonely. you buy ugly beaten down stocks. who wants to discuss companies no one has heard of ?
- media and the environment like brokers also encourage trading. no one will recommend buying a stock and sleeping on it for 5 years.
if you are a trader, please do not take this as a criticism of trading. These are just neutral observations (maybe incorrect) of an outsider. I may have bias against trading, but not a bias against people who do trading.
------------------------------------------------------------------------------------------------
I have noticed in general that the number of people interested in trading are far more than those interested in long term investing or value investing. For ex: there are far more blogs on trading than say value investing. There could be an overlap between the two groups too. I however have no aptitude for trading and it does not fit my temprament. I have said so in the past.
I can understand why there are more folks interested in trading. Trading does have an element of excitement. You get to do something quite often, whereas value investing or long term investing is as exciting as watching grass grow or paint dry. So this is my question – What are the average non – leveraged returns experienced by traders over a multi year period ..say 5-6 years (including a bull or bear market) ?
I agree there are several trading strategies and so to lump all of them under ‘trading’ is not smart. But at the risk of sounding dumb (which I am in terms of trading), I was curious to know what kind of returns do most people get ?
Sunday, June 22, 2008
Old flames and Old affairs
I have had love affairs with Gujarat gas, concor, asian paints, Blue star etc in the past. The original thesis when investing in these stocks played out and the final results were far better than what I had expected.
Then like all affairs, it was time to part. A few of these stocks got overvalued and I moved on.
Now unlike old girlfriends, there is no harm in revisiting these old relationships from time to time. You know the company, its management well and if you held it for a long time, then you would have become comfortable with the business too. So I tend to track these old flames regularly and if I find them to be attractive again, I will go ahead and invest again in them.
They key point when investing in the same stocks again is to avoid becoming emotional with these stocks which have treated you well in the past. It is important to analyse these companies as if you are analysing a new stock and check the price value relationship. If there is a substaintial gap, then I am fairly comfortable re-investing again.
Case in point : Gujarat gas. I sold off this stock by end of 2006 thinking that the stock was overvalued, after having held the stock for 3 years. Then last year on checking the fundamentals, I realised some of the risk in terms of gas pricing had been handled pretty well by the company. In addition the company has expanded its area of operations further and is doing very well. With the current spike in fuel prices, I think the company should do well for the next few years.
So no harm in revisiting these old flames from time to time and re-starting the old relationships again. Ofcourse I mean stocks and not girlfriends :) . Now this is one post my wife should not read (she hardly reads them anyway, so I am safe I guess).
Then like all affairs, it was time to part. A few of these stocks got overvalued and I moved on.
Now unlike old girlfriends, there is no harm in revisiting these old relationships from time to time. You know the company, its management well and if you held it for a long time, then you would have become comfortable with the business too. So I tend to track these old flames regularly and if I find them to be attractive again, I will go ahead and invest again in them.
They key point when investing in the same stocks again is to avoid becoming emotional with these stocks which have treated you well in the past. It is important to analyse these companies as if you are analysing a new stock and check the price value relationship. If there is a substaintial gap, then I am fairly comfortable re-investing again.
Case in point : Gujarat gas. I sold off this stock by end of 2006 thinking that the stock was overvalued, after having held the stock for 3 years. Then last year on checking the fundamentals, I realised some of the risk in terms of gas pricing had been handled pretty well by the company. In addition the company has expanded its area of operations further and is doing very well. With the current spike in fuel prices, I think the company should do well for the next few years.
So no harm in revisiting these old flames from time to time and re-starting the old relationships again. Ofcourse I mean stocks and not girlfriends :) . Now this is one post my wife should not read (she hardly reads them anyway, so I am safe I guess).
Old flames and Old affairs
I have had love affairs with Gujarat gas, concor, asian paints, Blue star etc in the past. The original thesis when investing in these stocks played out and the final results were far better than what I had expected.
Then like all affairs, it was time to part. A few of these stocks got overvalued and I moved on.
Now unlike old girlfriends, there is no harm in revisiting these old relationships from time to time. You know the company, its management well and if you held it for a long time, then you would have become comfortable with the business too. So I tend to track these old flames regularly and if I find them to be attractive again, I will go ahead and invest again in them.
They key point when investing in the same stocks again is to avoid becoming emotional with these stocks which have treated you well in the past. It is important to analyse these companies as if you are analysing a new stock and check the price value relationship. If there is a substaintial gap, then I am fairly comfortable re-investing again.
Case in point : Gujarat gas. I sold off this stock by end of 2006 thinking that the stock was overvalued, after having held the stock for 3 years. Then last year on checking the fundamentals, I realised some of the risk in terms of gas pricing had been handled pretty well by the company. In addition the company has expanded its area of operations further and is doing very well. With the current spike in fuel prices, I think the company should do well for the next few years.
So no harm in revisiting these old flames from time to time and re-starting the old relationships again. Ofcourse I mean stocks and not girlfriends :) . Now this is one post my wife should not read (she hardly reads them anyway, so I am safe I guess).
Then like all affairs, it was time to part. A few of these stocks got overvalued and I moved on.
Now unlike old girlfriends, there is no harm in revisiting these old relationships from time to time. You know the company, its management well and if you held it for a long time, then you would have become comfortable with the business too. So I tend to track these old flames regularly and if I find them to be attractive again, I will go ahead and invest again in them.
They key point when investing in the same stocks again is to avoid becoming emotional with these stocks which have treated you well in the past. It is important to analyse these companies as if you are analysing a new stock and check the price value relationship. If there is a substaintial gap, then I am fairly comfortable re-investing again.
Case in point : Gujarat gas. I sold off this stock by end of 2006 thinking that the stock was overvalued, after having held the stock for 3 years. Then last year on checking the fundamentals, I realised some of the risk in terms of gas pricing had been handled pretty well by the company. In addition the company has expanded its area of operations further and is doing very well. With the current spike in fuel prices, I think the company should do well for the next few years.
So no harm in revisiting these old flames from time to time and re-starting the old relationships again. Ofcourse I mean stocks and not girlfriends :) . Now this is one post my wife should not read (she hardly reads them anyway, so I am safe I guess).
Tuesday, June 17, 2008
Inflation and debt
I have been reviewing the results of some companies and a few points are standing out
- raw material cost, over heads and labor costs are now increasing faster than sales
- Net margins are stable or coming down. Profit growth has slowed
- Debt may start getting repriced soon. As a result interest costs could start increasing
Maybe this is not news. However the above has the following implications
- valuations for the market and several companies is still based on the low inflation, high growth and high ROE environment of 2002-2007. If we have stagflation (high inflation and low growth), we could see prices drop sharply.
- Some companies in response to high growth, have taken on large amounts of debt. If we have stagflation, these companies could get hit very badly. The stock price for such companies could plunge sharply.
- In contrast companies with strong competitive advantage and low debt can maintain margins due to pricing power of their products and low interest costs. Such companies may see lower impact to their stock price.
I am not predicting a long period of high inflation and low growth and cannot be sure if we will see drop in stock prices. History (mid 1990’s) gives us a clue. During mid 90’s in response to high inflation, RBI hiked the interest rates to around 15% and we had a period of low growth from 1997-1999. Stock market returns were also poor during this period.
Does it mean that we should sell our stocks and wait for the clouds to clear. I would say no. The future is never crystal clear. It never was and never will be. What we can, however be sure is that good companies, with strong sustianable competitive advantage, will do well in inflationary and recessionary times.
What such times gives us is low prices due to the pesimissm. These low prices can be used to invest in good companies at attractive prices to build a good portfolio. However this is not easy and not for the faint hearted. If the inflation drops and the growth picks up quickly , then the returns could be good in the short term. However if economic situation takes time to turnaround, then be prepared to wait for a long time for the returns to materialize.
- raw material cost, over heads and labor costs are now increasing faster than sales
- Net margins are stable or coming down. Profit growth has slowed
- Debt may start getting repriced soon. As a result interest costs could start increasing
Maybe this is not news. However the above has the following implications
- valuations for the market and several companies is still based on the low inflation, high growth and high ROE environment of 2002-2007. If we have stagflation (high inflation and low growth), we could see prices drop sharply.
- Some companies in response to high growth, have taken on large amounts of debt. If we have stagflation, these companies could get hit very badly. The stock price for such companies could plunge sharply.
- In contrast companies with strong competitive advantage and low debt can maintain margins due to pricing power of their products and low interest costs. Such companies may see lower impact to their stock price.
I am not predicting a long period of high inflation and low growth and cannot be sure if we will see drop in stock prices. History (mid 1990’s) gives us a clue. During mid 90’s in response to high inflation, RBI hiked the interest rates to around 15% and we had a period of low growth from 1997-1999. Stock market returns were also poor during this period.
Does it mean that we should sell our stocks and wait for the clouds to clear. I would say no. The future is never crystal clear. It never was and never will be. What we can, however be sure is that good companies, with strong sustianable competitive advantage, will do well in inflationary and recessionary times.
What such times gives us is low prices due to the pesimissm. These low prices can be used to invest in good companies at attractive prices to build a good portfolio. However this is not easy and not for the faint hearted. If the inflation drops and the growth picks up quickly , then the returns could be good in the short term. However if economic situation takes time to turnaround, then be prepared to wait for a long time for the returns to materialize.
Inflation and debt
I have been reviewing the results of some companies and a few points are standing out
- raw material cost, over heads and labor costs are now increasing faster than sales
- Net margins are stable or coming down. Profit growth has slowed
- Debt may start getting repriced soon. As a result interest costs could start increasing
Maybe this is not news. However the above has the following implications
- valuations for the market and several companies is still based on the low inflation, high growth and high ROE environment of 2002-2007. If we have stagflation (high inflation and low growth), we could see prices drop sharply.
- Some companies in response to high growth, have taken on large amounts of debt. If we have stagflation, these companies could get hit very badly. The stock price for such companies could plunge sharply.
- In contrast companies with strong competitive advantage and low debt can maintain margins due to pricing power of their products and low interest costs. Such companies may see lower impact to their stock price.
I am not predicting a long period of high inflation and low growth and cannot be sure if we will see drop in stock prices. History (mid 1990’s) gives us a clue. During mid 90’s in response to high inflation, RBI hiked the interest rates to around 15% and we had a period of low growth from 1997-1999. Stock market returns were also poor during this period.
Does it mean that we should sell our stocks and wait for the clouds to clear. I would say no. The future is never crystal clear. It never was and never will be. What we can, however be sure is that good companies, with strong sustianable competitive advantage, will do well in inflationary and recessionary times.
What such times gives us is low prices due to the pesimissm. These low prices can be used to invest in good companies at attractive prices to build a good portfolio. However this is not easy and not for the faint hearted. If the inflation drops and the growth picks up quickly , then the returns could be good in the short term. However if economic situation takes time to turnaround, then be prepared to wait for a long time for the returns to materialize.
- raw material cost, over heads and labor costs are now increasing faster than sales
- Net margins are stable or coming down. Profit growth has slowed
- Debt may start getting repriced soon. As a result interest costs could start increasing
Maybe this is not news. However the above has the following implications
- valuations for the market and several companies is still based on the low inflation, high growth and high ROE environment of 2002-2007. If we have stagflation (high inflation and low growth), we could see prices drop sharply.
- Some companies in response to high growth, have taken on large amounts of debt. If we have stagflation, these companies could get hit very badly. The stock price for such companies could plunge sharply.
- In contrast companies with strong competitive advantage and low debt can maintain margins due to pricing power of their products and low interest costs. Such companies may see lower impact to their stock price.
I am not predicting a long period of high inflation and low growth and cannot be sure if we will see drop in stock prices. History (mid 1990’s) gives us a clue. During mid 90’s in response to high inflation, RBI hiked the interest rates to around 15% and we had a period of low growth from 1997-1999. Stock market returns were also poor during this period.
