I have been asked via emails and comments on the process I follow in analysing stocks. I have written about my approach earlier, but may have never put it formally in a single post.
My approach essentially consists of the following steps
1. Idea generation – This is typically the first step in the process. It involves searching for undervalued ideas. I do not have a strict formula for the search process. I use icici direct website to run a few screens to generate some ideas. Some of the screens are as follows
PE less than 13
ROE greater than 13%,
debt / Equity less than 0.7
Once I get this list, I export it into excel and then add additional parameters to it such as Net profit performance for last 5 years, ROE for last 5 years etc . A few companies get eliminated at this stage if they had losses for the last few years and have only been profitable for a year or two. Once I have shorter list, I start looking at the Profit and loss statement, Balance sheet and ratios. A few companies get eliminated if I don’t like what I see at this point of time. For ex: If the free cash flow is poor for the company, I will remove the company from the list.
In some cases the elimination is not really scientific and is driven by my whims and fancy ( I am not as rational as I should be). So highly cyclical companies, which seem to have a very low PE due to sudden profit spurt are eliminated if their normalised PE is not attractive. After all this number crunching, I may be left with a 10-12 companies.
Another source of ideas are blogs of other value investors, articles or suggestions by some other investors I admire and follow. If I see them talking about a company, I add it to the list and start investigating it.
2. Annual report review – Once I have a list of interesting ideas, I start scanning the annual reports of these companies to look for any red flags or hidden value. Some companies get eliminated at this stage if I find something fishy. Once I like the numbers I see, I start reading the Annual report from the beginning, starting with the Director’s report, Management discussion etc.
3. Valuation template – Once I have a rough idea of the company and if the company still looks good, I start updating my valuation template. I start with the Quantitative numbers, follow it up with an industry analysis, competitive analysis etc. I keep referring back to the annual report to update the worksheets and answer some of the questions in the template. I also use this stage to generate more questions on the company.
4. Broad research – After updating the basic numbers and the qualitative worksheet, I may end up with some open questions. For ex: How is the industry expected to do over the next few years? . How will competition impact the company etc ?. At this point, I start doing some research on the net to find answers to these questions though I may or may not be successful at this stage in finding answers . I may even download the AR of the main competitors and review it to get a feel of the industry. This stage is fairly unstructured and I just trying to gather as much information about the company and industry as possible
5. Valuation – If I am still comfortable with the company, I start the DCF calculation and other valuation exercises. Over time I have realised the valuation exercise is fairly redundant. If the undervaluation is not perfectly obvious by now, then plugging some numbers and making a bunch of assumptions is not going to make the company an attractive buy. The numbers being plugged into the model are dependent on the qualitative analysis done during previous stages.
During this stage I go through a DCF valuation, comparative valuation and a probability based valuation exercise. If the numbers match with each other in all the approaches, then I am more confident of the Intrinsic value estimates
6. Portfolio inclusion – I typically try to keep 12-15 companies in my portfolio. So if a company has to get added, another has to go out. This prevents my portfolio from becoming a zoo of mediocre ideas. I compare the discount at which the new company is selling to my estimate of the intrinsic value. I then compare this discount with that of the other companies in my portfolio. If the new idea is better than an existing one, then it replaces it. Else I may make just a very small token investment to track the company and wait till it become more attractive or some other company goes out of the portfolio.
Although I have listed the steps in a very linear and logical fashion, in reality it is not so neat. Multiple steps are going on at the same time and I may sometimes skip a step too.
As you can see, the process is a bit elaborate and time consuming. I however do not find it cumbersome as I enjoy doing it.
Come to think of it, why should it be easy? is there any competitive profession in the world where you can make good money without any effort ? why should investing be any different ? Have you ever heard that someone has become a heart surgeon in a day?
Friday, August 15, 2008
Friday, August 08, 2008
Analysis – Ashok leyland, Suraj diamonds etc
I had suggested to the readers of this blog a few weeks back to send me a list of companies to analyse. I am posting on a few from the list
Ashok Leyland – I have written on Ashok leyland here and here. I have been analysing the annual results of the company for 2007-2008 and the key points are summarized below
Postitives :
The company has maintained its ROE and capital efficiency (Wcap ratio) inspite of tough market conditions. The sales growth was around 6%, which is decent in view of the slowdown in the Commercial vehicle markets. The netprofit growth and margin were also satisfactory. The company has also improved its market share in the current year.
In addition to the above, the company is investing in capacity and also in R&D (at 2%+ of sales). The company is also investing in several JVs for exports, electronic components for vehicles etc.
Negatives :
Competition in the industry is increasing with a lot of foreign players coming into the country. As a result the obsolence of models will speed up. There would also be a higher spend on R&D and Marketing to manage the competitive pressure.
The company is also expanding internationally which in itself carries a higher risk.
The company is a cyclical industry where the demand could be weak for some more time. This is strictly not a negative as the long term competitive advantages of the company are still intact.
I have uploaded a detailed analysis of Ashok leyland in google groups here (valuationtemplatev2ALLaug2008.xls)
A valid question would be – Why not invest in tata motors which is the clear industry leader. To that my response is – Tata motors as a company is too complex for me (maybe not for others) to analyse. The company has a lot of moving parts now. It a heavy vehicle, car manufacturer combined. In addition with foreign accqusitions of Jaguar and other brands there are additional unknowns too. In comparison AL is a much simpler company to understand and analyse. Hence my preference for Ashok leyland.
Suraj Diamonds
The company is in the diamond cutting and jewelry business. The revenue has grown by almost 300% in the last 5 years and so has the net profit. However the net margins are very low at around 2-3%. In the addition the ROE is less 10% even after improvements in the last few years. The company has low free cash flows. The net profits in aggregate are around 130 crs in the last 5 years. However around 50% have been used up for fixed asset and working capital. There has been a huge increase in the debtors position which is now around 1 years sales. The company looks cheap from a net profit perspective, however I am not too impressed by the ability of the business to generate free cash flow. There is fairly high increase in debtors which is quite risky in my opinion.
I would personally not proceed further with this stock untill I see the company is able to improve its free cash flow generation. The risk in such stocks is that the faster the company grows, the more capital either in form of debt or equity would required. This is fine in the short term, however if the business model generate poor free cash flows, then the stock only appears but is not really undervalued
A few additional companies have been emailed to me, which I have analysed in the past. I am providing the list and the links below
Maruti
HPCL – see here and here
Kothari products – It is still a net cash situation and an arbitrage opportunity too.
VST industries
Ashok Leyland – I have written on Ashok leyland here and here. I have been analysing the annual results of the company for 2007-2008 and the key points are summarized below
Postitives :
The company has maintained its ROE and capital efficiency (Wcap ratio) inspite of tough market conditions. The sales growth was around 6%, which is decent in view of the slowdown in the Commercial vehicle markets. The netprofit growth and margin were also satisfactory. The company has also improved its market share in the current year.
In addition to the above, the company is investing in capacity and also in R&D (at 2%+ of sales). The company is also investing in several JVs for exports, electronic components for vehicles etc.
Negatives :
Competition in the industry is increasing with a lot of foreign players coming into the country. As a result the obsolence of models will speed up. There would also be a higher spend on R&D and Marketing to manage the competitive pressure.
The company is also expanding internationally which in itself carries a higher risk.
The company is a cyclical industry where the demand could be weak for some more time. This is strictly not a negative as the long term competitive advantages of the company are still intact.
I have uploaded a detailed analysis of Ashok leyland in google groups here (valuationtemplatev2ALLaug2008.xls)
A valid question would be – Why not invest in tata motors which is the clear industry leader. To that my response is – Tata motors as a company is too complex for me (maybe not for others) to analyse. The company has a lot of moving parts now. It a heavy vehicle, car manufacturer combined. In addition with foreign accqusitions of Jaguar and other brands there are additional unknowns too. In comparison AL is a much simpler company to understand and analyse. Hence my preference for Ashok leyland.
Suraj Diamonds
The company is in the diamond cutting and jewelry business. The revenue has grown by almost 300% in the last 5 years and so has the net profit. However the net margins are very low at around 2-3%. In the addition the ROE is less 10% even after improvements in the last few years. The company has low free cash flows. The net profits in aggregate are around 130 crs in the last 5 years. However around 50% have been used up for fixed asset and working capital. There has been a huge increase in the debtors position which is now around 1 years sales. The company looks cheap from a net profit perspective, however I am not too impressed by the ability of the business to generate free cash flow. There is fairly high increase in debtors which is quite risky in my opinion.
I would personally not proceed further with this stock untill I see the company is able to improve its free cash flow generation. The risk in such stocks is that the faster the company grows, the more capital either in form of debt or equity would required. This is fine in the short term, however if the business model generate poor free cash flows, then the stock only appears but is not really undervalued
A few additional companies have been emailed to me, which I have analysed in the past. I am providing the list and the links below
Maruti
HPCL – see here and here
Kothari products – It is still a net cash situation and an arbitrage opportunity too.
VST industries
Analysis – Ashok leyland, Suraj diamonds etc
I had suggested to the readers of this blog a few weeks back to send me a list of companies to analyse. I am posting on a few from the list
Ashok Leyland – I have written on Ashok leyland here and here. I have been analysing the annual results of the company for 2007-2008 and the key points are summarized below
Postitives :
The company has maintained its ROE and capital efficiency (Wcap ratio) inspite of tough market conditions. The sales growth was around 6%, which is decent in view of the slowdown in the Commercial vehicle markets. The netprofit growth and margin were also satisfactory. The company has also improved its market share in the current year.
In addition to the above, the company is investing in capacity and also in R&D (at 2%+ of sales). The company is also investing in several JVs for exports, electronic components for vehicles etc.
Negatives :
Competition in the industry is increasing with a lot of foreign players coming into the country. As a result the obsolence of models will speed up. There would also be a higher spend on R&D and Marketing to manage the competitive pressure.
The company is also expanding internationally which in itself carries a higher risk.
The company is a cyclical industry where the demand could be weak for some more time. This is strictly not a negative as the long term competitive advantages of the company are still intact.
I have uploaded a detailed analysis of Ashok leyland in google groups here (valuationtemplatev2ALLaug2008.xls)
A valid question would be – Why not invest in tata motors which is the clear industry leader. To that my response is – Tata motors as a company is too complex for me (maybe not for others) to analyse. The company has a lot of moving parts now. It a heavy vehicle, car manufacturer combined. In addition with foreign accqusitions of Jaguar and other brands there are additional unknowns too. In comparison AL is a much simpler company to understand and analyse. Hence my preference for Ashok leyland.
Suraj Diamonds
The company is in the diamond cutting and jewelry business. The revenue has grown by almost 300% in the last 5 years and so has the net profit. However the net margins are very low at around 2-3%. In the addition the ROE is less 10% even after improvements in the last few years. The company has low free cash flows. The net profits in aggregate are around 130 crs in the last 5 years. However around 50% have been used up for fixed asset and working capital. There has been a huge increase in the debtors position which is now around 1 years sales. The company looks cheap from a net profit perspective, however I am not too impressed by the ability of the business to generate free cash flow. There is fairly high increase in debtors which is quite risky in my opinion.
I would personally not proceed further with this stock untill I see the company is able to improve its free cash flow generation. The risk in such stocks is that the faster the company grows, the more capital either in form of debt or equity would required. This is fine in the short term, however if the business model generate poor free cash flows, then the stock only appears but is not really undervalued
A few additional companies have been emailed to me, which I have analysed in the past. I am providing the list and the links below
Maruti
HPCL – see here and here
Kothari products – It is still a net cash situation and an arbitrage opportunity too.
VST industries
Ashok Leyland – I have written on Ashok leyland here and here. I have been analysing the annual results of the company for 2007-2008 and the key points are summarized below
Postitives :
The company has maintained its ROE and capital efficiency (Wcap ratio) inspite of tough market conditions. The sales growth was around 6%, which is decent in view of the slowdown in the Commercial vehicle markets. The netprofit growth and margin were also satisfactory. The company has also improved its market share in the current year.
In addition to the above, the company is investing in capacity and also in R&D (at 2%+ of sales). The company is also investing in several JVs for exports, electronic components for vehicles etc.
Negatives :
Competition in the industry is increasing with a lot of foreign players coming into the country. As a result the obsolence of models will speed up. There would also be a higher spend on R&D and Marketing to manage the competitive pressure.
The company is also expanding internationally which in itself carries a higher risk.
The company is a cyclical industry where the demand could be weak for some more time. This is strictly not a negative as the long term competitive advantages of the company are still intact.
I have uploaded a detailed analysis of Ashok leyland in google groups here (valuationtemplatev2ALLaug2008.xls)
A valid question would be – Why not invest in tata motors which is the clear industry leader. To that my response is – Tata motors as a company is too complex for me (maybe not for others) to analyse. The company has a lot of moving parts now. It a heavy vehicle, car manufacturer combined. In addition with foreign accqusitions of Jaguar and other brands there are additional unknowns too. In comparison AL is a much simpler company to understand and analyse. Hence my preference for Ashok leyland.