Does it mean that we should sell our stocks and wait for the clouds to clear. I would say no. The future is never crystal clear. It never was and never will be. What we can, however be sure is that good companies, with strong sustianable competitive advantage, will do well in inflationary and recessionary times.
What such times gives us is low prices due to the pesimissm. These low prices can be used to invest in good companies at attractive prices to build a good portfolio. However this is not easy and not for the faint hearted. If the inflation drops and the growth picks up quickly , then the returns could be good in the short term. However if economic situation takes time to turnaround, then be prepared to wait for a long time for the returns to materialize.
Saturday, June 14, 2008
What is hot today ?
I wrote about ‘rear view mirror investing’ in my previous post. What it essentially means is buying yesterday’s winners. As a far as long term investing is concerned, you will rarely make money buying yesterday’s winners. If like me, you believe that value investing is the way to go, then the focus has to be on companies and sectors which are currently out of fashion.
Lets try to invert – What is hot today. Let me think aloud and put a quick list below
Oil
Gold
Other Commodities like wheat, corn, metals etc
Energy companies (out of india ofcourse)
Real estate – In india it is a sure thing to make money and get rich :)
If you thought that this kind of investing was limited to investors, think again. Seasoned businessmen are prone to similar biases. Think telecom in US in 1998-2000 when companies invested huge sums of money in building capacity and then went bankrupt when the demand never materialized.
The same may be happening in real estate ..see this article and this. Maybe this is just a blip. But when real estate price (per sqft) starts becoming costlier than US, singapore, UK etc there is something funny happening.
So why do most people do it ? two reasons i can think of
- social proof : if everyone else is doing and making money, it must be right and i must do it too.
- laziness : If you imitate others, you dont have to think and take responsibility for your own decisions
Like driving, if you invest looking into the rear view mirror, then be prepared to get hurt (hopefully not badly).
The above may work for traders, momentum players etc. That is however not my area of competence and so you have to evaluate the above statement in light of long term investing.
Lets try to invert – What is hot today. Let me think aloud and put a quick list below
Oil
Gold
Other Commodities like wheat, corn, metals etc
Energy companies (out of india ofcourse)
Real estate – In india it is a sure thing to make money and get rich :)
If you thought that this kind of investing was limited to investors, think again. Seasoned businessmen are prone to similar biases. Think telecom in US in 1998-2000 when companies invested huge sums of money in building capacity and then went bankrupt when the demand never materialized.
The same may be happening in real estate ..see this article and this. Maybe this is just a blip. But when real estate price (per sqft) starts becoming costlier than US, singapore, UK etc there is something funny happening.
So why do most people do it ? two reasons i can think of
- social proof : if everyone else is doing and making money, it must be right and i must do it too.
- laziness : If you imitate others, you dont have to think and take responsibility for your own decisions
Like driving, if you invest looking into the rear view mirror, then be prepared to get hurt (hopefully not badly).
The above may work for traders, momentum players etc. That is however not my area of competence and so you have to evaluate the above statement in light of long term investing.
What is hot today ?
I wrote about ‘rear view mirror investing’ in my previous post. What it essentially means is buying yesterday’s winners. As a far as long term investing is concerned, you will rarely make money buying yesterday’s winners. If like me, you believe that value investing is the way to go, then the focus has to be on companies and sectors which are currently out of fashion.
Lets try to invert – What is hot today. Let me think aloud and put a quick list below
Oil
Gold
Other Commodities like wheat, corn, metals etc
Energy companies (out of india ofcourse)
Real estate – In india it is a sure thing to make money and get rich :)
If you thought that this kind of investing was limited to investors, think again. Seasoned businessmen are prone to similar biases. Think telecom in US in 1998-2000 when companies invested huge sums of money in building capacity and then went bankrupt when the demand never materialized.
The same may be happening in real estate ..see this article and this. Maybe this is just a blip. But when real estate price (per sqft) starts becoming costlier than US, singapore, UK etc there is something funny happening.
So why do most people do it ? two reasons i can think of
- social proof : if everyone else is doing and making money, it must be right and i must do it too.
- laziness : If you imitate others, you dont have to think and take responsibility for your own decisions
Like driving, if you invest looking into the rear view mirror, then be prepared to get hurt (hopefully not badly).
The above may work for traders, momentum players etc. That is however not my area of competence and so you have to evaluate the above statement in light of long term investing.
Lets try to invert – What is hot today. Let me think aloud and put a quick list below
Oil
Gold
Other Commodities like wheat, corn, metals etc
Energy companies (out of india ofcourse)
Real estate – In india it is a sure thing to make money and get rich :)
If you thought that this kind of investing was limited to investors, think again. Seasoned businessmen are prone to similar biases. Think telecom in US in 1998-2000 when companies invested huge sums of money in building capacity and then went bankrupt when the demand never materialized.
The same may be happening in real estate ..see this article and this. Maybe this is just a blip. But when real estate price (per sqft) starts becoming costlier than US, singapore, UK etc there is something funny happening.
So why do most people do it ? two reasons i can think of
- social proof : if everyone else is doing and making money, it must be right and i must do it too.
- laziness : If you imitate others, you dont have to think and take responsibility for your own decisions
Like driving, if you invest looking into the rear view mirror, then be prepared to get hurt (hopefully not badly).
The above may work for traders, momentum players etc. That is however not my area of competence and so you have to evaluate the above statement in light of long term investing.
Wednesday, June 11, 2008
Rear view mirror investing
Was reading this article – mutual fund NAVs take the plunge. The following caught my eye
“The high erosion in the NAVs is the outcome of heavy concentration by mutual fund industry in sectors like banking, real estate, capital goods, engineering, cement and construction which were going great guns in 2007, but have eroded sharply this year. Most schemes had comfortably ignored sectors like pharma, FMCG and IT, which have started to perform now. So, the funds that failed to tap in these opportunities then are paying a heavy price today.”
The above statement gives me such a feeling of deja-vu. History repeats itself in the stock market, again and again. I saw the same thing happen in 2000 with IT. Most of the mutual funds piled into the IT sector, right before the crash. The same seems to have happened now.
Ofcourse it takes courage of conviction to go against the crowd. It is not rocket science to figure out that a company selling at 70 times earnings could be overvalued. But then most of the fund managers, wanting to keep their jobs are more worried about their quarterly performance than doing well in the long run.
For those who say that the small investor is at a disadvantage v/s the pros, I would say it is complete hogwash. All other factors aside, as a small investor I am personally not forced to invest in the current hot stocks. At the cost of looking like a moron in the short run, I can afford to pickup undervalued scrips which will give me good long term returns. That advantage alone is more than all other advantages the big boys have such as more research, access to management etc.
This rear view approach is however not limited to the big boys alone. Unfortunately a lot of small investors do the same. However if they lose money, they end up blaming everyone except themselves.
I am guilty of doing the same thing in the past. However the sensible thing I did was to blame myself completely for the losses. It is not that I mindlessly go against the crowd ( I wont cross the road with a red signal when everyone else is standing on the sidewalk for the sake of going against the crowd :) ).
If am looking at a company, I need to convince myself why the market is undervaluing the company and what is my variant perception. For stocks which favored by everyone else, I have generally found that the market is either too optimistic or is valuing them fairly and hence it is unlikely that I will make good returns.
“The high erosion in the NAVs is the outcome of heavy concentration by mutual fund industry in sectors like banking, real estate, capital goods, engineering, cement and construction which were going great guns in 2007, but have eroded sharply this year. Most schemes had comfortably ignored sectors like pharma, FMCG and IT, which have started to perform now. So, the funds that failed to tap in these opportunities then are paying a heavy price today.”
The above statement gives me such a feeling of deja-vu. History repeats itself in the stock market, again and again. I saw the same thing happen in 2000 with IT. Most of the mutual funds piled into the IT sector, right before the crash. The same seems to have happened now.
Ofcourse it takes courage of conviction to go against the crowd. It is not rocket science to figure out that a company selling at 70 times earnings could be overvalued. But then most of the fund managers, wanting to keep their jobs are more worried about their quarterly performance than doing well in the long run.
For those who say that the small investor is at a disadvantage v/s the pros, I would say it is complete hogwash. All other factors aside, as a small investor I am personally not forced to invest in the current hot stocks. At the cost of looking like a moron in the short run, I can afford to pickup undervalued scrips which will give me good long term returns. That advantage alone is more than all other advantages the big boys have such as more research, access to management etc.
This rear view approach is however not limited to the big boys alone. Unfortunately a lot of small investors do the same. However if they lose money, they end up blaming everyone except themselves.
I am guilty of doing the same thing in the past. However the sensible thing I did was to blame myself completely for the losses. It is not that I mindlessly go against the crowd ( I wont cross the road with a red signal when everyone else is standing on the sidewalk for the sake of going against the crowd :) ).
If am looking at a company, I need to convince myself why the market is undervaluing the company and what is my variant perception. For stocks which favored by everyone else, I have generally found that the market is either too optimistic or is valuing them fairly and hence it is unlikely that I will make good returns.
Rear view mirror investing
Was reading this article – mutual fund NAVs take the plunge. The following caught my eye
“The high erosion in the NAVs is the outcome of heavy concentration by mutual fund industry in sectors like banking, real estate, capital goods, engineering, cement and construction which were going great guns in 2007, but have eroded sharply this year. Most schemes had comfortably ignored sectors like pharma, FMCG and IT, which have started to perform now. So, the funds that failed to tap in these opportunities then are paying a heavy price today.”
The above statement gives me such a feeling of deja-vu. History repeats itself in the stock market, again and again. I saw the same thing happen in 2000 with IT. Most of the mutual funds piled into the IT sector, right before the crash. The same seems to have happened now.
Ofcourse it takes courage of conviction to go against the crowd. It is not rocket science to figure out that a company selling at 70 times earnings could be overvalued. But then most of the fund managers, wanting to keep their jobs are more worried about their quarterly performance than doing well in the long run.
For those who say that the small investor is at a disadvantage v/s the pros, I would say it is complete hogwash. All other factors aside, as a small investor I am personally not forced to invest in the current hot stocks. At the cost of looking like a moron in the short run, I can afford to pickup undervalued scrips which will give me good long term returns. That advantage alone is more than all other advantages the big boys have such as more research, access to management etc.
This rear view approach is however not limited to the big boys alone. Unfortunately a lot of small investors do the same. However if they lose money, they end up blaming everyone except themselves.
I am guilty of doing the same thing in the past. However the sensible thing I did was to blame myself completely for the losses. It is not that I mindlessly go against the crowd ( I wont cross the road with a red signal when everyone else is standing on the sidewalk for the sake of going against the crowd :) ).
If am looking at a company, I need to convince myself why the market is undervaluing the company and what is my variant perception. For stocks which favored by everyone else, I have generally found that the market is either too optimistic or is valuing them fairly and hence it is unlikely that I will make good returns.
“The high erosion in the NAVs is the outcome of heavy concentration by mutual fund industry in sectors like banking, real estate, capital goods, engineering, cement and construction which were going great guns in 2007, but have eroded sharply this year. Most schemes had comfortably ignored sectors like pharma, FMCG and IT, which have started to perform now. So, the funds that failed to tap in these opportunities then are paying a heavy price today.”
The above statement gives me such a feeling of deja-vu. History repeats itself in the stock market, again and again. I saw the same thing happen in 2000 with IT. Most of the mutual funds piled into the IT sector, right before the crash. The same seems to have happened now.
Ofcourse it takes courage of conviction to go against the crowd. It is not rocket science to figure out that a company selling at 70 times earnings could be overvalued. But then most of the fund managers, wanting to keep their jobs are more worried about their quarterly performance than doing well in the long run.
For those who say that the small investor is at a disadvantage v/s the pros, I would say it is complete hogwash. All other factors aside, as a small investor I am personally not forced to invest in the current hot stocks. At the cost of looking like a moron in the short run, I can afford to pickup undervalued scrips which will give me good long term returns. That advantage alone is more than all other advantages the big boys have such as more research, access to management etc.
This rear view approach is however not limited to the big boys alone. Unfortunately a lot of small investors do the same. However if they lose money, they end up blaming everyone except themselves.
I am guilty of doing the same thing in the past. However the sensible thing I did was to blame myself completely for the losses. It is not that I mindlessly go against the crowd ( I wont cross the road with a red signal when everyone else is standing on the sidewalk for the sake of going against the crowd :) ).
If am looking at a company, I need to convince myself why the market is undervaluing the company and what is my variant perception. For stocks which favored by everyone else, I have generally found that the market is either too optimistic or is valuing them fairly and hence it is unlikely that I will make good returns.
Sunday, June 08, 2008
Inflation and portfolio strategy
With inflation at 9% or higher (depending on the numbers you believe), it may be too late to profit from the increase, but it makes sense to re-construct your portfolio to reduce the impact.
My plan, which I detail in this post, is a mix of reading and personal experiences. Ofcourse everyone has a unique situation, so my approach may not be valid for everyone. However some points may be of use to most of you.
1. Equity is one of the best hedges against inflation. Long term returns are definitely 12% + (I don’t think 40% is the norm unlike the last few years). If one can find and invest in good companies, one’s with strong competitive advantage and pricing power, then I think the returns will definitely be more than inflation. Ofcourse in the short run one can lose money, so equity is not hedge against inflation in short term.
2. Debt is usually a component of one’s portfolio. In period of rising inflation it makes sense to invest in floating rate funds. That way one is hedged against inflation and may get a return of 1-2% above inflation. However with the current lose monetary policy and low interest rates, the real returns from such funds may be negative. It is likely that the benchmark rates will be raised in response to the inflation. In such a scenario, floating rate funds may give returns slightly above inflation.
3. Avoid long term FD’s and such commitments. If you invest for 5 years at say 8%, and if inflation crosses 9-10%, then you are losing money. One option can be to break the deposit and re-invest, but there is generally a penalty and loss associated with it.
4. Real estate is good hedge especially if funded by a fixed rate loan. In hindsight 2003-2004 was a great time to invest in real estate. Interest rates were low, everyone thought inflation was gone and real estate seemed to be priced reasonably. However I am not sure how good real estate is now as an investment option in general.
5. Be good at your job/ profession etc . Now this is a non-financial advise, but in the end for most of us the biggest asset is our skills. I think constantly upgrading skills and doing well in our professions is one of the best hedges against inflation. If you are one of the top performers, you will earn more via better increments or higher profits from your business. So I think investing in yourself is one of best hedges against inflation.
Now a lot of people will say gold, metals etc. I personally have no interest in those options. The long term data in most of these options show that the returns track inflation. So in absence of some special understanding of these alternative asset classes, I prefer to avoid them. I think there is enough for me to do in equity and debt than to worry about all this other stuff.
Finally, I mentioned profit from inflation ..is that possible ? if you can fund a long term asset such as real estate with a fixed debt (when rates are low) then during inflationary periods the rental rises with the inflation whereas debt is fixed. So equity in the asset is rising faster than inflation.
Also if you can roughly estimate when inflation is peaking, an investment in long duration debt (such 10 year bonds or mutuals) will give good returns when inflation slows (due to repricing of bonds). This happened to investors during the 2000-2003 time frame.
My plan, which I detail in this post, is a mix of reading and personal experiences. Ofcourse everyone has a unique situation, so my approach may not be valid for everyone. However some points may be of use to most of you.
1. Equity is one of the best hedges against inflation. Long term returns are definitely 12% + (I don’t think 40% is the norm unlike the last few years). If one can find and invest in good companies, one’s with strong competitive advantage and pricing power, then I think the returns will definitely be more than inflation. Ofcourse in the short run one can lose money, so equity is not hedge against inflation in short term.
2. Debt is usually a component of one’s portfolio. In period of rising inflation it makes sense to invest in floating rate funds. That way one is hedged against inflation and may get a return of 1-2% above inflation. However with the current lose monetary policy and low interest rates, the real returns from such funds may be negative. It is likely that the benchmark rates will be raised in response to the inflation. In such a scenario, floating rate funds may give returns slightly above inflation.
3. Avoid long term FD’s and such commitments. If you invest for 5 years at say 8%, and if inflation crosses 9-10%, then you are losing money. One option can be to break the deposit and re-invest, but there is generally a penalty and loss associated with it.
4. Real estate is good hedge especially if funded by a fixed rate loan. In hindsight 2003-2004 was a great time to invest in real estate. Interest rates were low, everyone thought inflation was gone and real estate seemed to be priced reasonably. However I am not sure how good real estate is now as an investment option in general.
5. Be good at your job/ profession etc . Now this is a non-financial advise, but in the end for most of us the biggest asset is our skills. I think constantly upgrading skills and doing well in our professions is one of the best hedges against inflation. If you are one of the top performers, you will earn more via better increments or higher profits from your business. So I think investing in yourself is one of best hedges against inflation.
Now a lot of people will say gold, metals etc. I personally have no interest in those options. The long term data in most of these options show that the returns track inflation. So in absence of some special understanding of these alternative asset classes, I prefer to avoid them. I think there is enough for me to do in equity and debt than to worry about all this other stuff.
Finally, I mentioned profit from inflation ..is that possible ? if you can fund a long term asset such as real estate with a fixed debt (when rates are low) then during inflationary periods the rental rises with the inflation whereas debt is fixed. So equity in the asset is rising faster than inflation.
Also if you can roughly estimate when inflation is peaking, an investment in long duration debt (such 10 year bonds or mutuals) will give good returns when inflation slows (due to repricing of bonds). This happened to investors during the 2000-2003 time frame.
Inflation and portfolio strategy
With inflation at 9% or higher (depending on the numbers you believe), it may be too late to profit from the increase, but it makes sense to re-construct your portfolio to reduce the impact.
My plan, which I detail in this post, is a mix of reading and personal experiences. Ofcourse everyone has a unique situation, so my approach may not be valid for everyone. However some points may be of use to most of you.
1. Equity is one of the best hedges against inflation. Long term returns are definitely 12% + (I don’t think 40% is the norm unlike the last few years). If one can find and invest in good companies, one’s with strong competitive advantage and pricing power, then I think the returns will definitely be more than inflation. Ofcourse in the short run one can lose money, so equity is not hedge against inflation in short term.
2. Debt is usually a component of one’s portfolio. In period of rising inflation it makes sense to invest in floating rate funds. That way one is hedged against inflation and may get a return of 1-2% above inflation. However with the current lose monetary policy and low interest rates, the real returns from such funds may be negative. It is likely that the benchmark rates will be raised in response to the inflation. In such a scenario, floating rate funds may give returns slightly above inflation.
3. Avoid long term FD’s and such commitments. If you invest for 5 years at say 8%, and if inflation crosses 9-10%, then you are losing money. One option can be to break the deposit and re-invest, but there is generally a penalty and loss associated with it.
4. Real estate is good hedge especially if funded by a fixed rate loan. In hindsight 2003-2004 was a great time to invest in real estate. Interest rates were low, everyone thought inflation was gone and real estate seemed to be priced reasonably. However I am not sure how good real estate is now as an investment option in general.
5. Be good at your job/ profession etc . Now this is a non-financial advise, but in the end for most of us the biggest asset is our skills. I think constantly upgrading skills and doing well in our professions is one of the best hedges against inflation. If you are one of the top performers, you will earn more via better increments or higher profits from your business. So I think investing in yourself is one of best hedges against inflation.
Now a lot of people will say gold, metals etc. I personally have no interest in those options. The long term data in most of these options show that the returns track inflation. So in absence of some special understanding of these alternative asset classes, I prefer to avoid them. I think there is enough for me to do in equity and debt than to worry about all this other stuff.
Finally, I mentioned profit from inflation ..is that possible ? if you can fund a long term asset such as real estate with a fixed debt (when rates are low) then during inflationary periods the rental rises with the inflation whereas debt is fixed. So equity in the asset is rising faster than inflation.
Also if you can roughly estimate when inflation is peaking, an investment in long duration debt (such 10 year bonds or mutuals) will give good returns when inflation slows (due to repricing of bonds). This happened to investors during the 2000-2003 time frame.
My plan, which I detail in this post, is a mix of reading and personal experiences. Ofcourse everyone has a unique situation, so my approach may not be valid for everyone. However some points may be of use to most of you.
1. Equity is one of the best hedges against inflation. Long term returns are definitely 12% + (I don’t think 40% is the norm unlike the last few years). If one can find and invest in good companies, one’s with strong competitive advantage and pricing power, then I think the returns will definitely be more than inflation. Ofcourse in the short run one can lose money, so equity is not hedge against inflation in short term.
2. Debt is usually a component of one’s portfolio. In period of rising inflation it makes sense to invest in floating rate funds. That way one is hedged against inflation and may get a return of 1-2% above inflation. However with the current lose monetary policy and low interest rates, the real returns from such funds may be negative. It is likely that the benchmark rates will be raised in response to the inflation. In such a scenario, floating rate funds may give returns slightly above inflation.
3. Avoid long term FD’s and such commitments. If you invest for 5 years at say 8%, and if inflation crosses 9-10%, then you are losing money. One option can be to break the deposit and re-invest, but there is generally a penalty and loss associated with it.
4. Real estate is good hedge especially if funded by a fixed rate loan. In hindsight 2003-2004 was a great time to invest in real estate. Interest rates were low, everyone thought inflation was gone and real estate seemed to be priced reasonably. However I am not sure how good real estate is now as an investment option in general.
5. Be good at your job/ profession etc . Now this is a non-financial advise, but in the end for most of us the biggest asset is our skills. I think constantly upgrading skills and doing well in our professions is one of the best hedges against inflation. If you are one of the top performers, you will earn more via better increments or higher profits from your business. So I think investing in yourself is one of best hedges against inflation.
Now a lot of people will say gold, metals etc. I personally have no interest in those options. The long term data in most of these options show that the returns track inflation. So in absence of some special understanding of these alternative asset classes, I prefer to avoid them. I think there is enough for me to do in equity and debt than to worry about all this other stuff.
Finally, I mentioned profit from inflation ..is that possible ? if you can fund a long term asset such as real estate with a fixed debt (when rates are low) then during inflationary periods the rental rises with the inflation whereas debt is fixed. So equity in the asset is rising faster than inflation.
Also if you can roughly estimate when inflation is peaking, an investment in long duration debt (such 10 year bonds or mutuals) will give good returns when inflation slows (due to repricing of bonds). This happened to investors during the 2000-2003 time frame.
Monday, June 02, 2008
Analysis - Bharat Electronic limited (BEL)
About
Bharat Electronics Limited (BEL) is the largest defense equipment company in India catering to Defense services electronic requirement. BEL enjoys near monopoly status in supplying high-tech defense products like radars, sonars, communication equipment, electronic warfare equipment to the armed forces. Other division manufacturing civilian products supplies communication equipment to the telecom industry, voting machines etc.
The defence sector contributed to 76% of the revenue and the rest was from the civilian sector.
The company has a government mandated near monopoly for the defence sector business. In addition foreign vendors as a part of localization are required to source from BEL
Financials
The company has shown considerable improvement in financial performance. Topline has grown by 10% p.a for the last 5 years. The net profit has however grown by almost 20% p.a during the same period.
The higher bottom line growth has been driven by an increase in net margins from 10% to around 17% in 2008. Total Asset ratios have improved from around 8.2 to around 9.2 in 2007. The Wcap is negative or zero and the inventory turns have also improved 2.1 to 3.3. Only the recievables ratio has dropped from 3.1 to 2.5 in 2007.
The management seems to be aware of this and in 2007 has indicated that this was mainly due to incomplete projects and should improve in the current year.
The company is a cash rich company with cash net of debt of around 2200 Crs which could improve further in the current year.