Suraj Diamonds
The company is in the diamond cutting and jewelry business. The revenue has grown by almost 300% in the last 5 years and so has the net profit. However the net margins are very low at around 2-3%. In the addition the ROE is less 10% even after improvements in the last few years. The company has low free cash flows. The net profits in aggregate are around 130 crs in the last 5 years. However around 50% have been used up for fixed asset and working capital. There has been a huge increase in the debtors position which is now around 1 years sales. The company looks cheap from a net profit perspective, however I am not too impressed by the ability of the business to generate free cash flow. There is fairly high increase in debtors which is quite risky in my opinion.
I would personally not proceed further with this stock untill I see the company is able to improve its free cash flow generation. The risk in such stocks is that the faster the company grows, the more capital either in form of debt or equity would required. This is fine in the short term, however if the business model generate poor free cash flows, then the stock only appears but is not really undervalued
A few additional companies have been emailed to me, which I have analysed in the past. I am providing the list and the links below
Maruti
HPCL – see here and here
Kothari products – It is still a net cash situation and an arbitrage opportunity too.
VST industries
Tuesday, August 05, 2008
Analyst speak
Analyst recommendations -
Neutral – We are as clueless as you are about the future of the company, but I have to give some rating as I am being paid to do that.
Hold – Same as neutral
Buy – Holy Cow !! The stock price has gone up recently. Now that the whole world knows that the company is doing well, we are recommending the stock. Doesn’t matter if the company is overpriced …that is your problem.
Sell – (The opposite of buy ..literally and figuratively) Oh @##!! , The whole world knows that the company has gone to the dogs. The stock price has dropped like a stone. Better cover my ****.
Underweight or overweight – (Play of words) Means we are confused, but as we have to give some rating and have to generate some commision for the brokerage, sell a little or buy a little (we don’t care which, both will generate commisions for us)
I have nothing against individuals, but the profession forces honest, intelligent people to indulge in smoke and mirrors and put out garbage.
Neutral – We are as clueless as you are about the future of the company, but I have to give some rating as I am being paid to do that.
Hold – Same as neutral
Buy – Holy Cow !! The stock price has gone up recently. Now that the whole world knows that the company is doing well, we are recommending the stock. Doesn’t matter if the company is overpriced …that is your problem.
Sell – (The opposite of buy ..literally and figuratively) Oh @##!! , The whole world knows that the company has gone to the dogs. The stock price has dropped like a stone. Better cover my ****.
Underweight or overweight – (Play of words) Means we are confused, but as we have to give some rating and have to generate some commision for the brokerage, sell a little or buy a little (we don’t care which, both will generate commisions for us)
I have nothing against individuals, but the profession forces honest, intelligent people to indulge in smoke and mirrors and put out garbage.
Analyst speak
Analyst recommendations -
Neutral – We are as clueless as you are about the future of the company, but I have to give some rating as I am being paid to do that.
Hold – Same as neutral
Buy – Holy Cow !! The stock price has gone up recently. Now that the whole world knows that the company is doing well, we are recommending the stock. Doesn’t matter if the company is overpriced …that is your problem.
Sell – (The opposite of buy ..literally and figuratively) Oh @##!! , The whole world knows that the company has gone to the dogs. The stock price has dropped like a stone. Better cover my ****.
Underweight or overweight – (Play of words) Means we are confused, but as we have to give some rating and have to generate some commision for the brokerage, sell a little or buy a little (we don’t care which, both will generate commisions for us)
I have nothing against individuals, but the profession forces honest, intelligent people to indulge in smoke and mirrors and put out garbage.
Neutral – We are as clueless as you are about the future of the company, but I have to give some rating as I am being paid to do that.
Hold – Same as neutral
Buy – Holy Cow !! The stock price has gone up recently. Now that the whole world knows that the company is doing well, we are recommending the stock. Doesn’t matter if the company is overpriced …that is your problem.
Sell – (The opposite of buy ..literally and figuratively) Oh @##!! , The whole world knows that the company has gone to the dogs. The stock price has dropped like a stone. Better cover my ****.
Underweight or overweight – (Play of words) Means we are confused, but as we have to give some rating and have to generate some commision for the brokerage, sell a little or buy a little (we don’t care which, both will generate commisions for us)
I have nothing against individuals, but the profession forces honest, intelligent people to indulge in smoke and mirrors and put out garbage.
Saturday, August 02, 2008
And now on Twitter
Twitter is supposed to be a microblogging tool. It is like be cross between an SMS and a blog. This tool allows you to post entries (tweets ?) of about 140 characters. So one can use this to post or inform others about what you are doing, thinking etc almost on a real time basis
I originally thought that this tool would be a waste of time for me. However I read a few posts on this tool and have seen some other bloggers use this tool to communicate and discuss topics which are of interest but too short for a post.
So I have decided to give twitter a shot. You can follow me on twitter here. So what am I planning to write about ?
My initial thought is to post on interesting books, articles or posts I have read. I also plan to write on various developments in the business world and my thoughts on the same.
In the past, I would have a quick opinion on something, but found a post too long for it and in addition I was not wanting to clog my archives. I tend to post on a topic which interests me and after I have done some analysis or thinking on it.
It is still an experiment and if I realise it is taking too much of time or there is not much value being added, I may discontinue it. What I will not be writing on twitter are real time updates of what I am doing …like drinking coffee, reading something etc etc. I have not desire of boring anyone to death :)
If you are new to this blog, you can subscribe to this blog via RSS (click on the link or you can see the link at the top of the side bar under subscribe). Alternatively you can subscribe via email (you can be assured that I will not be spamming you)
I originally thought that this tool would be a waste of time for me. However I read a few posts on this tool and have seen some other bloggers use this tool to communicate and discuss topics which are of interest but too short for a post.
So I have decided to give twitter a shot. You can follow me on twitter here. So what am I planning to write about ?
My initial thought is to post on interesting books, articles or posts I have read. I also plan to write on various developments in the business world and my thoughts on the same.
In the past, I would have a quick opinion on something, but found a post too long for it and in addition I was not wanting to clog my archives. I tend to post on a topic which interests me and after I have done some analysis or thinking on it.
It is still an experiment and if I realise it is taking too much of time or there is not much value being added, I may discontinue it. What I will not be writing on twitter are real time updates of what I am doing …like drinking coffee, reading something etc etc. I have not desire of boring anyone to death :)
If you are new to this blog, you can subscribe to this blog via RSS (click on the link or you can see the link at the top of the side bar under subscribe). Alternatively you can subscribe via email (you can be assured that I will not be spamming you)
And now on Twitter
Twitter is supposed to be a microblogging tool. It is like be cross between an SMS and a blog. This tool allows you to post entries (tweets ?) of about 140 characters. So one can use this to post or inform others about what you are doing, thinking etc almost on a real time basis
I originally thought that this tool would be a waste of time for me. However I read a few posts on this tool and have seen some other bloggers use this tool to communicate and discuss topics which are of interest but too short for a post.
So I have decided to give twitter a shot. You can follow me on twitter here. So what am I planning to write about ?
My initial thought is to post on interesting books, articles or posts I have read. I also plan to write on various developments in the business world and my thoughts on the same.
In the past, I would have a quick opinion on something, but found a post too long for it and in addition I was not wanting to clog my archives. I tend to post on a topic which interests me and after I have done some analysis or thinking on it.
It is still an experiment and if I realise it is taking too much of time or there is not much value being added, I may discontinue it. What I will not be writing on twitter are real time updates of what I am doing …like drinking coffee, reading something etc etc. I have not desire of boring anyone to death :)
If you are new to this blog, you can subscribe to this blog via RSS (click on the link or you can see the link at the top of the side bar under subscribe). Alternatively you can subscribe via email (you can be assured that I will not be spamming you)
I originally thought that this tool would be a waste of time for me. However I read a few posts on this tool and have seen some other bloggers use this tool to communicate and discuss topics which are of interest but too short for a post.
So I have decided to give twitter a shot. You can follow me on twitter here. So what am I planning to write about ?
My initial thought is to post on interesting books, articles or posts I have read. I also plan to write on various developments in the business world and my thoughts on the same.
In the past, I would have a quick opinion on something, but found a post too long for it and in addition I was not wanting to clog my archives. I tend to post on a topic which interests me and after I have done some analysis or thinking on it.
It is still an experiment and if I realise it is taking too much of time or there is not much value being added, I may discontinue it. What I will not be writing on twitter are real time updates of what I am doing …like drinking coffee, reading something etc etc. I have not desire of boring anyone to death :)
If you are new to this blog, you can subscribe to this blog via RSS (click on the link or you can see the link at the top of the side bar under subscribe). Alternatively you can subscribe via email (you can be assured that I will not be spamming you)
Thursday, July 31, 2008
Arbitrage Process - II
In the previous post, I detailed the arbitrage process. In this post, let me provide some other resources to understand the process better.
Joe Ponzio (Fwallstreet) is a value investor and writes extremely well on value investing with a lot of clarity. He has written several posts on arbitrage with examples of specific companies such as the tribune company. In this post, and this post he talks of the 7 broad steps in a merger or accquisition. These steps are mainly around the due diligence of the deal, signing a definitive agreement, getting shareholder approval and follwed by the regulatory approvals. Once all the approvals have been taken, the probability of the transaction happening is high
As Joe’s indicates,correctly in this post – ‘In arbitrage, the goal is to earn high rates of return on an annualized basis in low-risk, high-certainty situations’. So by investing in a transaction which is past the major approvals, an investor can be confident that the transaction will happen , which reduces the risk component of an arbitrage transaction.
I would recommend you to read his arbitrage related post to get a good understanding on the process.
What are the kind transactions which can be considered for arbitrage ? I have written on these transactions in the past and am listing them here again
Spin-offs
Mergers : These can be friendly in nature or hostile. Friendly mergers have lower risk and lower return. Hostile mergers have higher risk and correspondingly higher returns. Mergers can involve cash merger where the target shareholder is paid cash for their holding or stock for stock exchange or a combination of the two.
Bankruptcy or restructuring
Recapitalizations
Arbitrage helps in generating positive returns during a bear market. However the downside is that this investment category requires a lot of work for the small returns you get in return. As a result arbitrage may not be suitable for someone who is able to devote only a few hours a month on investing.
Joe Ponzio (Fwallstreet) is a value investor and writes extremely well on value investing with a lot of clarity. He has written several posts on arbitrage with examples of specific companies such as the tribune company. In this post, and this post he talks of the 7 broad steps in a merger or accquisition. These steps are mainly around the due diligence of the deal, signing a definitive agreement, getting shareholder approval and follwed by the regulatory approvals. Once all the approvals have been taken, the probability of the transaction happening is high
As Joe’s indicates,correctly in this post – ‘In arbitrage, the goal is to earn high rates of return on an annualized basis in low-risk, high-certainty situations’. So by investing in a transaction which is past the major approvals, an investor can be confident that the transaction will happen , which reduces the risk component of an arbitrage transaction.
I would recommend you to read his arbitrage related post to get a good understanding on the process.
What are the kind transactions which can be considered for arbitrage ? I have written on these transactions in the past and am listing them here again
Spin-offs
Mergers : These can be friendly in nature or hostile. Friendly mergers have lower risk and lower return. Hostile mergers have higher risk and correspondingly higher returns. Mergers can involve cash merger where the target shareholder is paid cash for their holding or stock for stock exchange or a combination of the two.
Bankruptcy or restructuring
Recapitalizations
Arbitrage helps in generating positive returns during a bear market. However the downside is that this investment category requires a lot of work for the small returns you get in return. As a result arbitrage may not be suitable for someone who is able to devote only a few hours a month on investing.
Arbitrage Process - II
In the previous post, I detailed the arbitrage process. In this post, let me provide some other resources to understand the process better.
Joe Ponzio (Fwallstreet) is a value investor and writes extremely well on value investing with a lot of clarity. He has written several posts on arbitrage with examples of specific companies such as the tribune company. In this post, and this post he talks of the 7 broad steps in a merger or accquisition. These steps are mainly around the due diligence of the deal, signing a definitive agreement, getting shareholder approval and follwed by the regulatory approvals. Once all the approvals have been taken, the probability of the transaction happening is high
As Joe’s indicates,correctly in this post – ‘In arbitrage, the goal is to earn high rates of return on an annualized basis in low-risk, high-certainty situations’. So by investing in a transaction which is past the major approvals, an investor can be confident that the transaction will happen , which reduces the risk component of an arbitrage transaction.
I would recommend you to read his arbitrage related post to get a good understanding on the process.
What are the kind transactions which can be considered for arbitrage ? I have written on these transactions in the past and am listing them here again
Spin-offs
Mergers : These can be friendly in nature or hostile. Friendly mergers have lower risk and lower return. Hostile mergers have higher risk and correspondingly higher returns. Mergers can involve cash merger where the target shareholder is paid cash for their holding or stock for stock exchange or a combination of the two.
Bankruptcy or restructuring
Recapitalizations
Arbitrage helps in generating positive returns during a bear market. However the downside is that this investment category requires a lot of work for the small returns you get in return. As a result arbitrage may not be suitable for someone who is able to devote only a few hours a month on investing.
Joe Ponzio (Fwallstreet) is a value investor and writes extremely well on value investing with a lot of clarity. He has written several posts on arbitrage with examples of specific companies such as the tribune company. In this post, and this post he talks of the 7 broad steps in a merger or accquisition. These steps are mainly around the due diligence of the deal, signing a definitive agreement, getting shareholder approval and follwed by the regulatory approvals. Once all the approvals have been taken, the probability of the transaction happening is high
As Joe’s indicates,correctly in this post – ‘In arbitrage, the goal is to earn high rates of return on an annualized basis in low-risk, high-certainty situations’. So by investing in a transaction which is past the major approvals, an investor can be confident that the transaction will happen , which reduces the risk component of an arbitrage transaction.