The ROE seems to be steady, however net of cash it has been improving and the Return on incremental invested capital has gone up a lot.
Positives
The financials have improved substanially in the last 5 years. The net margins and Return on capital has gone up. The company has considerable cash on books. In addition the company spends almost 3-4% on R&D.
The company has introduced almost 25 products and systems in 2007. The company plans to continue this pace of new products in the future too.
The company has an order book of almost 90000 million in 2007 which is equivalent to 3 years of revenue at the curent rate.
The company will also benefit from the mandatory offset clause where in foreign vendors have to procure some portion of the contract from BEL.
Risks
The margins have gone up from 10% to around 17% in the current year driven by Raw material cost reduction. I am not sure how sustainable this improvement is. The long term average is still around 10-12 % and the current rise could be temporary.
The defence spending dropped around 1996-1998 time period and the net profits were low during that period. It looks unlikely that the government would drop defence spending now, however the risk remains.
Competition is very low in the defence sector, however the other segments do have some competition.
Competitive analysis
BEL is one of those rare companies which have very substantial competitive advantages. These advantages are government mandated and I find it diffcult to see how these will go away. Across the world there is a preference for domestic companies for defence contracts, more so in india.
Valuation
With an assumption of current growth and margins, the Intrinsic value comes to around 2100 Rs/ share. However a senstivity analysis of margins and topline gives the following numbers
Topline – 10%, margin – 10-12 % (long term average): 1650
Topline – 14%, margin – 10-12% : 2200
Topline –14%, margin – 17% : 3300
The central point for the intrinsic value seems to be around 2000-2200.
Conclusion
The company seems to be trading at 30-40% discount to instrinsic value. This is however not a sexy company. This is a company with substantial competitive advantages and will continue to be very profitable. However I don’t expect the market to suddenly discover this company and give a higher valuation. Most likely one can expect decent returns in the long run.
Bharat Electronics Limited (BEL) is the largest defense equipment company in India catering to Defense services electronic requirement. BEL enjoys near monopoly status in supplying high-tech defense products like radars, sonars, communication equipment, electronic warfare equipment to the armed forces. Other division manufacturing civilian products supplies communication equipment to the telecom industry, voting machines etc.
The defence sector contributed to 76% of the revenue and the rest was from the civilian sector.
The company has a government mandated near monopoly for the defence sector business. In addition foreign vendors as a part of localization are required to source from BEL
Financials
The company has shown considerable improvement in financial performance. Topline has grown by 10% p.a for the last 5 years. The net profit has however grown by almost 20% p.a during the same period.
The higher bottom line growth has been driven by an increase in net margins from 10% to around 17% in 2008. Total Asset ratios have improved from around 8.2 to around 9.2 in 2007. The Wcap is negative or zero and the inventory turns have also improved 2.1 to 3.3. Only the recievables ratio has dropped from 3.1 to 2.5 in 2007.
The management seems to be aware of this and in 2007 has indicated that this was mainly due to incomplete projects and should improve in the current year.
The company is a cash rich company with cash net of debt of around 2200 Crs which could improve further in the current year.
The ROE seems to be steady, however net of cash it has been improving and the Return on incremental invested capital has gone up a lot.
Positives
The financials have improved substanially in the last 5 years. The net margins and Return on capital has gone up. The company has considerable cash on books. In addition the company spends almost 3-4% on R&D.
The company has introduced almost 25 products and systems in 2007. The company plans to continue this pace of new products in the future too.
The company has an order book of almost 90000 million in 2007 which is equivalent to 3 years of revenue at the curent rate.
The company will also benefit from the mandatory offset clause where in foreign vendors have to procure some portion of the contract from BEL.
Risks
The margins have gone up from 10% to around 17% in the current year driven by Raw material cost reduction. I am not sure how sustainable this improvement is. The long term average is still around 10-12 % and the current rise could be temporary.
The defence spending dropped around 1996-1998 time period and the net profits were low during that period. It looks unlikely that the government would drop defence spending now, however the risk remains.
Competition is very low in the defence sector, however the other segments do have some competition.
Competitive analysis
BEL is one of those rare companies which have very substantial competitive advantages. These advantages are government mandated and I find it diffcult to see how these will go away. Across the world there is a preference for domestic companies for defence contracts, more so in india.
Valuation
With an assumption of current growth and margins, the Intrinsic value comes to around 2100 Rs/ share. However a senstivity analysis of margins and topline gives the following numbers
Topline – 10%, margin – 10-12 % (long term average): 1650
Topline – 14%, margin – 10-12% : 2200
Topline –14%, margin – 17% : 3300
The central point for the intrinsic value seems to be around 2000-2200.
Conclusion
The company seems to be trading at 30-40% discount to instrinsic value. This is however not a sexy company. This is a company with substantial competitive advantages and will continue to be very profitable. However I don’t expect the market to suddenly discover this company and give a higher valuation. Most likely one can expect decent returns in the long run.
Analysis - Bharat Electronic limited (BEL)
About
Bharat Electronics Limited (BEL) is the largest defense equipment company in India catering to Defense services electronic requirement. BEL enjoys near monopoly status in supplying high-tech defense products like radars, sonars, communication equipment, electronic warfare equipment to the armed forces. Other division manufacturing civilian products supplies communication equipment to the telecom industry, voting machines etc.
The defence sector contributed to 76% of the revenue and the rest was from the civilian sector.
The company has a government mandated near monopoly for the defence sector business. In addition foreign vendors as a part of localization are required to source from BEL
Financials
The company has shown considerable improvement in financial performance. Topline has grown by 10% p.a for the last 5 years. The net profit has however grown by almost 20% p.a during the same period.
The higher bottom line growth has been driven by an increase in net margins from 10% to around 17% in 2008. Total Asset ratios have improved from around 8.2 to around 9.2 in 2007. The Wcap is negative or zero and the inventory turns have also improved 2.1 to 3.3. Only the recievables ratio has dropped from 3.1 to 2.5 in 2007.
The management seems to be aware of this and in 2007 has indicated that this was mainly due to incomplete projects and should improve in the current year.
The company is a cash rich company with cash net of debt of around 2200 Crs which could improve further in the current year.
The ROE seems to be steady, however net of cash it has been improving and the Return on incremental invested capital has gone up a lot.
Positives
The financials have improved substanially in the last 5 years. The net margins and Return on capital has gone up. The company has considerable cash on books. In addition the company spends almost 3-4% on R&D.
The company has introduced almost 25 products and systems in 2007. The company plans to continue this pace of new products in the future too.
The company has an order book of almost 90000 million in 2007 which is equivalent to 3 years of revenue at the curent rate.
The company will also benefit from the mandatory offset clause where in foreign vendors have to procure some portion of the contract from BEL.
Risks
The margins have gone up from 10% to around 17% in the current year driven by Raw material cost reduction. I am not sure how sustainable this improvement is. The long term average is still around 10-12 % and the current rise could be temporary.
The defence spending dropped around 1996-1998 time period and the net profits were low during that period. It looks unlikely that the government would drop defence spending now, however the risk remains.
Competition is very low in the defence sector, however the other segments do have some competition.
Competitive analysis
BEL is one of those rare companies which have very substantial competitive advantages. These advantages are government mandated and I find it diffcult to see how these will go away. Across the world there is a preference for domestic companies for defence contracts, more so in india.
Valuation
With an assumption of current growth and margins, the Intrinsic value comes to around 2100 Rs/ share. However a senstivity analysis of margins and topline gives the following numbers
Topline – 10%, margin – 10-12 % (long term average): 1650
Topline – 14%, margin – 10-12% : 2200
Topline –14%, margin – 17% : 3300
The central point for the intrinsic value seems to be around 2000-2200.
Conclusion
The company seems to be trading at 30-40% discount to instrinsic value. This is however not a sexy company. This is a company with substantial competitive advantages and will continue to be very profitable. However I don’t expect the market to suddenly discover this company and give a higher valuation. Most likely one can expect decent returns in the long run.
Bharat Electronics Limited (BEL) is the largest defense equipment company in India catering to Defense services electronic requirement. BEL enjoys near monopoly status in supplying high-tech defense products like radars, sonars, communication equipment, electronic warfare equipment to the armed forces. Other division manufacturing civilian products supplies communication equipment to the telecom industry, voting machines etc.
The defence sector contributed to 76% of the revenue and the rest was from the civilian sector.
The company has a government mandated near monopoly for the defence sector business. In addition foreign vendors as a part of localization are required to source from BEL
Financials
The company has shown considerable improvement in financial performance. Topline has grown by 10% p.a for the last 5 years. The net profit has however grown by almost 20% p.a during the same period.
The higher bottom line growth has been driven by an increase in net margins from 10% to around 17% in 2008. Total Asset ratios have improved from around 8.2 to around 9.2 in 2007. The Wcap is negative or zero and the inventory turns have also improved 2.1 to 3.3. Only the recievables ratio has dropped from 3.1 to 2.5 in 2007.
The management seems to be aware of this and in 2007 has indicated that this was mainly due to incomplete projects and should improve in the current year.
The company is a cash rich company with cash net of debt of around 2200 Crs which could improve further in the current year.
The ROE seems to be steady, however net of cash it has been improving and the Return on incremental invested capital has gone up a lot.
Positives
The financials have improved substanially in the last 5 years. The net margins and Return on capital has gone up. The company has considerable cash on books. In addition the company spends almost 3-4% on R&D.
The company has introduced almost 25 products and systems in 2007. The company plans to continue this pace of new products in the future too.
The company has an order book of almost 90000 million in 2007 which is equivalent to 3 years of revenue at the curent rate.
The company will also benefit from the mandatory offset clause where in foreign vendors have to procure some portion of the contract from BEL.
Risks
The margins have gone up from 10% to around 17% in the current year driven by Raw material cost reduction. I am not sure how sustainable this improvement is. The long term average is still around 10-12 % and the current rise could be temporary.
The defence spending dropped around 1996-1998 time period and the net profits were low during that period. It looks unlikely that the government would drop defence spending now, however the risk remains.
Competition is very low in the defence sector, however the other segments do have some competition.
Competitive analysis
BEL is one of those rare companies which have very substantial competitive advantages. These advantages are government mandated and I find it diffcult to see how these will go away. Across the world there is a preference for domestic companies for defence contracts, more so in india.
Valuation
With an assumption of current growth and margins, the Intrinsic value comes to around 2100 Rs/ share. However a senstivity analysis of margins and topline gives the following numbers
Topline – 10%, margin – 10-12 % (long term average): 1650
Topline – 14%, margin – 10-12% : 2200
Topline –14%, margin – 17% : 3300
The central point for the intrinsic value seems to be around 2000-2200.
Conclusion
The company seems to be trading at 30-40% discount to instrinsic value. This is however not a sexy company. This is a company with substantial competitive advantages and will continue to be very profitable. However I don’t expect the market to suddenly discover this company and give a higher valuation. Most likely one can expect decent returns in the long run.
Saturday, May 31, 2008
Who would have thought?
Jan 2008 – Sub prime crisis in full swing, Rupee looked likely to appreciate (due to dollar weakness) , US on the edge of recession due to housing market collapse and high oil prices etc. IT companies were at an all time low
For ex: Infosys was selling between 1300-1400
May 2008 – Not much has changed in terms of fundamentals except that rupee has depreciated by 5-6 % (??!!) driving up inflation. The US economy has not gone into recession (yet !). Oil is now 125 USD+ and the future outlook seems to be as cloudy as ever (when is it ever completely clear ?)
So ….infosys is now selling at 2000+ (it jumped by 8% in US today). Other IT companies have increased by 50%+ too.
I will not try to explain why this is happening. My logic is as good as anyone's guess. You will soon find enough articles trying to explain the unexplainable or the irrational. Why even icici direct is now recommending NIIT tech :) …they have a target price of 180+ in the next six months. I think I will sell everything I have, and just buy this company for a sure 20% :)
Anyway, I am currently analyzing BEL (bharat electronics limited) and SRF and will be posting on them soon.
For ex: Infosys was selling between 1300-1400
May 2008 – Not much has changed in terms of fundamentals except that rupee has depreciated by 5-6 % (??!!) driving up inflation. The US economy has not gone into recession (yet !). Oil is now 125 USD+ and the future outlook seems to be as cloudy as ever (when is it ever completely clear ?)
So ….infosys is now selling at 2000+ (it jumped by 8% in US today). Other IT companies have increased by 50%+ too.
I will not try to explain why this is happening. My logic is as good as anyone's guess. You will soon find enough articles trying to explain the unexplainable or the irrational. Why even icici direct is now recommending NIIT tech :) …they have a target price of 180+ in the next six months. I think I will sell everything I have, and just buy this company for a sure 20% :)
Anyway, I am currently analyzing BEL (bharat electronics limited) and SRF and will be posting on them soon.
Who would have thought?
Jan 2008 – Sub prime crisis in full swing, Rupee looked likely to appreciate (due to dollar weakness) , US on the edge of recession due to housing market collapse and high oil prices etc. IT companies were at an all time low
For ex: Infosys was selling between 1300-1400
May 2008 – Not much has changed in terms of fundamentals except that rupee has depreciated by 5-6 % (??!!) driving up inflation. The US economy has not gone into recession (yet !). Oil is now 125 USD+ and the future outlook seems to be as cloudy as ever (when is it ever completely clear ?)
So ….infosys is now selling at 2000+ (it jumped by 8% in US today). Other IT companies have increased by 50%+ too.
I will not try to explain why this is happening. My logic is as good as anyone's guess. You will soon find enough articles trying to explain the unexplainable or the irrational. Why even icici direct is now recommending NIIT tech :) …they have a target price of 180+ in the next six months. I think I will sell everything I have, and just buy this company for a sure 20% :)
Anyway, I am currently analyzing BEL (bharat electronics limited) and SRF and will be posting on them soon.
For ex: Infosys was selling between 1300-1400
May 2008 – Not much has changed in terms of fundamentals except that rupee has depreciated by 5-6 % (??!!) driving up inflation. The US economy has not gone into recession (yet !). Oil is now 125 USD+ and the future outlook seems to be as cloudy as ever (when is it ever completely clear ?)
So ….infosys is now selling at 2000+ (it jumped by 8% in US today). Other IT companies have increased by 50%+ too.
I will not try to explain why this is happening. My logic is as good as anyone's guess. You will soon find enough articles trying to explain the unexplainable or the irrational. Why even icici direct is now recommending NIIT tech :) …they have a target price of 180+ in the next six months. I think I will sell everything I have, and just buy this company for a sure 20% :)
Anyway, I am currently analyzing BEL (bharat electronics limited) and SRF and will be posting on them soon.
Wednesday, May 28, 2008
Is it smart to exit HPCL ?
I got the below comment and thought of posting on it.
Rohit,
I am not sure if abandoning HPCL is such a good idea right now. You can buy good stocks at bargain only during distressed times. First crude prices will definitely go down. its just a temporary blip and secondly government cannot afford to shut down these PSU oil companies. Definitely PSU oil companies are not a long term bet for me..but for the short term ..i guess there is an excellent opportunity as of now. I know i can be wrong.
Selling is always a difficult decision especially if the underlying assumptions change. I personally analyse my stocks every quarter and more frequently if the underlying situation changes. In case of HPCL, I was banking on two key points
- Margins will not deteriorate drastically and maybe improve a bit in the next 2-3 years as other initiatives from the company bear fruit.
- market would realize that the company sells at 20-30% of asset values and will reduce the gap
Clearly the spike in Oil prices has invalidated the first point and the second may not happen soon due to point 1. I rarely make sell decision by short term drops in price. If the intrinsic value of the company is steady or growing, I will hold on to the company for a long time.
In case of HPCL, my key concern is that the intrinsic value of the company is being destroyed on a daily basis and at a very rapid rate. Time is not on my side in this case. The current oil price may turn out to be temporary. However I am not willing to bet on that as, the longer the oil price remain high, the more the company will bleed.
Finally an investment idea needs to be compared with all the other options or ideas. As of now, I can see other ideas which are better from a risk reward perspective and hence I decided to move out from HPCL.
Rohit,
I am not sure if abandoning HPCL is such a good idea right now. You can buy good stocks at bargain only during distressed times. First crude prices will definitely go down. its just a temporary blip and secondly government cannot afford to shut down these PSU oil companies. Definitely PSU oil companies are not a long term bet for me..but for the short term ..i guess there is an excellent opportunity as of now. I know i can be wrong.
Selling is always a difficult decision especially if the underlying assumptions change. I personally analyse my stocks every quarter and more frequently if the underlying situation changes. In case of HPCL, I was banking on two key points
- Margins will not deteriorate drastically and maybe improve a bit in the next 2-3 years as other initiatives from the company bear fruit.
- market would realize that the company sells at 20-30% of asset values and will reduce the gap
Clearly the spike in Oil prices has invalidated the first point and the second may not happen soon due to point 1. I rarely make sell decision by short term drops in price. If the intrinsic value of the company is steady or growing, I will hold on to the company for a long time.
In case of HPCL, my key concern is that the intrinsic value of the company is being destroyed on a daily basis and at a very rapid rate. Time is not on my side in this case. The current oil price may turn out to be temporary. However I am not willing to bet on that as, the longer the oil price remain high, the more the company will bleed.
Finally an investment idea needs to be compared with all the other options or ideas. As of now, I can see other ideas which are better from a risk reward perspective and hence I decided to move out from HPCL.
Is it smart to exit HPCL ?
I got the below comment and thought of posting on it.
Rohit,
I am not sure if abandoning HPCL is such a good idea right now. You can buy good stocks at bargain only during distressed times. First crude prices will definitely go down. its just a temporary blip and secondly government cannot afford to shut down these PSU oil companies. Definitely PSU oil companies are not a long term bet for me..but for the short term ..i guess there is an excellent opportunity as of now. I know i can be wrong.
Selling is always a difficult decision especially if the underlying assumptions change. I personally analyse my stocks every quarter and more frequently if the underlying situation changes. In case of HPCL, I was banking on two key points
- Margins will not deteriorate drastically and maybe improve a bit in the next 2-3 years as other initiatives from the company bear fruit.
- market would realize that the company sells at 20-30% of asset values and will reduce the gap
Clearly the spike in Oil prices has invalidated the first point and the second may not happen soon due to point 1. I rarely make sell decision by short term drops in price. If the intrinsic value of the company is steady or growing, I will hold on to the company for a long time.
In case of HPCL, my key concern is that the intrinsic value of the company is being destroyed on a daily basis and at a very rapid rate. Time is not on my side in this case. The current oil price may turn out to be temporary. However I am not willing to bet on that as, the longer the oil price remain high, the more the company will bleed.
Finally an investment idea needs to be compared with all the other options or ideas. As of now, I can see other ideas which are better from a risk reward perspective and hence I decided to move out from HPCL.
Rohit,
I am not sure if abandoning HPCL is such a good idea right now. You can buy good stocks at bargain only during distressed times. First crude prices will definitely go down. its just a temporary blip and secondly government cannot afford to shut down these PSU oil companies. Definitely PSU oil companies are not a long term bet for me..but for the short term ..i guess there is an excellent opportunity as of now. I know i can be wrong.
Selling is always a difficult decision especially if the underlying assumptions change. I personally analyse my stocks every quarter and more frequently if the underlying situation changes. In case of HPCL, I was banking on two key points
- Margins will not deteriorate drastically and maybe improve a bit in the next 2-3 years as other initiatives from the company bear fruit.
- market would realize that the company sells at 20-30% of asset values and will reduce the gap
Clearly the spike in Oil prices has invalidated the first point and the second may not happen soon due to point 1. I rarely make sell decision by short term drops in price. If the intrinsic value of the company is steady or growing, I will hold on to the company for a long time.
In case of HPCL, my key concern is that the intrinsic value of the company is being destroyed on a daily basis and at a very rapid rate. Time is not on my side in this case. The current oil price may turn out to be temporary. However I am not willing to bet on that as, the longer the oil price remain high, the more the company will bleed.
Finally an investment idea needs to be compared with all the other options or ideas. As of now, I can see other ideas which are better from a risk reward perspective and hence I decided to move out from HPCL.
Friday, May 23, 2008
Change of mind - HPCL
I had written the post below on 20-May. Since then the government has started thinking of raising the fuel prices. Note the word – thinking. The decision to raise prices is easier said than done. Even if the prices are raised, the haemorrhaging of the oil companies will reduce only partly.
-----------------------------------------------------------------------------------------------------------------------------------------------------------
I had written about HPCL earlier see here and here
The key elements of the investment thesis was as follows
1. The company is currently engaged in diversifying its revenue streams via various initiatives and reduce the impact of the pig headed policies of the government. These initiatives are lube marketing, Gas distribution and retail initiatives and oil trading and risk management. The market is currently not valuing any of these real options.
2. The GRM and net refining margins are at their lowest. Going forward the worst case sceanrio is that they would remain at the same level. If that is the case, the bottom line should still improve as the various company intiatives take effect (see page 53 of Annual report)
3. The 9 MMT refinery and expansion of Vizag refinery to 15 MMT and export of the petro-products and E&P activities should help the company improve its margins going forward.
The key unsaid assumption was that oil would not spike sharply. Oil prices are now at 130 usd a barrel (double the levels at the time of the analysis) and show no signs of coming down. In addition , I also read the following report – oil firms weeks away from bankruptcy. Now I do not believe the oil firms will go bankrupt – technically speaking. It is in the interest of the government to keep these companies alive. However the future looks bleak for these companies for the following reasons
1. Oil prices are unlikely to come down anytime soon. So the only way the government can sustain these companies is by issuing oil bonds. To raise cash, these companies will have to sell the oil bonds at some discount , incurring losses.
2. The government is unlikely to compensate these companies fully, wanting to keep the deficeit under control. As a result expect these company to incur losses for the forseeable future. In such a scenario, I am not sure how much these companies can invest in profitable growth and other assets.
3. These companies will increasingly look like the State SEB and other power companies in the long run – forever subsidsing the consumer due government pressure and unable to grow the business or invest in it.
Key learnings
1. I was clearly wrong about point 2 in the thesis. I never expected the oil prices to spike to 120+ (if i knew, oil futures would have been a great investment) . I never expected this government to remove the subsidy (and the next government wont do that either – it is not in their self interest). However the price spike in crude will be devastating to the oil companies.
2. Ignoring key pyschological principle – self interest combined with a crude price shock. Individuals and goverments take actions which are in their personal interest. Which political party is ever going to increase fuel prices and risk losing elections. I expected the government to behave in the way it is now. However self interest combined with high crude price will hurt the companies big time. As long as the prices were 100 usd or lower, the situation was bad, but now it is dire for these companies.
The loan waiver was still a one time event (hopefully). However the above subsidy is ongoing and will hurt the oil companies in the long run (in the short run they will be compensated via oil bonds and other mechanism). The above thesis was reasonable for moderately high crude prices. However the current price shock could drive the networth to zero.
Disclosure – I am exiting my position at a small gain. HPCL has not been a big position for me. The risk reward situation was good initially. However with the oil prices shooting up, I think the risk is not commensurate with the return.
Added note : In life there is no free lunch. Till date the government has subsidized fuel by gouging the oil companies. That well is now dry. Eventually all this subsidy will have to be paid by someone. It will likely come through taxes and higher inflation (most likely a combination of both).
-----------------------------------------------------------------------------------------------------------------------------------------------------------
I had written about HPCL earlier see here and here
The key elements of the investment thesis was as follows
1. The company is currently engaged in diversifying its revenue streams via various initiatives and reduce the impact of the pig headed policies of the government. These initiatives are lube marketing, Gas distribution and retail initiatives and oil trading and risk management. The market is currently not valuing any of these real options.