I would recommend you to read his arbitrage related post to get a good understanding on the process.
What are the kind transactions which can be considered for arbitrage ? I have written on these transactions in the past and am listing them here again
Spin-offs
Mergers : These can be friendly in nature or hostile. Friendly mergers have lower risk and lower return. Hostile mergers have higher risk and correspondingly higher returns. Mergers can involve cash merger where the target shareholder is paid cash for their holding or stock for stock exchange or a combination of the two.
Bankruptcy or restructuring
Recapitalizations
Arbitrage helps in generating positive returns during a bear market. However the downside is that this investment category requires a lot of work for the small returns you get in return. As a result arbitrage may not be suitable for someone who is able to devote only a few hours a month on investing.
Monday, July 28, 2008
Arbitrage process - I
I have been reading a book on risk arbitrage and came across the following steps in a typical deal (merger, spin-off, recap etc)
Deal announcement – This generally involves a press release or filing of an offer with BSE/ NSE with the requisite details. An investor has to be on a constant lookut for such announcements.
Gather and analyse information – After the investor comes to know about the deal, the next step involves gathering and analysing information.
The following are the various types of information which needs to be considered
Financial information: This involves reading all the filings with the stock exchange, Financial details of the companies involved such as the annual report, quarterly reports and analyst reports.
Legal information: gather and analyse any legal information which may impact the deal. For ex: check if there is an legal dispute in which the target or the acquiring company is involved, which may impact the success of the deal
Any tax and accounting implication should also be studied
Interpret and estimate – This stage involves the interpreting the information from step 2 and coming up with values for the following three variables
Returns estimate – The formulae used for the returns would as follows: Final target company price-Current price / Current price. In addition if the deal involves a stock for stock merger, then the investor should add the dividends to be received. If however the deal involves a mix of cash and stock, then the total return can be calculated as follows
(% of cash* amount of cash+% of stock * amount of stock)- Current price / Current price
If the transaction involves shorting the accquiring company stock and using borrowed money, then the return should be reduced by the dividends which needs to paid for the shorted stock and also by the interest cost of the borrowed capital.
Risk estimate – The risk in the transaction is the downside risk of the target company + Upside risk of the accquiring company
Downside risk = Current price – estimate of target company price if the deal fails
If the deal fails, and the investor has shorted the accquiring company stock to hedge, then he may incur an upsideside risk too
Upside risk = estimate of the accquiring company price if deal breaks – current price
The estimate of the prices for the target and accquiring company is done based on several factors such the pre-deal price, price of other companies in the industry etc.
Probability – This is the probaility of the deal coming through. The investor may assume there is an 80% probaility of the deal coming through. His estimate of returns my be 15% and estimate of risk may be 30%.
Based on these numbers the risk adjusted return is = .8*.15+.2*-.3 = 6%. This could be the absolute returns. If the investor expects the deal to complete in one month, then the annualized return is 72%.
It is important to consider the time it will take for the transaction or deal to happen and use that to estimate the annualized returns. The longer the time for the successful closure, the lower the annualized returns.
Estimation of probability is a very subjective exercise. An an investor one has to analyse the various subjective elements of a deal and estimate the likelyhood of the deal being successful.
The earlier one invests in a deal, the more the uncertainity and hence higher the spread. In the event that there are multiple scenarios possible for a deal such as possiblity of a white knight appearing, then the risk/return of each scenario needs to wieghted with the probability of that scenario to arrive at the estimated returns for a deal.
Next Post : Other resources to understand the arbitrage process
Deal announcement – This generally involves a press release or filing of an offer with BSE/ NSE with the requisite details. An investor has to be on a constant lookut for such announcements.
Gather and analyse information – After the investor comes to know about the deal, the next step involves gathering and analysing information.
The following are the various types of information which needs to be considered
Financial information: This involves reading all the filings with the stock exchange, Financial details of the companies involved such as the annual report, quarterly reports and analyst reports.
Legal information: gather and analyse any legal information which may impact the deal. For ex: check if there is an legal dispute in which the target or the acquiring company is involved, which may impact the success of the deal
Any tax and accounting implication should also be studied
Interpret and estimate – This stage involves the interpreting the information from step 2 and coming up with values for the following three variables
Returns estimate – The formulae used for the returns would as follows: Final target company price-Current price / Current price. In addition if the deal involves a stock for stock merger, then the investor should add the dividends to be received. If however the deal involves a mix of cash and stock, then the total return can be calculated as follows
(% of cash* amount of cash+% of stock * amount of stock)- Current price / Current price
If the transaction involves shorting the accquiring company stock and using borrowed money, then the return should be reduced by the dividends which needs to paid for the shorted stock and also by the interest cost of the borrowed capital.
Risk estimate – The risk in the transaction is the downside risk of the target company + Upside risk of the accquiring company
Downside risk = Current price – estimate of target company price if the deal fails
If the deal fails, and the investor has shorted the accquiring company stock to hedge, then he may incur an upsideside risk too
Upside risk = estimate of the accquiring company price if deal breaks – current price
The estimate of the prices for the target and accquiring company is done based on several factors such the pre-deal price, price of other companies in the industry etc.
Probability – This is the probaility of the deal coming through. The investor may assume there is an 80% probaility of the deal coming through. His estimate of returns my be 15% and estimate of risk may be 30%.
Based on these numbers the risk adjusted return is = .8*.15+.2*-.3 = 6%. This could be the absolute returns. If the investor expects the deal to complete in one month, then the annualized return is 72%.
It is important to consider the time it will take for the transaction or deal to happen and use that to estimate the annualized returns. The longer the time for the successful closure, the lower the annualized returns.
Estimation of probability is a very subjective exercise. An an investor one has to analyse the various subjective elements of a deal and estimate the likelyhood of the deal being successful.
The earlier one invests in a deal, the more the uncertainity and hence higher the spread. In the event that there are multiple scenarios possible for a deal such as possiblity of a white knight appearing, then the risk/return of each scenario needs to wieghted with the probability of that scenario to arrive at the estimated returns for a deal.
Next Post : Other resources to understand the arbitrage process
Arbitrage process - I
I have been reading a book on risk arbitrage and came across the following steps in a typical deal (merger, spin-off, recap etc)
Deal announcement – This generally involves a press release or filing of an offer with BSE/ NSE with the requisite details. An investor has to be on a constant lookut for such announcements.
Gather and analyse information – After the investor comes to know about the deal, the next step involves gathering and analysing information.
The following are the various types of information which needs to be considered
Financial information: This involves reading all the filings with the stock exchange, Financial details of the companies involved such as the annual report, quarterly reports and analyst reports.
Legal information: gather and analyse any legal information which may impact the deal. For ex: check if there is an legal dispute in which the target or the acquiring company is involved, which may impact the success of the deal
Any tax and accounting implication should also be studied
Interpret and estimate – This stage involves the interpreting the information from step 2 and coming up with values for the following three variables
Returns estimate – The formulae used for the returns would as follows: Final target company price-Current price / Current price. In addition if the deal involves a stock for stock merger, then the investor should add the dividends to be received. If however the deal involves a mix of cash and stock, then the total return can be calculated as follows
(% of cash* amount of cash+% of stock * amount of stock)- Current price / Current price
If the transaction involves shorting the accquiring company stock and using borrowed money, then the return should be reduced by the dividends which needs to paid for the shorted stock and also by the interest cost of the borrowed capital.
Risk estimate – The risk in the transaction is the downside risk of the target company + Upside risk of the accquiring company
Downside risk = Current price – estimate of target company price if the deal fails
If the deal fails, and the investor has shorted the accquiring company stock to hedge, then he may incur an upsideside risk too
Upside risk = estimate of the accquiring company price if deal breaks – current price
The estimate of the prices for the target and accquiring company is done based on several factors such the pre-deal price, price of other companies in the industry etc.
Probability – This is the probaility of the deal coming through. The investor may assume there is an 80% probaility of the deal coming through. His estimate of returns my be 15% and estimate of risk may be 30%.
Based on these numbers the risk adjusted return is = .8*.15+.2*-.3 = 6%. This could be the absolute returns. If the investor expects the deal to complete in one month, then the annualized return is 72%.
It is important to consider the time it will take for the transaction or deal to happen and use that to estimate the annualized returns. The longer the time for the successful closure, the lower the annualized returns.
Estimation of probability is a very subjective exercise. An an investor one has to analyse the various subjective elements of a deal and estimate the likelyhood of the deal being successful.
The earlier one invests in a deal, the more the uncertainity and hence higher the spread. In the event that there are multiple scenarios possible for a deal such as possiblity of a white knight appearing, then the risk/return of each scenario needs to wieghted with the probability of that scenario to arrive at the estimated returns for a deal.
Next Post : Other resources to understand the arbitrage process
Deal announcement – This generally involves a press release or filing of an offer with BSE/ NSE with the requisite details. An investor has to be on a constant lookut for such announcements.
Gather and analyse information – After the investor comes to know about the deal, the next step involves gathering and analysing information.
The following are the various types of information which needs to be considered
Financial information: This involves reading all the filings with the stock exchange, Financial details of the companies involved such as the annual report, quarterly reports and analyst reports.
Legal information: gather and analyse any legal information which may impact the deal. For ex: check if there is an legal dispute in which the target or the acquiring company is involved, which may impact the success of the deal
Any tax and accounting implication should also be studied
Interpret and estimate – This stage involves the interpreting the information from step 2 and coming up with values for the following three variables
Returns estimate – The formulae used for the returns would as follows: Final target company price-Current price / Current price. In addition if the deal involves a stock for stock merger, then the investor should add the dividends to be received. If however the deal involves a mix of cash and stock, then the total return can be calculated as follows
(% of cash* amount of cash+% of stock * amount of stock)- Current price / Current price
If the transaction involves shorting the accquiring company stock and using borrowed money, then the return should be reduced by the dividends which needs to paid for the shorted stock and also by the interest cost of the borrowed capital.
Risk estimate – The risk in the transaction is the downside risk of the target company + Upside risk of the accquiring company
Downside risk = Current price – estimate of target company price if the deal fails
If the deal fails, and the investor has shorted the accquiring company stock to hedge, then he may incur an upsideside risk too
Upside risk = estimate of the accquiring company price if deal breaks – current price
The estimate of the prices for the target and accquiring company is done based on several factors such the pre-deal price, price of other companies in the industry etc.
Probability – This is the probaility of the deal coming through. The investor may assume there is an 80% probaility of the deal coming through. His estimate of returns my be 15% and estimate of risk may be 30%.
Based on these numbers the risk adjusted return is = .8*.15+.2*-.3 = 6%. This could be the absolute returns. If the investor expects the deal to complete in one month, then the annualized return is 72%.
It is important to consider the time it will take for the transaction or deal to happen and use that to estimate the annualized returns. The longer the time for the successful closure, the lower the annualized returns.
Estimation of probability is a very subjective exercise. An an investor one has to analyse the various subjective elements of a deal and estimate the likelyhood of the deal being successful.
The earlier one invests in a deal, the more the uncertainity and hence higher the spread. In the event that there are multiple scenarios possible for a deal such as possiblity of a white knight appearing, then the risk/return of each scenario needs to wieghted with the probability of that scenario to arrive at the estimated returns for a deal.
Next Post : Other resources to understand the arbitrage process
Friday, July 25, 2008
Those were the times !!
2004-2007
Inflation – 3-5%
Sensex – 300% up
Interest rates – around 7-8%
Salary hikes – 20% minimum
Real estate – 200% or more up
A few more years of this, and I could have retired. Ahh ..life was good !!. All I had to do was to buy a house, anywhere or pick a stock which I heard from my panwala or barber.
how I long for those times again :)
I want a new bubble !!!!!
Inflation – 3-5%
Sensex – 300% up
Interest rates – around 7-8%
Salary hikes – 20% minimum
Real estate – 200% or more up
A few more years of this, and I could have retired. Ahh ..life was good !!. All I had to do was to buy a house, anywhere or pick a stock which I heard from my panwala or barber.
how I long for those times again :)
I want a new bubble !!!!!
Those were the times !!
2004-2007
Inflation – 3-5%
Sensex – 300% up
Interest rates – around 7-8%
Salary hikes – 20% minimum
Real estate – 200% or more up
A few more years of this, and I could have retired. Ahh ..life was good !!. All I had to do was to buy a house, anywhere or pick a stock which I heard from my panwala or barber.
how I long for those times again :)
I want a new bubble !!!!!
Inflation – 3-5%
Sensex – 300% up
Interest rates – around 7-8%
Salary hikes – 20% minimum
Real estate – 200% or more up
A few more years of this, and I could have retired. Ahh ..life was good !!. All I had to do was to buy a house, anywhere or pick a stock which I heard from my panwala or barber.
how I long for those times again :)
I want a new bubble !!!!!
Wednesday, July 23, 2008
Responding to comments - NIIT tech valuation
I have posted on NIIT tech earlier here. I had done a quick back of the envelope calculation and uploaded the same in the google groups – see the file valuationtemplatev3NIITtemp.xls. I have been asked on the logic of the valuation via comments and emails. So here goes,
Following are the assumptions in the valuation
- Topline will grow by around 10% per annum for the next 2-3 years
- PBT margins will drop from 17% to around 10% in 2-3 years
- New tax rate will increase from around 15% to 25%
- Net margins will drop from the current 14.5 % to 7% due to the above factors.