2. The GRM and net refining margins are at their lowest. Going forward the worst case sceanrio is that they would remain at the same level. If that is the case, the bottom line should still improve as the various company intiatives take effect (see page 53 of Annual report)
3. The 9 MMT refinery and expansion of Vizag refinery to 15 MMT and export of the petro-products and E&P activities should help the company improve its margins going forward.
The key unsaid assumption was that oil would not spike sharply. Oil prices are now at 130 usd a barrel (double the levels at the time of the analysis) and show no signs of coming down. In addition , I also read the following report – oil firms weeks away from bankruptcy. Now I do not believe the oil firms will go bankrupt – technically speaking. It is in the interest of the government to keep these companies alive. However the future looks bleak for these companies for the following reasons
1. Oil prices are unlikely to come down anytime soon. So the only way the government can sustain these companies is by issuing oil bonds. To raise cash, these companies will have to sell the oil bonds at some discount , incurring losses.
2. The government is unlikely to compensate these companies fully, wanting to keep the deficeit under control. As a result expect these company to incur losses for the forseeable future. In such a scenario, I am not sure how much these companies can invest in profitable growth and other assets.
3. These companies will increasingly look like the State SEB and other power companies in the long run – forever subsidsing the consumer due government pressure and unable to grow the business or invest in it.
Key learnings
1. I was clearly wrong about point 2 in the thesis. I never expected the oil prices to spike to 120+ (if i knew, oil futures would have been a great investment) . I never expected this government to remove the subsidy (and the next government wont do that either – it is not in their self interest). However the price spike in crude will be devastating to the oil companies.
2. Ignoring key pyschological principle – self interest combined with a crude price shock. Individuals and goverments take actions which are in their personal interest. Which political party is ever going to increase fuel prices and risk losing elections. I expected the government to behave in the way it is now. However self interest combined with high crude price will hurt the companies big time. As long as the prices were 100 usd or lower, the situation was bad, but now it is dire for these companies.
The loan waiver was still a one time event (hopefully). However the above subsidy is ongoing and will hurt the oil companies in the long run (in the short run they will be compensated via oil bonds and other mechanism). The above thesis was reasonable for moderately high crude prices. However the current price shock could drive the networth to zero.
Disclosure – I am exiting my position at a small gain. HPCL has not been a big position for me. The risk reward situation was good initially. However with the oil prices shooting up, I think the risk is not commensurate with the return.
Added note : In life there is no free lunch. Till date the government has subsidized fuel by gouging the oil companies. That well is now dry. Eventually all this subsidy will have to be paid by someone. It will likely come through taxes and higher inflation (most likely a combination of both).
Change of mind - HPCL
I had written the post below on 20-May. Since then the government has started thinking of raising the fuel prices. Note the word – thinking. The decision to raise prices is easier said than done. Even if the prices are raised, the haemorrhaging of the oil companies will reduce only partly.
-----------------------------------------------------------------------------------------------------------------------------------------------------------
I had written about HPCL earlier see here and here
The key elements of the investment thesis was as follows
1. The company is currently engaged in diversifying its revenue streams via various initiatives and reduce the impact of the pig headed policies of the government. These initiatives are lube marketing, Gas distribution and retail initiatives and oil trading and risk management. The market is currently not valuing any of these real options.
2. The GRM and net refining margins are at their lowest. Going forward the worst case sceanrio is that they would remain at the same level. If that is the case, the bottom line should still improve as the various company intiatives take effect (see page 53 of Annual report)
3. The 9 MMT refinery and expansion of Vizag refinery to 15 MMT and export of the petro-products and E&P activities should help the company improve its margins going forward.
The key unsaid assumption was that oil would not spike sharply. Oil prices are now at 130 usd a barrel (double the levels at the time of the analysis) and show no signs of coming down. In addition , I also read the following report – oil firms weeks away from bankruptcy. Now I do not believe the oil firms will go bankrupt – technically speaking. It is in the interest of the government to keep these companies alive. However the future looks bleak for these companies for the following reasons
1. Oil prices are unlikely to come down anytime soon. So the only way the government can sustain these companies is by issuing oil bonds. To raise cash, these companies will have to sell the oil bonds at some discount , incurring losses.
2. The government is unlikely to compensate these companies fully, wanting to keep the deficeit under control. As a result expect these company to incur losses for the forseeable future. In such a scenario, I am not sure how much these companies can invest in profitable growth and other assets.
3. These companies will increasingly look like the State SEB and other power companies in the long run – forever subsidsing the consumer due government pressure and unable to grow the business or invest in it.
Key learnings
1. I was clearly wrong about point 2 in the thesis. I never expected the oil prices to spike to 120+ (if i knew, oil futures would have been a great investment) . I never expected this government to remove the subsidy (and the next government wont do that either – it is not in their self interest). However the price spike in crude will be devastating to the oil companies.
2. Ignoring key pyschological principle – self interest combined with a crude price shock. Individuals and goverments take actions which are in their personal interest. Which political party is ever going to increase fuel prices and risk losing elections. I expected the government to behave in the way it is now. However self interest combined with high crude price will hurt the companies big time. As long as the prices were 100 usd or lower, the situation was bad, but now it is dire for these companies.
The loan waiver was still a one time event (hopefully). However the above subsidy is ongoing and will hurt the oil companies in the long run (in the short run they will be compensated via oil bonds and other mechanism). The above thesis was reasonable for moderately high crude prices. However the current price shock could drive the networth to zero.
Disclosure – I am exiting my position at a small gain. HPCL has not been a big position for me. The risk reward situation was good initially. However with the oil prices shooting up, I think the risk is not commensurate with the return.
Added note : In life there is no free lunch. Till date the government has subsidized fuel by gouging the oil companies. That well is now dry. Eventually all this subsidy will have to be paid by someone. It will likely come through taxes and higher inflation (most likely a combination of both).
-----------------------------------------------------------------------------------------------------------------------------------------------------------
I had written about HPCL earlier see here and here
The key elements of the investment thesis was as follows
1. The company is currently engaged in diversifying its revenue streams via various initiatives and reduce the impact of the pig headed policies of the government. These initiatives are lube marketing, Gas distribution and retail initiatives and oil trading and risk management. The market is currently not valuing any of these real options.
2. The GRM and net refining margins are at their lowest. Going forward the worst case sceanrio is that they would remain at the same level. If that is the case, the bottom line should still improve as the various company intiatives take effect (see page 53 of Annual report)
3. The 9 MMT refinery and expansion of Vizag refinery to 15 MMT and export of the petro-products and E&P activities should help the company improve its margins going forward.
The key unsaid assumption was that oil would not spike sharply. Oil prices are now at 130 usd a barrel (double the levels at the time of the analysis) and show no signs of coming down. In addition , I also read the following report – oil firms weeks away from bankruptcy. Now I do not believe the oil firms will go bankrupt – technically speaking. It is in the interest of the government to keep these companies alive. However the future looks bleak for these companies for the following reasons
1. Oil prices are unlikely to come down anytime soon. So the only way the government can sustain these companies is by issuing oil bonds. To raise cash, these companies will have to sell the oil bonds at some discount , incurring losses.
2. The government is unlikely to compensate these companies fully, wanting to keep the deficeit under control. As a result expect these company to incur losses for the forseeable future. In such a scenario, I am not sure how much these companies can invest in profitable growth and other assets.
3. These companies will increasingly look like the State SEB and other power companies in the long run – forever subsidsing the consumer due government pressure and unable to grow the business or invest in it.
Key learnings
1. I was clearly wrong about point 2 in the thesis. I never expected the oil prices to spike to 120+ (if i knew, oil futures would have been a great investment) . I never expected this government to remove the subsidy (and the next government wont do that either – it is not in their self interest). However the price spike in crude will be devastating to the oil companies.
2. Ignoring key pyschological principle – self interest combined with a crude price shock. Individuals and goverments take actions which are in their personal interest. Which political party is ever going to increase fuel prices and risk losing elections. I expected the government to behave in the way it is now. However self interest combined with high crude price will hurt the companies big time. As long as the prices were 100 usd or lower, the situation was bad, but now it is dire for these companies.
The loan waiver was still a one time event (hopefully). However the above subsidy is ongoing and will hurt the oil companies in the long run (in the short run they will be compensated via oil bonds and other mechanism). The above thesis was reasonable for moderately high crude prices. However the current price shock could drive the networth to zero.
Disclosure – I am exiting my position at a small gain. HPCL has not been a big position for me. The risk reward situation was good initially. However with the oil prices shooting up, I think the risk is not commensurate with the return.
Added note : In life there is no free lunch. Till date the government has subsidized fuel by gouging the oil companies. That well is now dry. Eventually all this subsidy will have to be paid by someone. It will likely come through taxes and higher inflation (most likely a combination of both).
Tuesday, May 20, 2008
What you will not find on this blog
Stock tips – I do not believe in giving or receiving it. My approach is to analyse a stock and post the facts and my opinions. I would leave it to the reader to accept or reject my analysis. It is upto the reader to take a decision to buy or avoid the stock. I don’t even recommend stocks to my friends and family. If they make money based on my tip its because they were smart to take my advise. If they lose, I am to be blamed for the stupid tip. So either way it’s a no win proposition for me.
Price targets – I don’t believe in them. It is difficult enough to analyse a company and arrive at the intrinsic value. I think it close to impossible to predict when the market would close the valuation gap. So price targets are basically guesses and my guess is as good as anyone else. I am personally not selling a research report and don’t need to satisfy anyone’s need for a predicition. So better not to predict the unpredictable
Market, interest rate, and other short term prediction – No different than trying to predict stock prices. Only more difficult if not impossible
Analysis of gold, real estate, option etc – I do not have sufficient skills to do justice to these topics. Maybe options in the future, but I doubt gold and real estate.
Reviews or sales pitch – This blog is more of a personal interest. The ads you see are contextual ads from yahoo or from a few sponsors.
Net Net , this blog is an expression of my personal passion – investing and all things about it. I have no interest in selling anything and if I do manage to make some money from sponsorship – well that will hopefully pay for my coffee :)
Price targets – I don’t believe in them. It is difficult enough to analyse a company and arrive at the intrinsic value. I think it close to impossible to predict when the market would close the valuation gap. So price targets are basically guesses and my guess is as good as anyone else. I am personally not selling a research report and don’t need to satisfy anyone’s need for a predicition. So better not to predict the unpredictable
Market, interest rate, and other short term prediction – No different than trying to predict stock prices. Only more difficult if not impossible
Analysis of gold, real estate, option etc – I do not have sufficient skills to do justice to these topics. Maybe options in the future, but I doubt gold and real estate.
Reviews or sales pitch – This blog is more of a personal interest. The ads you see are contextual ads from yahoo or from a few sponsors.
Net Net , this blog is an expression of my personal passion – investing and all things about it. I have no interest in selling anything and if I do manage to make some money from sponsorship – well that will hopefully pay for my coffee :)
What you will not find on this blog
Stock tips – I do not believe in giving or receiving it. My approach is to analyse a stock and post the facts and my opinions. I would leave it to the reader to accept or reject my analysis. It is upto the reader to take a decision to buy or avoid the stock. I don’t even recommend stocks to my friends and family. If they make money based on my tip its because they were smart to take my advise. If they lose, I am to be blamed for the stupid tip. So either way it’s a no win proposition for me.
Price targets – I don’t believe in them. It is difficult enough to analyse a company and arrive at the intrinsic value. I think it close to impossible to predict when the market would close the valuation gap. So price targets are basically guesses and my guess is as good as anyone else. I am personally not selling a research report and don’t need to satisfy anyone’s need for a predicition. So better not to predict the unpredictable
Market, interest rate, and other short term prediction – No different than trying to predict stock prices. Only more difficult if not impossible
Analysis of gold, real estate, option etc – I do not have sufficient skills to do justice to these topics. Maybe options in the future, but I doubt gold and real estate.