I personally think, the above assumptions are very conservative. It is possible that the company can do worse than this, but based on current facts, I think that is a low probability.
So based on the above assumptions the net profit for 2010 is around 90 Crs. I have taken a multiplier of 14 and added the cash on books to arrive at a rough valuation of around 1550 Crs (I have also added the pending options to the share count).
To see what a PE of 14 means, please look at the spreadsheet quantitative calculation – worksheet ROC and PE. Look for the DCF calculation with ROC of 25% (approximate ROE for NIIT tech). A growth of 8% for 3-4 years gives a PE of 14. So I am talking of a growth of 7-8% in profits after 2010.
The valuation is dependent on the assumptions above. Ofcourse these assumptions are not set in stone. If the US market goes into a deep recession or the management does something very negative, then the netprofit could be lower than what I have assumed. If you believe that the market is pricing NIIT tech correctly, then your underlying assumption is that the company is going to fall off the cliff in the next 2-3 years (basically shutdown in the next 3-4 years).
Based on the past performance and this quarter’s result, I don’t see any reason to believe that. However I can and will change my mind if the future invalidates my assumptions. So as I have said before, please do not consider my analysis as a recommendation for the stock.
As an aside, I have received the maximum number of emails and comments on this stock. Its not too surprising as a lot of readers of this blog are from the IT industry and tend to invest more in IT stocks.
Following are the assumptions in the valuation
- Topline will grow by around 10% per annum for the next 2-3 years
- PBT margins will drop from 17% to around 10% in 2-3 years
- New tax rate will increase from around 15% to 25%
- Net margins will drop from the current 14.5 % to 7% due to the above factors.
I personally think, the above assumptions are very conservative. It is possible that the company can do worse than this, but based on current facts, I think that is a low probability.
So based on the above assumptions the net profit for 2010 is around 90 Crs. I have taken a multiplier of 14 and added the cash on books to arrive at a rough valuation of around 1550 Crs (I have also added the pending options to the share count).
To see what a PE of 14 means, please look at the spreadsheet quantitative calculation – worksheet ROC and PE. Look for the DCF calculation with ROC of 25% (approximate ROE for NIIT tech). A growth of 8% for 3-4 years gives a PE of 14. So I am talking of a growth of 7-8% in profits after 2010.
The valuation is dependent on the assumptions above. Ofcourse these assumptions are not set in stone. If the US market goes into a deep recession or the management does something very negative, then the netprofit could be lower than what I have assumed. If you believe that the market is pricing NIIT tech correctly, then your underlying assumption is that the company is going to fall off the cliff in the next 2-3 years (basically shutdown in the next 3-4 years).
Based on the past performance and this quarter’s result, I don’t see any reason to believe that. However I can and will change my mind if the future invalidates my assumptions. So as I have said before, please do not consider my analysis as a recommendation for the stock.
As an aside, I have received the maximum number of emails and comments on this stock. Its not too surprising as a lot of readers of this blog are from the IT industry and tend to invest more in IT stocks.
Responding to comments - NIIT tech valuation
I have posted on NIIT tech earlier here. I had done a quick back of the envelope calculation and uploaded the same in the google groups – see the file valuationtemplatev3NIITtemp.xls. I have been asked on the logic of the valuation via comments and emails. So here goes,
Following are the assumptions in the valuation
- Topline will grow by around 10% per annum for the next 2-3 years
- PBT margins will drop from 17% to around 10% in 2-3 years
- New tax rate will increase from around 15% to 25%
- Net margins will drop from the current 14.5 % to 7% due to the above factors.
I personally think, the above assumptions are very conservative. It is possible that the company can do worse than this, but based on current facts, I think that is a low probability.
So based on the above assumptions the net profit for 2010 is around 90 Crs. I have taken a multiplier of 14 and added the cash on books to arrive at a rough valuation of around 1550 Crs (I have also added the pending options to the share count).
To see what a PE of 14 means, please look at the spreadsheet quantitative calculation – worksheet ROC and PE. Look for the DCF calculation with ROC of 25% (approximate ROE for NIIT tech). A growth of 8% for 3-4 years gives a PE of 14. So I am talking of a growth of 7-8% in profits after 2010.
The valuation is dependent on the assumptions above. Ofcourse these assumptions are not set in stone. If the US market goes into a deep recession or the management does something very negative, then the netprofit could be lower than what I have assumed. If you believe that the market is pricing NIIT tech correctly, then your underlying assumption is that the company is going to fall off the cliff in the next 2-3 years (basically shutdown in the next 3-4 years).
Based on the past performance and this quarter’s result, I don’t see any reason to believe that. However I can and will change my mind if the future invalidates my assumptions. So as I have said before, please do not consider my analysis as a recommendation for the stock.
As an aside, I have received the maximum number of emails and comments on this stock. Its not too surprising as a lot of readers of this blog are from the IT industry and tend to invest more in IT stocks.
Following are the assumptions in the valuation
- Topline will grow by around 10% per annum for the next 2-3 years
- PBT margins will drop from 17% to around 10% in 2-3 years
- New tax rate will increase from around 15% to 25%
- Net margins will drop from the current 14.5 % to 7% due to the above factors.
I personally think, the above assumptions are very conservative. It is possible that the company can do worse than this, but based on current facts, I think that is a low probability.
So based on the above assumptions the net profit for 2010 is around 90 Crs. I have taken a multiplier of 14 and added the cash on books to arrive at a rough valuation of around 1550 Crs (I have also added the pending options to the share count).
To see what a PE of 14 means, please look at the spreadsheet quantitative calculation – worksheet ROC and PE. Look for the DCF calculation with ROC of 25% (approximate ROE for NIIT tech). A growth of 8% for 3-4 years gives a PE of 14. So I am talking of a growth of 7-8% in profits after 2010.
The valuation is dependent on the assumptions above. Ofcourse these assumptions are not set in stone. If the US market goes into a deep recession or the management does something very negative, then the netprofit could be lower than what I have assumed. If you believe that the market is pricing NIIT tech correctly, then your underlying assumption is that the company is going to fall off the cliff in the next 2-3 years (basically shutdown in the next 3-4 years).
Based on the past performance and this quarter’s result, I don’t see any reason to believe that. However I can and will change my mind if the future invalidates my assumptions. So as I have said before, please do not consider my analysis as a recommendation for the stock.
As an aside, I have received the maximum number of emails and comments on this stock. Its not too surprising as a lot of readers of this blog are from the IT industry and tend to invest more in IT stocks.
Sunday, July 20, 2008
Cement Industry – Stock analysis
I received a list of companies to analyse based on my earlier post. In order to do a better analysis, I am trying to club all the stocks from the same industry. As there are several cement companies in the list, I decided to take a stab at the cement stocks first.
My earlier analysis of the cement industry is here and here. In addition I have analysed the industry and updated my analysis in the file business analysis in the google group. Please have a look under the column commodity – cement.
The cement industry is a cyclical commodity industry where the profit and return on capital is dependent on the demand cycle picture. From the mid 90’s to 2002-2003 period, there was an excess of supply and hence prices were depressed. Most companies had poor to non-existent profits and accordingly the stock prices suffered. Since 2003, the demand has increased rapidly and so have the prices. The profit margins are now in excess of 20% for some companies and ROE in excess of 40% for companies such as ambuja cements. I personally think these are fairly high returns for this industry and the best of the companies in the industry would earn around a max of 20% over a business cycle.
Valuation of cement companies should not be done on the basis of peak earnings alone. This holds true for most commodity companies. Case in point – sugar companies. In 2006-2007, these companies appeared cheap based on their peak earnings. However when the cycle turned downwards, the stock prices got wacked. The economics of the cement industry are not as bad (there is lesser government intervention), however the valuation approach should be similar to the sugar industry. One has to be careful in extrapolating the peak earnings and assuming that the stock is undervalued.
Due to the cyclicality and commodity nature of the industry, analysis and valuation of cement companies is more diffcult as one has to figure out where the industry stands in terms of the business cycle . High returns can be made if one can predict the key turnaround points in the business cycle.
Mysore cement –
This is an interesting company. The company was taken over by the heidelberg group and made a tender offer to buy shares from the public at 54 Rs/ share in 2006 . SEBI directed the group to set the price at 72.5 per share. This was recently overturned by SAT and the heidelberg group can now initiate a tender offer to buy the shares from the public at Rs54 per share.
In addition the company alloted 66.5 Million shares at Rs 54 per share in 2006 to the group. This capital was used to pay off the accumulated debts and wipe out the accumulated losses. The company has also become profitable from 2007 since the new management took over.
In addition a recent news, indicates that indorama cement would be merging with mysore cement taking the capacity to 2.8 Million tonnes. The company further plans to expand the capacity to 5.9 Million tonnes.
The financial look good, with the company solidly in the black, no debt and cash of almost 180 crs on the books. The impact of the new management can clearly be seen from the P&L account, balance sheet improvement and aggressive plans of the company to expand capacity through mergers and greenfield projects.
So if everything is so good, then one should go and buy the stock? I would hold on that before I can figure out the following
- Cement is a cyclical industry. Currently the industry is on an upswing and hence all cement companies are making good money. How will mysore cement fare when the cycle turns south (supply exceeds demand)
- What is the cost structure for mysore cement? Cost is critical in a commodity industry such as cement.
- Future plans of the management. Scale is important in the industry. Mysore cement is still at 2.8 Million tonnes and even after capacity expansion would still be one of the smaller companies
One interesting development is the tender offer. The stock is quoting at around 30 Rs and the tender offer should be around 54 Rs. The stock may be a good arbitrage opportunity, even if the long term prospects of the company needs a more thorough analysis.
Ambuja cements
Ambuja cements has been one of most profitable cement companies in india and has made money even during the downturns. They have the highest net profit margins in the industry at 30% and ROE of almost 40%. Net profit margins have grown from 10% to around 30% and the profit as a result has grown by 8 times in the last 5 years.
The company sells at around 560 Crs/ Million tons of capacity compared to say 170 Crs/ Million tons of capacity for Mysore cement. The difference is high and understandable as Ambuja cement is a well run company with huge capacity and a very efficient cost structure.
The company is currently selling at a PE of 7 based on last year’s net profit numbers. Based on normalised profit margins of around 12-15%, the company is selling at a PE of around 12-13. I would say the company is undervalued by 20-25% at best.
If you believe that the net margins are sustainable, consider the following fact : Net margins in 2003 and before were around 10% and have expanded to around 30% in the last 2 years.
Grasim, ACC, Ultratech etc
Grasim has a blend of cement, VSF and other businesses. The cement business seems to be doing well in line with industry. The other companies such as ACC and ultratech have also been performing well in the last 2-3 years. Most of the top cement companies now have margins in the range of 18-22%, ROE in excess of 30% and high profit growth rates in excess of 20-30%.
The valuations of these companies are fairly close. Most of these tier I companies are selling at 7-8 times profit in comparison to the smaller companies which are selling at 4-5 times or lesser.
I am reaching the following conclusions after looking at the complete sector
- The cement industry has enjoyed very high growth rates and great profits for the last few years. The profits margins are not sustainable. New capacity, cost pressure and competition are bound to drive the margins to long term averages of around 10-12% in the next few years
- Most of the companies appear undervalued in terms of the last 2 years profits. However on the basis of normalized profits they are selling at 12-13 times earnings. At best, these companies appear undervalued by 20-25%. There may be a bit of undervaluation, but not by a huge amount.
- Considering the level of undervaluation in some sectors such as pharma, IT etc and the better economics enjoyed by those industries compared to Cement, I am personally not too keen on investing in the cement sector. If I had to pick up one cement company to put my money in for the long term, I would prefer ambuja cement (if I had to that is !!)
My earlier analysis of the cement industry is here and here. In addition I have analysed the industry and updated my analysis in the file business analysis in the google group. Please have a look under the column commodity – cement.
The cement industry is a cyclical commodity industry where the profit and return on capital is dependent on the demand cycle picture. From the mid 90’s to 2002-2003 period, there was an excess of supply and hence prices were depressed. Most companies had poor to non-existent profits and accordingly the stock prices suffered. Since 2003, the demand has increased rapidly and so have the prices. The profit margins are now in excess of 20% for some companies and ROE in excess of 40% for companies such as ambuja cements. I personally think these are fairly high returns for this industry and the best of the companies in the industry would earn around a max of 20% over a business cycle.
Valuation of cement companies should not be done on the basis of peak earnings alone. This holds true for most commodity companies. Case in point – sugar companies. In 2006-2007, these companies appeared cheap based on their peak earnings. However when the cycle turned downwards, the stock prices got wacked. The economics of the cement industry are not as bad (there is lesser government intervention), however the valuation approach should be similar to the sugar industry. One has to be careful in extrapolating the peak earnings and assuming that the stock is undervalued.
Due to the cyclicality and commodity nature of the industry, analysis and valuation of cement companies is more diffcult as one has to figure out where the industry stands in terms of the business cycle . High returns can be made if one can predict the key turnaround points in the business cycle.
Mysore cement –
This is an interesting company. The company was taken over by the heidelberg group and made a tender offer to buy shares from the public at 54 Rs/ share in 2006 . SEBI directed the group to set the price at 72.5 per share. This was recently overturned by SAT and the heidelberg group can now initiate a tender offer to buy the shares from the public at Rs54 per share.
In addition the company alloted 66.5 Million shares at Rs 54 per share in 2006 to the group. This capital was used to pay off the accumulated debts and wipe out the accumulated losses. The company has also become profitable from 2007 since the new management took over.
In addition a recent news, indicates that indorama cement would be merging with mysore cement taking the capacity to 2.8 Million tonnes. The company further plans to expand the capacity to 5.9 Million tonnes.
The financial look good, with the company solidly in the black, no debt and cash of almost 180 crs on the books. The impact of the new management can clearly be seen from the P&L account, balance sheet improvement and aggressive plans of the company to expand capacity through mergers and greenfield projects.
So if everything is so good, then one should go and buy the stock? I would hold on that before I can figure out the following
- Cement is a cyclical industry. Currently the industry is on an upswing and hence all cement companies are making good money. How will mysore cement fare when the cycle turns south (supply exceeds demand)
- What is the cost structure for mysore cement? Cost is critical in a commodity industry such as cement.
- Future plans of the management. Scale is important in the industry. Mysore cement is still at 2.8 Million tonnes and even after capacity expansion would still be one of the smaller companies
One interesting development is the tender offer. The stock is quoting at around 30 Rs and the tender offer should be around 54 Rs. The stock may be a good arbitrage opportunity, even if the long term prospects of the company needs a more thorough analysis.
Ambuja cements
Ambuja cements has been one of most profitable cement companies in india and has made money even during the downturns. They have the highest net profit margins in the industry at 30% and ROE of almost 40%. Net profit margins have grown from 10% to around 30% and the profit as a result has grown by 8 times in the last 5 years.
The company sells at around 560 Crs/ Million tons of capacity compared to say 170 Crs/ Million tons of capacity for Mysore cement. The difference is high and understandable as Ambuja cement is a well run company with huge capacity and a very efficient cost structure.
The company is currently selling at a PE of 7 based on last year’s net profit numbers. Based on normalised profit margins of around 12-15%, the company is selling at a PE of around 12-13. I would say the company is undervalued by 20-25% at best.
If you believe that the net margins are sustainable, consider the following fact : Net margins in 2003 and before were around 10% and have expanded to around 30% in the last 2 years.
Grasim, ACC, Ultratech etc
Grasim has a blend of cement, VSF and other businesses. The cement business seems to be doing well in line with industry. The other companies such as ACC and ultratech have also been performing well in the last 2-3 years. Most of the top cement companies now have margins in the range of 18-22%, ROE in excess of 30% and high profit growth rates in excess of 20-30%.
The valuations of these companies are fairly close. Most of these tier I companies are selling at 7-8 times profit in comparison to the smaller companies which are selling at 4-5 times or lesser.
I am reaching the following conclusions after looking at the complete sector
- The cement industry has enjoyed very high growth rates and great profits for the last few years. The profits margins are not sustainable. New capacity, cost pressure and competition are bound to drive the margins to long term averages of around 10-12% in the next few years
- Most of the companies appear undervalued in terms of the last 2 years profits. However on the basis of normalized profits they are selling at 12-13 times earnings. At best, these companies appear undervalued by 20-25%. There may be a bit of undervaluation, but not by a huge amount.
- Considering the level of undervaluation in some sectors such as pharma, IT etc and the better economics enjoyed by those industries compared to Cement, I am personally not too keen on investing in the cement sector. If I had to pick up one cement company to put my money in for the long term, I would prefer ambuja cement (if I had to that is !!)
Cement Industry – Stock analysis
I received a list of companies to analyse based on my earlier post. In order to do a better analysis, I am trying to club all the stocks from the same industry. As there are several cement companies in the list, I decided to take a stab at the cement stocks first.
My earlier analysis of the cement industry is here and here. In addition I have analysed the industry and updated my analysis in the file business analysis in the google group. Please have a look under the column commodity – cement.
The cement industry is a cyclical commodity industry where the profit and return on capital is dependent on the demand cycle picture. From the mid 90’s to 2002-2003 period, there was an excess of supply and hence prices were depressed. Most companies had poor to non-existent profits and accordingly the stock prices suffered. Since 2003, the demand has increased rapidly and so have the prices. The profit margins are now in excess of 20% for some companies and ROE in excess of 40% for companies such as ambuja cements. I personally think these are fairly high returns for this industry and the best of the companies in the industry would earn around a max of 20% over a business cycle.
Valuation of cement companies should not be done on the basis of peak earnings alone. This holds true for most commodity companies. Case in point – sugar companies. In 2006-2007, these companies appeared cheap based on their peak earnings. However when the cycle turned downwards, the stock prices got wacked. The economics of the cement industry are not as bad (there is lesser government intervention), however the valuation approach should be similar to the sugar industry. One has to be careful in extrapolating the peak earnings and assuming that the stock is undervalued.
Due to the cyclicality and commodity nature of the industry, analysis and valuation of cement companies is more diffcult as one has to figure out where the industry stands in terms of the business cycle . High returns can be made if one can predict the key turnaround points in the business cycle.
Mysore cement –
This is an interesting company. The company was taken over by the heidelberg group and made a tender offer to buy shares from the public at 54 Rs/ share in 2006 . SEBI directed the group to set the price at 72.5 per share. This was recently overturned by SAT and the heidelberg group can now initiate a tender offer to buy the shares from the public at Rs54 per share.
In addition the company alloted 66.5 Million shares at Rs 54 per share in 2006 to the group. This capital was used to pay off the accumulated debts and wipe out the accumulated losses. The company has also become profitable from 2007 since the new management took over.
In addition a recent news, indicates that indorama cement would be merging with mysore cement taking the capacity to 2.8 Million tonnes. The company further plans to expand the capacity to 5.9 Million tonnes.
The financial look good, with the company solidly in the black, no debt and cash of almost 180 crs on the books. The impact of the new management can clearly be seen from the P&L account, balance sheet improvement and aggressive plans of the company to expand capacity through mergers and greenfield projects.
So if everything is so good, then one should go and buy the stock? I would hold on that before I can figure out the following
- Cement is a cyclical industry. Currently the industry is on an upswing and hence all cement companies are making good money. How will mysore cement fare when the cycle turns south (supply exceeds demand)
- What is the cost structure for mysore cement? Cost is critical in a commodity industry such as cement.
- Future plans of the management. Scale is important in the industry. Mysore cement is still at 2.8 Million tonnes and even after capacity expansion would still be one of the smaller companies
One interesting development is the tender offer. The stock is quoting at around 30 Rs and the tender offer should be around 54 Rs. The stock may be a good arbitrage opportunity, even if the long term prospects of the company needs a more thorough analysis.
Ambuja cements
Ambuja cements has been one of most profitable cement companies in india and has made money even during the downturns. They have the highest net profit margins in the industry at 30% and ROE of almost 40%. Net profit margins have grown from 10% to around 30% and the profit as a result has grown by 8 times in the last 5 years.
The company sells at around 560 Crs/ Million tons of capacity compared to say 170 Crs/ Million tons of capacity for Mysore cement. The difference is high and understandable as Ambuja cement is a well run company with huge capacity and a very efficient cost structure.
The company is currently selling at a PE of 7 based on last year’s net profit numbers. Based on normalised profit margins of around 12-15%, the company is selling at a PE of around 12-13. I would say the company is undervalued by 20-25% at best.
If you believe that the net margins are sustainable, consider the following fact : Net margins in 2003 and before were around 10% and have expanded to around 30% in the last 2 years.
Grasim, ACC, Ultratech etc
Grasim has a blend of cement, VSF and other businesses. The cement business seems to be doing well in line with industry. The other companies such as ACC and ultratech have also been performing well in the last 2-3 years. Most of the top cement companies now have margins in the range of 18-22%, ROE in excess of 30% and high profit growth rates in excess of 20-30%.
The valuations of these companies are fairly close. Most of these tier I companies are selling at 7-8 times profit in comparison to the smaller companies which are selling at 4-5 times or lesser.
I am reaching the following conclusions after looking at the complete sector
- The cement industry has enjoyed very high growth rates and great profits for the last few years. The profits margins are not sustainable. New capacity, cost pressure and competition are bound to drive the margins to long term averages of around 10-12% in the next few years
- Most of the companies appear undervalued in terms of the last 2 years profits. However on the basis of normalized profits they are selling at 12-13 times earnings. At best, these companies appear undervalued by 20-25%. There may be a bit of undervaluation, but not by a huge amount.
- Considering the level of undervaluation in some sectors such as pharma, IT etc and the better economics enjoyed by those industries compared to Cement, I am personally not too keen on investing in the cement sector. If I had to pick up one cement company to put my money in for the long term, I would prefer ambuja cement (if I had to that is !!)
My earlier analysis of the cement industry is here and here. In addition I have analysed the industry and updated my analysis in the file business analysis in the google group. Please have a look under the column commodity – cement.
The cement industry is a cyclical commodity industry where the profit and return on capital is dependent on the demand cycle picture. From the mid 90’s to 2002-2003 period, there was an excess of supply and hence prices were depressed. Most companies had poor to non-existent profits and accordingly the stock prices suffered. Since 2003, the demand has increased rapidly and so have the prices. The profit margins are now in excess of 20% for some companies and ROE in excess of 40% for companies such as ambuja cements. I personally think these are fairly high returns for this industry and the best of the companies in the industry would earn around a max of 20% over a business cycle.
Valuation of cement companies should not be done on the basis of peak earnings alone. This holds true for most commodity companies. Case in point – sugar companies. In 2006-2007, these companies appeared cheap based on their peak earnings. However when the cycle turned downwards, the stock prices got wacked. The economics of the cement industry are not as bad (there is lesser government intervention), however the valuation approach should be similar to the sugar industry. One has to be careful in extrapolating the peak earnings and assuming that the stock is undervalued.
Due to the cyclicality and commodity nature of the industry, analysis and valuation of cement companies is more diffcult as one has to figure out where the industry stands in terms of the business cycle . High returns can be made if one can predict the key turnaround points in the business cycle.
Mysore cement –
This is an interesting company. The company was taken over by the heidelberg group and made a tender offer to buy shares from the public at 54 Rs/ share in 2006 . SEBI directed the group to set the price at 72.5 per share. This was recently overturned by SAT and the heidelberg group can now initiate a tender offer to buy the shares from the public at Rs54 per share.
In addition the company alloted 66.5 Million shares at Rs 54 per share in 2006 to the group. This capital was used to pay off the accumulated debts and wipe out the accumulated losses. The company has also become profitable from 2007 since the new management took over.
In addition a recent news, indicates that indorama cement would be merging with mysore cement taking the capacity to 2.8 Million tonnes. The company further plans to expand the capacity to 5.9 Million tonnes.
The financial look good, with the company solidly in the black, no debt and cash of almost 180 crs on the books. The impact of the new management can clearly be seen from the P&L account, balance sheet improvement and aggressive plans of the company to expand capacity through mergers and greenfield projects.
So if everything is so good, then one should go and buy the stock? I would hold on that before I can figure out the following
- Cement is a cyclical industry. Currently the industry is on an upswing and hence all cement companies are making good money. How will mysore cement fare when the cycle turns south (supply exceeds demand)
- What is the cost structure for mysore cement? Cost is critical in a commodity industry such as cement.
- Future plans of the management. Scale is important in the industry. Mysore cement is still at 2.8 Million tonnes and even after capacity expansion would still be one of the smaller companies
One interesting development is the tender offer. The stock is quoting at around 30 Rs and the tender offer should be around 54 Rs. The stock may be a good arbitrage opportunity, even if the long term prospects of the company needs a more thorough analysis.
Ambuja cements
Ambuja cements has been one of most profitable cement companies in india and has made money even during the downturns. They have the highest net profit margins in the industry at 30% and ROE of almost 40%. Net profit margins have grown from 10% to around 30% and the profit as a result has grown by 8 times in the last 5 years.
The company sells at around 560 Crs/ Million tons of capacity compared to say 170 Crs/ Million tons of capacity for Mysore cement. The difference is high and understandable as Ambuja cement is a well run company with huge capacity and a very efficient cost structure.
The company is currently selling at a PE of 7 based on last year’s net profit numbers. Based on normalised profit margins of around 12-15%, the company is selling at a PE of around 12-13. I would say the company is undervalued by 20-25% at best.
If you believe that the net margins are sustainable, consider the following fact : Net margins in 2003 and before were around 10% and have expanded to around 30% in the last 2 years.
Grasim, ACC, Ultratech etc
Grasim has a blend of cement, VSF and other businesses. The cement business seems to be doing well in line with industry. The other companies such as ACC and ultratech have also been performing well in the last 2-3 years. Most of the top cement companies now have margins in the range of 18-22%, ROE in excess of 30% and high profit growth rates in excess of 20-30%.
The valuations of these companies are fairly close. Most of these tier I companies are selling at 7-8 times profit in comparison to the smaller companies which are selling at 4-5 times or lesser.