Reviews or sales pitch – This blog is more of a personal interest. The ads you see are contextual ads from yahoo or from a few sponsors.
Net Net , this blog is an expression of my personal passion – investing and all things about it. I have no interest in selling anything and if I do manage to make some money from sponsorship – well that will hopefully pay for my coffee :)
Price targets – I don’t believe in them. It is difficult enough to analyse a company and arrive at the intrinsic value. I think it close to impossible to predict when the market would close the valuation gap. So price targets are basically guesses and my guess is as good as anyone else. I am personally not selling a research report and don’t need to satisfy anyone’s need for a predicition. So better not to predict the unpredictable
Market, interest rate, and other short term prediction – No different than trying to predict stock prices. Only more difficult if not impossible
Analysis of gold, real estate, option etc – I do not have sufficient skills to do justice to these topics. Maybe options in the future, but I doubt gold and real estate.
Reviews or sales pitch – This blog is more of a personal interest. The ads you see are contextual ads from yahoo or from a few sponsors.
Net Net , this blog is an expression of my personal passion – investing and all things about it. I have no interest in selling anything and if I do manage to make some money from sponsorship – well that will hopefully pay for my coffee :)
Thursday, May 15, 2008
Analysis - Maruti Suzuki Ltd
About
Maruti Suzuki is india’s largest car company with brands such as Maruti 800, Alto, Swift etc. The company sold around 760000 cars in FY08 and currently holds a 50%+ market share
Financials
The company has achieved a 10%+ growth for the last few years. In addition the ROE has been 20%+ for the last few years and net of cash the ratio is upwards of 50%. The net profit margins have gone up from 5.8% to 9.8% in the current year. The company is a zero debt company and has almost 3000 Crs + cash and investments as of 2007.
In addition the efficiency ratios have improved from 2003 onwards. The company is now working on 0 Wcap. The recievables ratio is up from 14 to around 19 (2007). The total asset ratio has improved to around 5.
The company has thus improved its profitability and asset turns in the last few years. The improvement in net margins is really commendable as this has happened in times of rising raw material prices and higher competition.
Positives
Maruti is one the most well know brands. I really doubt if there is an indian who is not aware of maruti suzuki (rather their cars).
The company has a strong balance sheet, great brands and has been able to add new successful models consistently in the past few years. In addition the company now has full support from the parent for new models.
In addition to the above the company has the largest dealer and service network.
Risks
I see competition as the biggest risk. There will be swings in the demand. However as India prospers, the unit volumes are bound to go up. However with China and India being the high growth markets globally, there is bound to be intense competition in this sector. This could have an impact on the margins going forward.
The risk to margins is not from the pricing alone. Higher competition means, shorter product cycles and hence the amorization of the development expenses is now over shorter period. Case in point – The Company has rightly hiked its depreciation rates.
In addition during the year 2000-2002, the company had quite a stumble. The company was suddenly faced with slowing demand and increased competition. As a result the company made its first loss in years. However the company has learnt from it and has become far more efficient.
Competitive analysis
The firm has competitive advantage from a high market share and well know brands. The high volumes drives economies of scale for the company in manufacturing, purchasing, distribution and such scale driven activities.
In addition the company has increased the lead by expanding its distribution networks (more dealers), opening new service centres and by expanding into allied services such as insurance and used car sales. All this results in higher customer lockin and more repeat business.
Valuation
It is quite apparent that the company has considerable competitive advantage. However what is not easy to figure is how competition will increase and impact margins in the future.
With an assumption that the margins will remain between 7-9% (which is slightly higher than the global averages) and a 8-10% growth, and CAP of 9 years , the intrinsic value comes to around 1200-1300. I think the growth and CAP assumptions are reasonable. However the net margins are a wild card.
Added note: A 6-7% margin assumption would give an intrinsic value of around 1100.
Conclusion
The company sells at around 40% discount to the above intrinsic value. However I still have my doubts on the net margins. As a result although the company appears undervalued at current prices, I do not have any investment in the company. I would be prefer to have a higher discount to intrinsic value to make a commitment in order to reduce the downside risk from net margins.
Disclaimer – I may change my mind based on new information and may invest in the company. I may however not post when I do so. So as usual please make your own decision and read the disclaimer.
Maruti Suzuki is india’s largest car company with brands such as Maruti 800, Alto, Swift etc. The company sold around 760000 cars in FY08 and currently holds a 50%+ market share
Financials
The company has achieved a 10%+ growth for the last few years. In addition the ROE has been 20%+ for the last few years and net of cash the ratio is upwards of 50%. The net profit margins have gone up from 5.8% to 9.8% in the current year. The company is a zero debt company and has almost 3000 Crs + cash and investments as of 2007.
In addition the efficiency ratios have improved from 2003 onwards. The company is now working on 0 Wcap. The recievables ratio is up from 14 to around 19 (2007). The total asset ratio has improved to around 5.
The company has thus improved its profitability and asset turns in the last few years. The improvement in net margins is really commendable as this has happened in times of rising raw material prices and higher competition.
Positives
Maruti is one the most well know brands. I really doubt if there is an indian who is not aware of maruti suzuki (rather their cars).
The company has a strong balance sheet, great brands and has been able to add new successful models consistently in the past few years. In addition the company now has full support from the parent for new models.
In addition to the above the company has the largest dealer and service network.
Risks
I see competition as the biggest risk. There will be swings in the demand. However as India prospers, the unit volumes are bound to go up. However with China and India being the high growth markets globally, there is bound to be intense competition in this sector. This could have an impact on the margins going forward.
The risk to margins is not from the pricing alone. Higher competition means, shorter product cycles and hence the amorization of the development expenses is now over shorter period. Case in point – The Company has rightly hiked its depreciation rates.
In addition during the year 2000-2002, the company had quite a stumble. The company was suddenly faced with slowing demand and increased competition. As a result the company made its first loss in years. However the company has learnt from it and has become far more efficient.
Competitive analysis
The firm has competitive advantage from a high market share and well know brands. The high volumes drives economies of scale for the company in manufacturing, purchasing, distribution and such scale driven activities.
In addition the company has increased the lead by expanding its distribution networks (more dealers), opening new service centres and by expanding into allied services such as insurance and used car sales. All this results in higher customer lockin and more repeat business.
Valuation
It is quite apparent that the company has considerable competitive advantage. However what is not easy to figure is how competition will increase and impact margins in the future.
With an assumption that the margins will remain between 7-9% (which is slightly higher than the global averages) and a 8-10% growth, and CAP of 9 years , the intrinsic value comes to around 1200-1300. I think the growth and CAP assumptions are reasonable. However the net margins are a wild card.
Added note: A 6-7% margin assumption would give an intrinsic value of around 1100.
Conclusion
The company sells at around 40% discount to the above intrinsic value. However I still have my doubts on the net margins. As a result although the company appears undervalued at current prices, I do not have any investment in the company. I would be prefer to have a higher discount to intrinsic value to make a commitment in order to reduce the downside risk from net margins.
Disclaimer – I may change my mind based on new information and may invest in the company. I may however not post when I do so. So as usual please make your own decision and read the disclaimer.
Analysis - Maruti Suzuki Ltd
About
Maruti Suzuki is india’s largest car company with brands such as Maruti 800, Alto, Swift etc. The company sold around 760000 cars in FY08 and currently holds a 50%+ market share
Financials
The company has achieved a 10%+ growth for the last few years. In addition the ROE has been 20%+ for the last few years and net of cash the ratio is upwards of 50%. The net profit margins have gone up from 5.8% to 9.8% in the current year. The company is a zero debt company and has almost 3000 Crs + cash and investments as of 2007.
In addition the efficiency ratios have improved from 2003 onwards. The company is now working on 0 Wcap. The recievables ratio is up from 14 to around 19 (2007). The total asset ratio has improved to around 5.
The company has thus improved its profitability and asset turns in the last few years. The improvement in net margins is really commendable as this has happened in times of rising raw material prices and higher competition.
Positives
Maruti is one the most well know brands. I really doubt if there is an indian who is not aware of maruti suzuki (rather their cars).
The company has a strong balance sheet, great brands and has been able to add new successful models consistently in the past few years. In addition the company now has full support from the parent for new models.
In addition to the above the company has the largest dealer and service network.
Risks
I see competition as the biggest risk. There will be swings in the demand. However as India prospers, the unit volumes are bound to go up. However with China and India being the high growth markets globally, there is bound to be intense competition in this sector. This could have an impact on the margins going forward.
The risk to margins is not from the pricing alone. Higher competition means, shorter product cycles and hence the amorization of the development expenses is now over shorter period. Case in point – The Company has rightly hiked its depreciation rates.
In addition during the year 2000-2002, the company had quite a stumble. The company was suddenly faced with slowing demand and increased competition. As a result the company made its first loss in years. However the company has learnt from it and has become far more efficient.
Competitive analysis
The firm has competitive advantage from a high market share and well know brands. The high volumes drives economies of scale for the company in manufacturing, purchasing, distribution and such scale driven activities.
In addition the company has increased the lead by expanding its distribution networks (more dealers), opening new service centres and by expanding into allied services such as insurance and used car sales. All this results in higher customer lockin and more repeat business.
Valuation
It is quite apparent that the company has considerable competitive advantage. However what is not easy to figure is how competition will increase and impact margins in the future.
With an assumption that the margins will remain between 7-9% (which is slightly higher than the global averages) and a 8-10% growth, and CAP of 9 years , the intrinsic value comes to around 1200-1300. I think the growth and CAP assumptions are reasonable. However the net margins are a wild card.
Added note: A 6-7% margin assumption would give an intrinsic value of around 1100.
Conclusion
The company sells at around 40% discount to the above intrinsic value. However I still have my doubts on the net margins. As a result although the company appears undervalued at current prices, I do not have any investment in the company. I would be prefer to have a higher discount to intrinsic value to make a commitment in order to reduce the downside risk from net margins.
Disclaimer – I may change my mind based on new information and may invest in the company. I may however not post when I do so. So as usual please make your own decision and read the disclaimer.
Maruti Suzuki is india’s largest car company with brands such as Maruti 800, Alto, Swift etc. The company sold around 760000 cars in FY08 and currently holds a 50%+ market share
Financials
The company has achieved a 10%+ growth for the last few years. In addition the ROE has been 20%+ for the last few years and net of cash the ratio is upwards of 50%. The net profit margins have gone up from 5.8% to 9.8% in the current year. The company is a zero debt company and has almost 3000 Crs + cash and investments as of 2007.
In addition the efficiency ratios have improved from 2003 onwards. The company is now working on 0 Wcap. The recievables ratio is up from 14 to around 19 (2007). The total asset ratio has improved to around 5.
The company has thus improved its profitability and asset turns in the last few years. The improvement in net margins is really commendable as this has happened in times of rising raw material prices and higher competition.
Positives
Maruti is one the most well know brands. I really doubt if there is an indian who is not aware of maruti suzuki (rather their cars).
The company has a strong balance sheet, great brands and has been able to add new successful models consistently in the past few years. In addition the company now has full support from the parent for new models.
In addition to the above the company has the largest dealer and service network.
Risks
I see competition as the biggest risk. There will be swings in the demand. However as India prospers, the unit volumes are bound to go up. However with China and India being the high growth markets globally, there is bound to be intense competition in this sector. This could have an impact on the margins going forward.
The risk to margins is not from the pricing alone. Higher competition means, shorter product cycles and hence the amorization of the development expenses is now over shorter period. Case in point – The Company has rightly hiked its depreciation rates.
In addition during the year 2000-2002, the company had quite a stumble. The company was suddenly faced with slowing demand and increased competition. As a result the company made its first loss in years. However the company has learnt from it and has become far more efficient.