I am reaching the following conclusions after looking at the complete sector
- The cement industry has enjoyed very high growth rates and great profits for the last few years. The profits margins are not sustainable. New capacity, cost pressure and competition are bound to drive the margins to long term averages of around 10-12% in the next few years
- Most of the companies appear undervalued in terms of the last 2 years profits. However on the basis of normalized profits they are selling at 12-13 times earnings. At best, these companies appear undervalued by 20-25%. There may be a bit of undervaluation, but not by a huge amount.
- Considering the level of undervaluation in some sectors such as pharma, IT etc and the better economics enjoyed by those industries compared to Cement, I am personally not too keen on investing in the cement sector. If I had to pick up one cement company to put my money in for the long term, I would prefer ambuja cement (if I had to that is !!)
Tuesday, July 15, 2008
Responding to comments and emails
I receive several comments and emails with questions which require a detailed response. Instead of replying through an email or a comment, I am posting my reply as I thought others may find the discussion useful
Question : Does the increase in inflation and interest rates, impact the intrinsic value calculation ? Would you not increase the discount rate and reduce the instrinsic value as the long term government bonds rates have increased?
My response : You can find my approach to calculating intrinsic value here. In addition my valuation template also has the format for calculating intrinsic value. You can download it from here.
As some of you would have noticed, the discount rate I use is around 12%. This is strictly not as per finance theory. The typical textbook way to calculate discount rates, is to use the CAPM model (use the cost of equity and debt to calculate the discount rate). I am however more influenced by buffett and munger and their way of looking at stocks. For me, the discount rate or hurdle rate is my opportunity cost.
What is opportunity cost ? It is the return I can normally get from other investment options (debt and equity included). So if I have to invest in a stock, the expected return should be more than my opportunity cost (with a margin of safety to compensate for the risk).
When the long term rates were around 10-12 % in early 2000, I had a hurdle rate of around 13-14%. However when the rates dropped to around 8-9%, I dropped the hurdle rate to 11-12%. If you believe that the long term rates are likely to stay around 10% or higher for quite some time, then it would make sense to increase the discount rate you are using. However in my case, I plan to hold the discount rate at 11-12% till I get a strong feel that the long term rates in india would be above 10% for quite some time to come. Even in that case I may bump up the discount rate by 1-2% at best.
The market is ofcourse adjusting the valuation due to rise in the inflation and interest rates by dropping the prices. However we cannot be sure if this rise in inflation is temporary (6-12 months) or we are in for long term inflation
From prashant
Wondering what you did with your mutual fund investment(I guess you hold diversified equity funds) during Dec 07 / Jan 08 when valuations were sky high? A friend of mine informed me in Dec, 07 that he is swapping all equity funds to debt / balance funds. I ignored the info and thought SIP would take care of any correction. At the peak, gains were around 60% on the total money invested (during SIP of 1-1/2 years - infact I invested extra money in MF during all corrections) and now around -8%.
Actually I was not tracking the market and was taking care of monthly SIP money only. Now looking at current situation, I think I missed the opportunity. I should have done the same as my friend did. Lesson Learned – at a very high cost!!!
My response :
I have done this swapping in and out, jumping up and down and sideways and all around in the past. So after all the jumping and hopping, I decided to do some analysis in 2007 to see how I would have done in the last 8-9 years if I had just done an SIP. Well to my utter surprise, my returns were only 1% better than what I would have got through a dumb SIP plan in a decent mutual fund. With expense loads factored in, I have fared worse than an SIP plan.
I have seen from my past experience when I tried to time mutual funds, I ended up second guessing myself. When the market tanked, I was out and still waiting to get in.Then finally the market resumed its upwards course, but I was still twidling my thumbs. So this jumping in and out over the last decade has costed me a lot.
So this is what I decided – find 4-5 decent mutual funds. I don’t mean the top 5 or top 3 funds which is diffcult to find in terms of future performance. You can find the top 5 funds for the last X years, but that is no assurance that those funds will do equally well in the next X years. So I look at the funds with long histories (more the better) and if they have beaten the market by 3-5%, I set an SIP in them.
Will this give me the highest possible returns ? No it would not. Will I have bragging rights that I was smart to recognize the market top and jump out at the right time ? No, I will not. But I think I will end up following a fairly intelligent investment policy and make good returns. In addition this frees up my time and energy to pursue other activities.
Question : Does the increase in inflation and interest rates, impact the intrinsic value calculation ? Would you not increase the discount rate and reduce the instrinsic value as the long term government bonds rates have increased?
My response : You can find my approach to calculating intrinsic value here. In addition my valuation template also has the format for calculating intrinsic value. You can download it from here.
As some of you would have noticed, the discount rate I use is around 12%. This is strictly not as per finance theory. The typical textbook way to calculate discount rates, is to use the CAPM model (use the cost of equity and debt to calculate the discount rate). I am however more influenced by buffett and munger and their way of looking at stocks. For me, the discount rate or hurdle rate is my opportunity cost.
What is opportunity cost ? It is the return I can normally get from other investment options (debt and equity included). So if I have to invest in a stock, the expected return should be more than my opportunity cost (with a margin of safety to compensate for the risk).
When the long term rates were around 10-12 % in early 2000, I had a hurdle rate of around 13-14%. However when the rates dropped to around 8-9%, I dropped the hurdle rate to 11-12%. If you believe that the long term rates are likely to stay around 10% or higher for quite some time, then it would make sense to increase the discount rate you are using. However in my case, I plan to hold the discount rate at 11-12% till I get a strong feel that the long term rates in india would be above 10% for quite some time to come. Even in that case I may bump up the discount rate by 1-2% at best.
The market is ofcourse adjusting the valuation due to rise in the inflation and interest rates by dropping the prices. However we cannot be sure if this rise in inflation is temporary (6-12 months) or we are in for long term inflation
From prashant
Wondering what you did with your mutual fund investment(I guess you hold diversified equity funds) during Dec 07 / Jan 08 when valuations were sky high? A friend of mine informed me in Dec, 07 that he is swapping all equity funds to debt / balance funds. I ignored the info and thought SIP would take care of any correction. At the peak, gains were around 60% on the total money invested (during SIP of 1-1/2 years - infact I invested extra money in MF during all corrections) and now around -8%.
Actually I was not tracking the market and was taking care of monthly SIP money only. Now looking at current situation, I think I missed the opportunity. I should have done the same as my friend did. Lesson Learned – at a very high cost!!!
My response :
I have done this swapping in and out, jumping up and down and sideways and all around in the past. So after all the jumping and hopping, I decided to do some analysis in 2007 to see how I would have done in the last 8-9 years if I had just done an SIP. Well to my utter surprise, my returns were only 1% better than what I would have got through a dumb SIP plan in a decent mutual fund. With expense loads factored in, I have fared worse than an SIP plan.
I have seen from my past experience when I tried to time mutual funds, I ended up second guessing myself. When the market tanked, I was out and still waiting to get in.Then finally the market resumed its upwards course, but I was still twidling my thumbs. So this jumping in and out over the last decade has costed me a lot.
So this is what I decided – find 4-5 decent mutual funds. I don’t mean the top 5 or top 3 funds which is diffcult to find in terms of future performance. You can find the top 5 funds for the last X years, but that is no assurance that those funds will do equally well in the next X years. So I look at the funds with long histories (more the better) and if they have beaten the market by 3-5%, I set an SIP in them.
Will this give me the highest possible returns ? No it would not. Will I have bragging rights that I was smart to recognize the market top and jump out at the right time ? No, I will not. But I think I will end up following a fairly intelligent investment policy and make good returns. In addition this frees up my time and energy to pursue other activities.
Responding to comments and emails
I receive several comments and emails with questions which require a detailed response. Instead of replying through an email or a comment, I am posting my reply as I thought others may find the discussion useful
Question : Does the increase in inflation and interest rates, impact the intrinsic value calculation ? Would you not increase the discount rate and reduce the instrinsic value as the long term government bonds rates have increased?
My response : You can find my approach to calculating intrinsic value here. In addition my valuation template also has the format for calculating intrinsic value. You can download it from here.
As some of you would have noticed, the discount rate I use is around 12%. This is strictly not as per finance theory. The typical textbook way to calculate discount rates, is to use the CAPM model (use the cost of equity and debt to calculate the discount rate). I am however more influenced by buffett and munger and their way of looking at stocks. For me, the discount rate or hurdle rate is my opportunity cost.
What is opportunity cost ? It is the return I can normally get from other investment options (debt and equity included). So if I have to invest in a stock, the expected return should be more than my opportunity cost (with a margin of safety to compensate for the risk).
When the long term rates were around 10-12 % in early 2000, I had a hurdle rate of around 13-14%. However when the rates dropped to around 8-9%, I dropped the hurdle rate to 11-12%. If you believe that the long term rates are likely to stay around 10% or higher for quite some time, then it would make sense to increase the discount rate you are using. However in my case, I plan to hold the discount rate at 11-12% till I get a strong feel that the long term rates in india would be above 10% for quite some time to come. Even in that case I may bump up the discount rate by 1-2% at best.
The market is ofcourse adjusting the valuation due to rise in the inflation and interest rates by dropping the prices. However we cannot be sure if this rise in inflation is temporary (6-12 months) or we are in for long term inflation
From prashant
Wondering what you did with your mutual fund investment(I guess you hold diversified equity funds) during Dec 07 / Jan 08 when valuations were sky high? A friend of mine informed me in Dec, 07 that he is swapping all equity funds to debt / balance funds. I ignored the info and thought SIP would take care of any correction. At the peak, gains were around 60% on the total money invested (during SIP of 1-1/2 years - infact I invested extra money in MF during all corrections) and now around -8%.
Actually I was not tracking the market and was taking care of monthly SIP money only. Now looking at current situation, I think I missed the opportunity. I should have done the same as my friend did. Lesson Learned – at a very high cost!!!
My response :
I have done this swapping in and out, jumping up and down and sideways and all around in the past. So after all the jumping and hopping, I decided to do some analysis in 2007 to see how I would have done in the last 8-9 years if I had just done an SIP. Well to my utter surprise, my returns were only 1% better than what I would have got through a dumb SIP plan in a decent mutual fund. With expense loads factored in, I have fared worse than an SIP plan.
I have seen from my past experience when I tried to time mutual funds, I ended up second guessing myself. When the market tanked, I was out and still waiting to get in.Then finally the market resumed its upwards course, but I was still twidling my thumbs. So this jumping in and out over the last decade has costed me a lot.
So this is what I decided – find 4-5 decent mutual funds. I don’t mean the top 5 or top 3 funds which is diffcult to find in terms of future performance. You can find the top 5 funds for the last X years, but that is no assurance that those funds will do equally well in the next X years. So I look at the funds with long histories (more the better) and if they have beaten the market by 3-5%, I set an SIP in them.
Will this give me the highest possible returns ? No it would not. Will I have bragging rights that I was smart to recognize the market top and jump out at the right time ? No, I will not. But I think I will end up following a fairly intelligent investment policy and make good returns. In addition this frees up my time and energy to pursue other activities.
Question : Does the increase in inflation and interest rates, impact the intrinsic value calculation ? Would you not increase the discount rate and reduce the instrinsic value as the long term government bonds rates have increased?
My response : You can find my approach to calculating intrinsic value here. In addition my valuation template also has the format for calculating intrinsic value. You can download it from here.
As some of you would have noticed, the discount rate I use is around 12%. This is strictly not as per finance theory. The typical textbook way to calculate discount rates, is to use the CAPM model (use the cost of equity and debt to calculate the discount rate). I am however more influenced by buffett and munger and their way of looking at stocks. For me, the discount rate or hurdle rate is my opportunity cost.
What is opportunity cost ? It is the return I can normally get from other investment options (debt and equity included). So if I have to invest in a stock, the expected return should be more than my opportunity cost (with a margin of safety to compensate for the risk).
When the long term rates were around 10-12 % in early 2000, I had a hurdle rate of around 13-14%. However when the rates dropped to around 8-9%, I dropped the hurdle rate to 11-12%. If you believe that the long term rates are likely to stay around 10% or higher for quite some time, then it would make sense to increase the discount rate you are using. However in my case, I plan to hold the discount rate at 11-12% till I get a strong feel that the long term rates in india would be above 10% for quite some time to come. Even in that case I may bump up the discount rate by 1-2% at best.
The market is ofcourse adjusting the valuation due to rise in the inflation and interest rates by dropping the prices. However we cannot be sure if this rise in inflation is temporary (6-12 months) or we are in for long term inflation
From prashant
Wondering what you did with your mutual fund investment(I guess you hold diversified equity funds) during Dec 07 / Jan 08 when valuations were sky high? A friend of mine informed me in Dec, 07 that he is swapping all equity funds to debt / balance funds. I ignored the info and thought SIP would take care of any correction. At the peak, gains were around 60% on the total money invested (during SIP of 1-1/2 years - infact I invested extra money in MF during all corrections) and now around -8%.
Actually I was not tracking the market and was taking care of monthly SIP money only. Now looking at current situation, I think I missed the opportunity. I should have done the same as my friend did. Lesson Learned – at a very high cost!!!
My response :
I have done this swapping in and out, jumping up and down and sideways and all around in the past. So after all the jumping and hopping, I decided to do some analysis in 2007 to see how I would have done in the last 8-9 years if I had just done an SIP. Well to my utter surprise, my returns were only 1% better than what I would have got through a dumb SIP plan in a decent mutual fund. With expense loads factored in, I have fared worse than an SIP plan.
I have seen from my past experience when I tried to time mutual funds, I ended up second guessing myself. When the market tanked, I was out and still waiting to get in.Then finally the market resumed its upwards course, but I was still twidling my thumbs. So this jumping in and out over the last decade has costed me a lot.
So this is what I decided – find 4-5 decent mutual funds. I don’t mean the top 5 or top 3 funds which is diffcult to find in terms of future performance. You can find the top 5 funds for the last X years, but that is no assurance that those funds will do equally well in the next X years. So I look at the funds with long histories (more the better) and if they have beaten the market by 3-5%, I set an SIP in them.
Will this give me the highest possible returns ? No it would not. Will I have bragging rights that I was smart to recognize the market top and jump out at the right time ? No, I will not. But I think I will end up following a fairly intelligent investment policy and make good returns. In addition this frees up my time and energy to pursue other activities.
Wednesday, July 09, 2008
An assured way to lose money
There are only a few times in the world of investing when you can be fairly sure. Most of my equity analysis has words like likely, could be etc. Equity investing is a probabilistic exercise. You can 60-70 or maybe 90% confident, but no one can say anything with a 100% confidence. There is no such thing as a sure gain.That is however not the case with the downside. Sometimes you can be sure that you will lose, no matter what. For ex: if you jump from the 4th floor of a building …you get my hint.
With stock markets down, the tendency of a lot of investors would be to take refuge in fixed income instruments such as Bonds, FD etc. But are they really safe ?
Inflation is now at 11.5% and it could stay there for some time. The usual policy action is to raise the short term to slowdown the growth and also the inflation. Due to the poorly developed debt markets in india, RBI does not have the same leverage as other central bankers in developed countries such as the FED. As a result, the RBI will have to raise the short terms rates pretty high to influence inflation. This was the case in the mid 90’s when the RBI had to raise the rates to around 13% to damp the inflation.
The current returns on Bank FD’s is around 10% for 1 year duration. Similary fixed income debt funds are providing a return of around 8-9% before expenses. Net of expenses the returns would be 7-8%. So if you decide to invest in a long dated FD be prepared to lose at least 2-3% of principal by way of inflation.
In the year 2000-2003, interest rates came down from 10%+ to around 7-8%. As a result debt funds gave 15%+ returns during that time period. We could see that phase in reverse now. As short term rates rise, debt funds could give negative returns.
So what should one do ? If I have invest in fixed income debt, I would prefer short duration floating rate funds. See here , to understand what is duration.
I would generally look at the following points when selecting a short duration floating rate fund
- duration of the fund. Should be less than a year. See average maturity in the image at the top
- average credit rating should be AAA
- Known fund house
- Returns for the last 2-3 years should have atleast matched the category returns.
This is kind of investing is really a defensive one. The best outcome one can hope for is preservation of capital net of inflation.
An assured way to lose money
There are only a few times in the world of investing when you can be fairly sure. Most of my equity analysis has words like likely, could be etc. Equity investing is a probabilistic exercise. You can 60-70 or maybe 90% confident, but no one can say anything with a 100% confidence. There is no such thing as a sure gain.That is however not the case with the downside. Sometimes you can be sure that you will lose, no matter what. For ex: if you jump from the 4th floor of a building …you get my hint.
With stock markets down, the tendency of a lot of investors would be to take refuge in fixed income instruments such as Bonds, FD etc. But are they really safe ?
Inflation is now at 11.5% and it could stay there for some time. The usual policy action is to raise the short term to slowdown the growth and also the inflation. Due to the poorly developed debt markets in india, RBI does not have the same leverage as other central bankers in developed countries such as the FED. As a result, the RBI will have to raise the short terms rates pretty high to influence inflation. This was the case in the mid 90’s when the RBI had to raise the rates to around 13% to damp the inflation.
The current returns on Bank FD’s is around 10% for 1 year duration. Similary fixed income debt funds are providing a return of around 8-9% before expenses. Net of expenses the returns would be 7-8%. So if you decide to invest in a long dated FD be prepared to lose at least 2-3% of principal by way of inflation.
In the year 2000-2003, interest rates came down from 10%+ to around 7-8%. As a result debt funds gave 15%+ returns during that time period. We could see that phase in reverse now. As short term rates rise, debt funds could give negative returns.
So what should one do ? If I have invest in fixed income debt, I would prefer short duration floating rate funds. See here , to understand what is duration.
I would generally look at the following points when selecting a short duration floating rate fund
- duration of the fund. Should be less than a year. See average maturity in the image at the top
- average credit rating should be AAA
- Known fund house
- Returns for the last 2-3 years should have atleast matched the category returns.
This is kind of investing is really a defensive one. The best outcome one can hope for is preservation of capital net of inflation.
Tuesday, July 08, 2008
Opinion on stocks of your choice
update : 9-Jul
I did not expect a flood of emails and several comments on this post. It was my mistake in not specifiying a limit on the numbers companies per email or comment. As a result i have a list of around 300 companies now to analyse and growing :)
To make it manageable for me, i would request you to limit the number of companies to 2-3 per comment or email. You can select your top 2-3 companies and hopefully i would be able to cover the entire list in 2-3 posts.
---------------------------------------------------------------------------------------
I get emails and sometimes comments asking for my opinion on stocks. I am thinking of doing, twice a month post, analysing all such stocks sent to me via emails or comments.
Please feel free to leave the stock names through either an email to my id – rohitc99@indiatimes.com or via a comment. I will consolidate the names over 2 weeks and post a quick analysis on each one of them.
However you have to keep in mind the following filter criteria I use to analyse stocks. Stocks which don’t meet these criteria are generally rejected by me without spending too much time on them.
1.Debt/ equity ratio <= 1
2.ROE over a 3-5 year period of more than 12%
3.No losses for more than 1 year in the last 5-7 years
4.Mcap of more than 20-30 Crs (can be relaxed)
5.No obvious fraud by the management in the past
6.PE not more than 40
If the fundamentals are poor, or valuations too high I tend to move on and not spent too much time on it. If like me, you need 10-15 stocks in the portfolio, there is no need to spend time in figuring out a difficult idea when there are easier ones available. A lot of times stocks may have good fundamentals and may be slightly undervalued. In such cases I tend to put the stock on a watch list and would follow it till it becomes undervalued (50% of intrinsic value).
Some of the stocks you may mention may land in such a bucket. It does’nt mean that I don’t find value in the stock, just that it is not cheap enough for me. So please leave names of stocks you want me to look at. If I get sufficient response, I will try to make it a regular effort on the blog.
Opinion on stocks of your choice
update : 9-Jul
I did not expect a flood of emails and several comments on this post. It was my mistake in not specifiying a limit on the numbers companies per email or comment. As a result i have a list of around 300 companies now to analyse and growing :)
To make it manageable for me, i would request you to limit the number of companies to 2-3 per comment or email. You can select your top 2-3 companies and hopefully i would be able to cover the entire list in 2-3 posts.
---------------------------------------------------------------------------------------
I get emails and sometimes comments asking for my opinion on stocks. I am thinking of doing, twice a month post, analysing all such stocks sent to me via emails or comments.
Please feel free to leave the stock names through either an email to my id – rohitc99@indiatimes.com or via a comment. I will consolidate the names over 2 weeks and post a quick analysis on each one of them.
However you have to keep in mind the following filter criteria I use to analyse stocks. Stocks which don’t meet these criteria are generally rejected by me without spending too much time on them.
1.Debt/ equity ratio <= 1
2.ROE over a 3-5 year period of more than 12%
3.No losses for more than 1 year in the last 5-7 years
4.Mcap of more than 20-30 Crs (can be relaxed)
5.No obvious fraud by the management in the past
6.PE not more than 40
If the fundamentals are poor, or valuations too high I tend to move on and not spent too much time on it. If like me, you need 10-15 stocks in the portfolio, there is no need to spend time in figuring out a difficult idea when there are easier ones available. A lot of times stocks may have good fundamentals and may be slightly undervalued. In such cases I tend to put the stock on a watch list and would follow it till it becomes undervalued (50% of intrinsic value).
Some of the stocks you may mention may land in such a bucket. It does’nt mean that I don’t find value in the stock, just that it is not cheap enough for me. So please leave names of stocks you want me to look at. If I get sufficient response, I will try to make it a regular effort on the blog.
Sunday, July 06, 2008
Rapid fire analysis of multiple stocks
In the previous post, I was asked to give an opinion on several stocks. I have fairly broad filters when selecting stocks. As a result I drop companies pretty quickly. Once they make through my filters, I spend quite a bit of time analysing and mulling over them. Frankly I don’t need more than 10-12 stocks to build a decent portfolio, so I don’t spend time on companies which don’t catch my attention, either due to the fundamentals or due to valuations
So here is my opionion on the stocks listed in the comments (please note the word opinion as I have really not done a detailed analysis on them)
Please note that for a stock to excite me, the fundamentals have to be good and the stock has to be fairly undervalued (selling at 50% of intrinsic value). So you may find that I am not too enthusiatic of some stocks if they don’t appear to be undervalued to me even if the fundamentals are good.
Following stocks are from mumbai jurno
Punj Lloyd – The net profits have grown by 30 times in the last 4 years. The company has a debt equity ratio of more than 1 which is on the higher side for my comfort. The market has recognized the rapid growth and inspite of the recent drop, the company is valued at 30 times its recent earnings. I personally will not invest in this stock for two reasons – I am not confident if the company can continue this level of growth and the valuation are on the higher side for me.
Voltas – I was invested in bluestar from 2003 to 2006 (see here). I exited blue star last year as I found the valuations to be on the higher side. The company has shown a high profit growth ( 5 times in last 5 years) and has a high ROE of almost 50%. The company has very low debt. Though the valuation (PE of around 20) is a bit on the higher side, I would personally put the company on my watch list and analyse it a bit further to make a decision.
Amararaja Batteries – This is the auto components industry. Overall I am not too excited by the economics of this industry. If the auto industry is under price pressure, it is bound to pass on those cost pressures to their suppliers. As a result auto component companies over a business cycle do not enjoy high profits. Most the companies in the industry do not have a high competitive advantage due buyer power, poor pricing strenght etc. I had analysed exide some time back, but never pulled the trigger. This is from memory – I think exide enjoys more than 50% market share in the industry. In such an industry a distant no.2 such as amaraja may not have very high pricing strength and may see its profits dip when the cycle turns downwards. So although the stock appears undervalued, I would be careful jumping into it. Looking into the rear view mirror (last year’s profit) may not be the smart thing to do in this stock. It is critical to figure out how the company will do going forward.
Venus Remedies – Company appears undervalued and has shown very high growth in the last few years. I would have to analyse if the growth is sustainable or not to make a decision.
Kamat Hotels – 2007 Debt equity ratio is 2:1, with the company carrying a debt of 270 Crs in 2007 (have not seen 2008 numbers). This debt is almost 10 times 2007 net profit numbers. This stock would fail to pass my fundamental filters and I generally end up passing on companies with this level of debt
ICSA (India) – This company like Punj lloyd and amaraja has shown phenomenal growth in the last 5 years. On a personal level such growth makes me nervous (although the market gets all excited by it). Before I touch this stock I would want to analyse the reason behind the growth and the sustainability of this growth. Basic numbers do not give the complete story. So I will need to research far more to make a decision on the company. A high growth in the last few years is good thing, but I would not extrapolate that growth blindly and buy the stock.
Axis Bank – Fundamentally a good bank. The P/B ratio is around 3 and the ROE has been dropping for the last few years. ROE is now at 12% which could be due to the additional capital raised by the bank. The bank is doing very well and growing rapidly too. I would personally track the stock, but the price is not cheap enough for me.
Yes Bank – This stock is current sweetheart of a lot of people. If I say something bad, some of you will beat me up :) . The bank has good fundamentals. However at the current P/B of 4-5, the valuation is still too high for me.
From hardtoget
Alok – 2007 AR shows a debt of 3300 Crs (Debt equity ratio of 4). Unless 2008 is drastically different, this company is not for me. A debt equity ratio of more than 1 is generally a no go decision for me. I am not comfortable at all with such a high debt equity ratio, especially in cyclical industry
From vivek
Balmer Lawrie – I hold this stock. See analysis here
Berger Paints – I worked in asian paints and have seen how berger operates fairly closely. If there is one company other than asian paints which is aggressive and does a good job, it is berger. The company has a fantastic sales organisation. The fundamentals of the company are good and the valuation looks attractive too. If I was not as baised towards asian paints ( I hold this stock), I would invest in Berger paints.
Tata Tea – The company seems to have good fundamentals, good brands and decent valuation. I will be analysing the stock further.
Glaxo Consumer – I hold this stock. See analysis here
Castrol – The company has great brands, a good distribution network, very high ROE and great fundamentals. The valuation seems to be a bit on the higher side for me to pull the trigger. My key concerns are management quality and impact of oil pricing on the company’s profits. A few years back, I think the management tried to buy out the domestic shareholders at a low price. As a result I am not too comfortable with the management. In addition need to see if their margins will be impacted drastically by the oil price changes.
Hindustan Sanitaryware – Fundamentals look good, although the 2007 debt is a bit on the higher side. The valuations are quite attractive. I think the company is worth a closer look.