Competitive analysis
The firm has competitive advantage from a high market share and well know brands. The high volumes drives economies of scale for the company in manufacturing, purchasing, distribution and such scale driven activities.
In addition the company has increased the lead by expanding its distribution networks (more dealers), opening new service centres and by expanding into allied services such as insurance and used car sales. All this results in higher customer lockin and more repeat business.
Valuation
It is quite apparent that the company has considerable competitive advantage. However what is not easy to figure is how competition will increase and impact margins in the future.
With an assumption that the margins will remain between 7-9% (which is slightly higher than the global averages) and a 8-10% growth, and CAP of 9 years , the intrinsic value comes to around 1200-1300. I think the growth and CAP assumptions are reasonable. However the net margins are a wild card.
Added note: A 6-7% margin assumption would give an intrinsic value of around 1100.
Conclusion
The company sells at around 40% discount to the above intrinsic value. However I still have my doubts on the net margins. As a result although the company appears undervalued at current prices, I do not have any investment in the company. I would be prefer to have a higher discount to intrinsic value to make a commitment in order to reduce the downside risk from net margins.
Disclaimer – I may change my mind based on new information and may invest in the company. I may however not post when I do so. So as usual please make your own decision and read the disclaimer.
Thursday, May 08, 2008
Analysis - Balmer Lawrie
Balmer lawrie is a diversified company engaged in the following businesses
Industrial packaging
Greases and lubes
Logisitics
Tours and travel
Others
Each business has its own economics which range from the good (logistics) to the terrible (tea).
A few key points
- The company has identified three areas for future expansion - logistics management, travel and tourism and industrial packaging. It is looking for a strategic alliance for its tea marketing operations, leather chemicals business and tourism. It may even be looking at exiting the tea business
- The company plans to invest 200-300 Crs in the good businesses such as Logisitics, travel and tourism etc
- Most of the businesses are cyclical except logistics. The logisitics business is the most profitable and accounts for more than 60% of the profits and total value while utlizing less than 30% of the total capital
- The company has several JV which contribute to around 10% of netprofits
- The capital allocation has improved for the company. The extra capital has been used to retire debt and generate cash
- The correct approach to valuing this company is to do a sum of parts. Each business must be valued separately as it has different economics. The indivual valuation should be summed up to arrive at the final value. I have done a rough back of the envelope analysis and uploaded here
Additional note : I have a position in the stock. This stock has now become a long term holding now. I bought this stock in 2004 time frame at around 160 / share and have added since then. The price has increased since then. However the intrinsic value of the company has grown faster and hence I feel the company is still substanially undervalued. However this stock may require quite a bit of patience and I don’t forsee a quick jump anytime soon (I wont mind if this prediction is wrong :) )
I am however not recommending this stock for anyone and would suggest you to make your own decision. As usual please read disclaimer at the bottom of the page
Industrial packaging
Greases and lubes
Logisitics
Tours and travel
Others
Each business has its own economics which range from the good (logistics) to the terrible (tea).
A few key points
- The company has identified three areas for future expansion - logistics management, travel and tourism and industrial packaging. It is looking for a strategic alliance for its tea marketing operations, leather chemicals business and tourism. It may even be looking at exiting the tea business
- The company plans to invest 200-300 Crs in the good businesses such as Logisitics, travel and tourism etc
- Most of the businesses are cyclical except logistics. The logisitics business is the most profitable and accounts for more than 60% of the profits and total value while utlizing less than 30% of the total capital
- The company has several JV which contribute to around 10% of netprofits
- The capital allocation has improved for the company. The extra capital has been used to retire debt and generate cash
- The correct approach to valuing this company is to do a sum of parts. Each business must be valued separately as it has different economics. The indivual valuation should be summed up to arrive at the final value. I have done a rough back of the envelope analysis and uploaded here
Additional note : I have a position in the stock. This stock has now become a long term holding now. I bought this stock in 2004 time frame at around 160 / share and have added since then. The price has increased since then. However the intrinsic value of the company has grown faster and hence I feel the company is still substanially undervalued. However this stock may require quite a bit of patience and I don’t forsee a quick jump anytime soon (I wont mind if this prediction is wrong :) )
I am however not recommending this stock for anyone and would suggest you to make your own decision. As usual please read disclaimer at the bottom of the page
Analysis - Balmer Lawrie
Balmer lawrie is a diversified company engaged in the following businesses
Industrial packaging
Greases and lubes
Logisitics
Tours and travel
Others
Each business has its own economics which range from the good (logistics) to the terrible (tea).
A few key points
- The company has identified three areas for future expansion - logistics management, travel and tourism and industrial packaging. It is looking for a strategic alliance for its tea marketing operations, leather chemicals business and tourism. It may even be looking at exiting the tea business
- The company plans to invest 200-300 Crs in the good businesses such as Logisitics, travel and tourism etc
- Most of the businesses are cyclical except logistics. The logisitics business is the most profitable and accounts for more than 60% of the profits and total value while utlizing less than 30% of the total capital
- The company has several JV which contribute to around 10% of netprofits
- The capital allocation has improved for the company. The extra capital has been used to retire debt and generate cash
- The correct approach to valuing this company is to do a sum of parts. Each business must be valued separately as it has different economics. The indivual valuation should be summed up to arrive at the final value. I have done a rough back of the envelope analysis and uploaded here
Additional note : I have a position in the stock. This stock has now become a long term holding now. I bought this stock in 2004 time frame at around 160 / share and have added since then. The price has increased since then. However the intrinsic value of the company has grown faster and hence I feel the company is still substanially undervalued. However this stock may require quite a bit of patience and I don’t forsee a quick jump anytime soon (I wont mind if this prediction is wrong :) )
I am however not recommending this stock for anyone and would suggest you to make your own decision. As usual please read disclaimer at the bottom of the page
Industrial packaging
Greases and lubes
Logisitics
Tours and travel
Others
Each business has its own economics which range from the good (logistics) to the terrible (tea).
A few key points
- The company has identified three areas for future expansion - logistics management, travel and tourism and industrial packaging. It is looking for a strategic alliance for its tea marketing operations, leather chemicals business and tourism. It may even be looking at exiting the tea business
- The company plans to invest 200-300 Crs in the good businesses such as Logisitics, travel and tourism etc
- Most of the businesses are cyclical except logistics. The logisitics business is the most profitable and accounts for more than 60% of the profits and total value while utlizing less than 30% of the total capital
- The company has several JV which contribute to around 10% of netprofits
- The capital allocation has improved for the company. The extra capital has been used to retire debt and generate cash
- The correct approach to valuing this company is to do a sum of parts. Each business must be valued separately as it has different economics. The indivual valuation should be summed up to arrive at the final value. I have done a rough back of the envelope analysis and uploaded here
Additional note : I have a position in the stock. This stock has now become a long term holding now. I bought this stock in 2004 time frame at around 160 / share and have added since then. The price has increased since then. However the intrinsic value of the company has grown faster and hence I feel the company is still substanially undervalued. However this stock may require quite a bit of patience and I don’t forsee a quick jump anytime soon (I wont mind if this prediction is wrong :) )
I am however not recommending this stock for anyone and would suggest you to make your own decision. As usual please read disclaimer at the bottom of the page
Monday, May 05, 2008
The three risks for IT industry
I had recently posted on NIIT tech and uploaded the valuation (see here). The way I see it, there seem to be three key risks for the IT industry which I have tried to include in my valuations.
Risk 1 : US slowdown – This is a medium term risk and should not impact the long term economics of the IT industry. On the contrary I think the slow down will not really impact the industry much in terms of overall growth. There could be a bit of a slow down and some pricing pressure. But not much beyond that.
Risk 2 : Rupee appreciation – I think this with cost pressures is the most critical risks as this would impact the margins of the IT companies. In the scenario I have built I am assuming that margins will drop by half in the next 2 years due to the appreciation and cost pressure
Risk 3 : Taxation issues – The tax holiday enjoyed by the industry would be taken out by the government. In response to the slowdown and rupee appreciation the government has extended the tax holiday and there has been a sudden rally due to that. However I think the tax breaks are bound to go, only question is when. However this risk is definable and can easily be worked into the valuation
In my valuation I have assumed the worst case scenario for all the three risks. However as we saw recently if the rupee appreciates, the tax breaks could get extended a bit and that could mitigate the impact. So it is quite likely that the worst may not come to pass. The stock price assumed the worst in march. Since then there has some correction as the market realised that things are not as bad. However it would not take much to change the mood again.
Risk 1 : US slowdown – This is a medium term risk and should not impact the long term economics of the IT industry. On the contrary I think the slow down will not really impact the industry much in terms of overall growth. There could be a bit of a slow down and some pricing pressure. But not much beyond that.
Risk 2 : Rupee appreciation – I think this with cost pressures is the most critical risks as this would impact the margins of the IT companies. In the scenario I have built I am assuming that margins will drop by half in the next 2 years due to the appreciation and cost pressure
Risk 3 : Taxation issues – The tax holiday enjoyed by the industry would be taken out by the government. In response to the slowdown and rupee appreciation the government has extended the tax holiday and there has been a sudden rally due to that. However I think the tax breaks are bound to go, only question is when. However this risk is definable and can easily be worked into the valuation
In my valuation I have assumed the worst case scenario for all the three risks. However as we saw recently if the rupee appreciates, the tax breaks could get extended a bit and that could mitigate the impact. So it is quite likely that the worst may not come to pass. The stock price assumed the worst in march. Since then there has some correction as the market realised that things are not as bad. However it would not take much to change the mood again.
The three risks for IT industry
I had recently posted on NIIT tech and uploaded the valuation (see here). The way I see it, there seem to be three key risks for the IT industry which I have tried to include in my valuations.
Risk 1 : US slowdown – This is a medium term risk and should not impact the long term economics of the IT industry. On the contrary I think the slow down will not really impact the industry much in terms of overall growth. There could be a bit of a slow down and some pricing pressure. But not much beyond that.
Risk 2 : Rupee appreciation – I think this with cost pressures is the most critical risks as this would impact the margins of the IT companies. In the scenario I have built I am assuming that margins will drop by half in the next 2 years due to the appreciation and cost pressure
Risk 3 : Taxation issues – The tax holiday enjoyed by the industry would be taken out by the government. In response to the slowdown and rupee appreciation the government has extended the tax holiday and there has been a sudden rally due to that. However I think the tax breaks are bound to go, only question is when. However this risk is definable and can easily be worked into the valuation
In my valuation I have assumed the worst case scenario for all the three risks. However as we saw recently if the rupee appreciates, the tax breaks could get extended a bit and that could mitigate the impact. So it is quite likely that the worst may not come to pass. The stock price assumed the worst in march. Since then there has some correction as the market realised that things are not as bad. However it would not take much to change the mood again.
Risk 1 : US slowdown – This is a medium term risk and should not impact the long term economics of the IT industry. On the contrary I think the slow down will not really impact the industry much in terms of overall growth. There could be a bit of a slow down and some pricing pressure. But not much beyond that.
Risk 2 : Rupee appreciation – I think this with cost pressures is the most critical risks as this would impact the margins of the IT companies. In the scenario I have built I am assuming that margins will drop by half in the next 2 years due to the appreciation and cost pressure
Risk 3 : Taxation issues – The tax holiday enjoyed by the industry would be taken out by the government. In response to the slowdown and rupee appreciation the government has extended the tax holiday and there has been a sudden rally due to that. However I think the tax breaks are bound to go, only question is when. However this risk is definable and can easily be worked into the valuation
In my valuation I have assumed the worst case scenario for all the three risks. However as we saw recently if the rupee appreciates, the tax breaks could get extended a bit and that could mitigate the impact. So it is quite likely that the worst may not come to pass. The stock price assumed the worst in march. Since then there has some correction as the market realised that things are not as bad. However it would not take much to change the mood again.
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.
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.
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