So here is my opionion on the stocks listed in the comments (please note the word opinion as I have really not done a detailed analysis on them)
Please note that for a stock to excite me, the fundamentals have to be good and the stock has to be fairly undervalued (selling at 50% of intrinsic value). So you may find that I am not too enthusiatic of some stocks if they don’t appear to be undervalued to me even if the fundamentals are good.
Following stocks are from mumbai jurno
Punj Lloyd – The net profits have grown by 30 times in the last 4 years. The company has a debt equity ratio of more than 1 which is on the higher side for my comfort. The market has recognized the rapid growth and inspite of the recent drop, the company is valued at 30 times its recent earnings. I personally will not invest in this stock for two reasons – I am not confident if the company can continue this level of growth and the valuation are on the higher side for me.
Voltas – I was invested in bluestar from 2003 to 2006 (see here). I exited blue star last year as I found the valuations to be on the higher side. The company has shown a high profit growth ( 5 times in last 5 years) and has a high ROE of almost 50%. The company has very low debt. Though the valuation (PE of around 20) is a bit on the higher side, I would personally put the company on my watch list and analyse it a bit further to make a decision.
Amararaja Batteries – This is the auto components industry. Overall I am not too excited by the economics of this industry. If the auto industry is under price pressure, it is bound to pass on those cost pressures to their suppliers. As a result auto component companies over a business cycle do not enjoy high profits. Most the companies in the industry do not have a high competitive advantage due buyer power, poor pricing strenght etc. I had analysed exide some time back, but never pulled the trigger. This is from memory – I think exide enjoys more than 50% market share in the industry. In such an industry a distant no.2 such as amaraja may not have very high pricing strength and may see its profits dip when the cycle turns downwards. So although the stock appears undervalued, I would be careful jumping into it. Looking into the rear view mirror (last year’s profit) may not be the smart thing to do in this stock. It is critical to figure out how the company will do going forward.
Venus Remedies – Company appears undervalued and has shown very high growth in the last few years. I would have to analyse if the growth is sustainable or not to make a decision.
Kamat Hotels – 2007 Debt equity ratio is 2:1, with the company carrying a debt of 270 Crs in 2007 (have not seen 2008 numbers). This debt is almost 10 times 2007 net profit numbers. This stock would fail to pass my fundamental filters and I generally end up passing on companies with this level of debt
ICSA (India) – This company like Punj lloyd and amaraja has shown phenomenal growth in the last 5 years. On a personal level such growth makes me nervous (although the market gets all excited by it). Before I touch this stock I would want to analyse the reason behind the growth and the sustainability of this growth. Basic numbers do not give the complete story. So I will need to research far more to make a decision on the company. A high growth in the last few years is good thing, but I would not extrapolate that growth blindly and buy the stock.
Axis Bank – Fundamentally a good bank. The P/B ratio is around 3 and the ROE has been dropping for the last few years. ROE is now at 12% which could be due to the additional capital raised by the bank. The bank is doing very well and growing rapidly too. I would personally track the stock, but the price is not cheap enough for me.
Yes Bank – This stock is current sweetheart of a lot of people. If I say something bad, some of you will beat me up :) . The bank has good fundamentals. However at the current P/B of 4-5, the valuation is still too high for me.
From hardtoget
Alok – 2007 AR shows a debt of 3300 Crs (Debt equity ratio of 4). Unless 2008 is drastically different, this company is not for me. A debt equity ratio of more than 1 is generally a no go decision for me. I am not comfortable at all with such a high debt equity ratio, especially in cyclical industry
From vivek
Balmer Lawrie – I hold this stock. See analysis here
Berger Paints – I worked in asian paints and have seen how berger operates fairly closely. If there is one company other than asian paints which is aggressive and does a good job, it is berger. The company has a fantastic sales organisation. The fundamentals of the company are good and the valuation looks attractive too. If I was not as baised towards asian paints ( I hold this stock), I would invest in Berger paints.
Tata Tea – The company seems to have good fundamentals, good brands and decent valuation. I will be analysing the stock further.
Glaxo Consumer – I hold this stock. See analysis here
Castrol – The company has great brands, a good distribution network, very high ROE and great fundamentals. The valuation seems to be a bit on the higher side for me to pull the trigger. My key concerns are management quality and impact of oil pricing on the company’s profits. A few years back, I think the management tried to buy out the domestic shareholders at a low price. As a result I am not too comfortable with the management. In addition need to see if their margins will be impacted drastically by the oil price changes.
Hindustan Sanitaryware – Fundamentals look good, although the 2007 debt is a bit on the higher side. The valuations are quite attractive. I think the company is worth a closer look.
Rapid fire analysis of multiple stocks
In the previous post, I was asked to give an opinion on several stocks. I have fairly broad filters when selecting stocks. As a result I drop companies pretty quickly. Once they make through my filters, I spend quite a bit of time analysing and mulling over them. Frankly I don’t need more than 10-12 stocks to build a decent portfolio, so I don’t spend time on companies which don’t catch my attention, either due to the fundamentals or due to valuations
So here is my opionion on the stocks listed in the comments (please note the word opinion as I have really not done a detailed analysis on them)
Please note that for a stock to excite me, the fundamentals have to be good and the stock has to be fairly undervalued (selling at 50% of intrinsic value). So you may find that I am not too enthusiatic of some stocks if they don’t appear to be undervalued to me even if the fundamentals are good.
Following stocks are from mumbai jurno
Punj Lloyd – The net profits have grown by 30 times in the last 4 years. The company has a debt equity ratio of more than 1 which is on the higher side for my comfort. The market has recognized the rapid growth and inspite of the recent drop, the company is valued at 30 times its recent earnings. I personally will not invest in this stock for two reasons – I am not confident if the company can continue this level of growth and the valuation are on the higher side for me.
Voltas – I was invested in bluestar from 2003 to 2006 (see here). I exited blue star last year as I found the valuations to be on the higher side. The company has shown a high profit growth ( 5 times in last 5 years) and has a high ROE of almost 50%. The company has very low debt. Though the valuation (PE of around 20) is a bit on the higher side, I would personally put the company on my watch list and analyse it a bit further to make a decision.
Amararaja Batteries – This is the auto components industry. Overall I am not too excited by the economics of this industry. If the auto industry is under price pressure, it is bound to pass on those cost pressures to their suppliers. As a result auto component companies over a business cycle do not enjoy high profits. Most the companies in the industry do not have a high competitive advantage due buyer power, poor pricing strenght etc. I had analysed exide some time back, but never pulled the trigger. This is from memory – I think exide enjoys more than 50% market share in the industry. In such an industry a distant no.2 such as amaraja may not have very high pricing strength and may see its profits dip when the cycle turns downwards. So although the stock appears undervalued, I would be careful jumping into it. Looking into the rear view mirror (last year’s profit) may not be the smart thing to do in this stock. It is critical to figure out how the company will do going forward.
Venus Remedies – Company appears undervalued and has shown very high growth in the last few years. I would have to analyse if the growth is sustainable or not to make a decision.
Kamat Hotels – 2007 Debt equity ratio is 2:1, with the company carrying a debt of 270 Crs in 2007 (have not seen 2008 numbers). This debt is almost 10 times 2007 net profit numbers. This stock would fail to pass my fundamental filters and I generally end up passing on companies with this level of debt
ICSA (India) – This company like Punj lloyd and amaraja has shown phenomenal growth in the last 5 years. On a personal level such growth makes me nervous (although the market gets all excited by it). Before I touch this stock I would want to analyse the reason behind the growth and the sustainability of this growth. Basic numbers do not give the complete story. So I will need to research far more to make a decision on the company. A high growth in the last few years is good thing, but I would not extrapolate that growth blindly and buy the stock.
Axis Bank – Fundamentally a good bank. The P/B ratio is around 3 and the ROE has been dropping for the last few years. ROE is now at 12% which could be due to the additional capital raised by the bank. The bank is doing very well and growing rapidly too. I would personally track the stock, but the price is not cheap enough for me.
Yes Bank – This stock is current sweetheart of a lot of people. If I say something bad, some of you will beat me up :) . The bank has good fundamentals. However at the current P/B of 4-5, the valuation is still too high for me.
From hardtoget
Alok – 2007 AR shows a debt of 3300 Crs (Debt equity ratio of 4). Unless 2008 is drastically different, this company is not for me. A debt equity ratio of more than 1 is generally a no go decision for me. I am not comfortable at all with such a high debt equity ratio, especially in cyclical industry
From vivek
Balmer Lawrie – I hold this stock. See analysis here
Berger Paints – I worked in asian paints and have seen how berger operates fairly closely. If there is one company other than asian paints which is aggressive and does a good job, it is berger. The company has a fantastic sales organisation. The fundamentals of the company are good and the valuation looks attractive too. If I was not as baised towards asian paints ( I hold this stock), I would invest in Berger paints.
Tata Tea – The company seems to have good fundamentals, good brands and decent valuation. I will be analysing the stock further.
Glaxo Consumer – I hold this stock. See analysis here
Castrol – The company has great brands, a good distribution network, very high ROE and great fundamentals. The valuation seems to be a bit on the higher side for me to pull the trigger. My key concerns are management quality and impact of oil pricing on the company’s profits. A few years back, I think the management tried to buy out the domestic shareholders at a low price. As a result I am not too comfortable with the management. In addition need to see if their margins will be impacted drastically by the oil price changes.
Hindustan Sanitaryware – Fundamentals look good, although the 2007 debt is a bit on the higher side. The valuations are quite attractive. I think the company is worth a closer look.
So here is my opionion on the stocks listed in the comments (please note the word opinion as I have really not done a detailed analysis on them)
Please note that for a stock to excite me, the fundamentals have to be good and the stock has to be fairly undervalued (selling at 50% of intrinsic value). So you may find that I am not too enthusiatic of some stocks if they don’t appear to be undervalued to me even if the fundamentals are good.
Following stocks are from mumbai jurno
Punj Lloyd – The net profits have grown by 30 times in the last 4 years. The company has a debt equity ratio of more than 1 which is on the higher side for my comfort. The market has recognized the rapid growth and inspite of the recent drop, the company is valued at 30 times its recent earnings. I personally will not invest in this stock for two reasons – I am not confident if the company can continue this level of growth and the valuation are on the higher side for me.
Voltas – I was invested in bluestar from 2003 to 2006 (see here). I exited blue star last year as I found the valuations to be on the higher side. The company has shown a high profit growth ( 5 times in last 5 years) and has a high ROE of almost 50%. The company has very low debt. Though the valuation (PE of around 20) is a bit on the higher side, I would personally put the company on my watch list and analyse it a bit further to make a decision.
Amararaja Batteries – This is the auto components industry. Overall I am not too excited by the economics of this industry. If the auto industry is under price pressure, it is bound to pass on those cost pressures to their suppliers. As a result auto component companies over a business cycle do not enjoy high profits. Most the companies in the industry do not have a high competitive advantage due buyer power, poor pricing strenght etc. I had analysed exide some time back, but never pulled the trigger. This is from memory – I think exide enjoys more than 50% market share in the industry. In such an industry a distant no.2 such as amaraja may not have very high pricing strength and may see its profits dip when the cycle turns downwards. So although the stock appears undervalued, I would be careful jumping into it. Looking into the rear view mirror (last year’s profit) may not be the smart thing to do in this stock. It is critical to figure out how the company will do going forward.
Venus Remedies – Company appears undervalued and has shown very high growth in the last few years. I would have to analyse if the growth is sustainable or not to make a decision.
Kamat Hotels – 2007 Debt equity ratio is 2:1, with the company carrying a debt of 270 Crs in 2007 (have not seen 2008 numbers). This debt is almost 10 times 2007 net profit numbers. This stock would fail to pass my fundamental filters and I generally end up passing on companies with this level of debt
ICSA (India) – This company like Punj lloyd and amaraja has shown phenomenal growth in the last 5 years. On a personal level such growth makes me nervous (although the market gets all excited by it). Before I touch this stock I would want to analyse the reason behind the growth and the sustainability of this growth. Basic numbers do not give the complete story. So I will need to research far more to make a decision on the company. A high growth in the last few years is good thing, but I would not extrapolate that growth blindly and buy the stock.
Axis Bank – Fundamentally a good bank. The P/B ratio is around 3 and the ROE has been dropping for the last few years. ROE is now at 12% which could be due to the additional capital raised by the bank. The bank is doing very well and growing rapidly too. I would personally track the stock, but the price is not cheap enough for me.
Yes Bank – This stock is current sweetheart of a lot of people. If I say something bad, some of you will beat me up :) . The bank has good fundamentals. However at the current P/B of 4-5, the valuation is still too high for me.
From hardtoget
Alok – 2007 AR shows a debt of 3300 Crs (Debt equity ratio of 4). Unless 2008 is drastically different, this company is not for me. A debt equity ratio of more than 1 is generally a no go decision for me. I am not comfortable at all with such a high debt equity ratio, especially in cyclical industry
From vivek
Balmer Lawrie – I hold this stock. See analysis here
Berger Paints – I worked in asian paints and have seen how berger operates fairly closely. If there is one company other than asian paints which is aggressive and does a good job, it is berger. The company has a fantastic sales organisation. The fundamentals of the company are good and the valuation looks attractive too. If I was not as baised towards asian paints ( I hold this stock), I would invest in Berger paints.
Tata Tea – The company seems to have good fundamentals, good brands and decent valuation. I will be analysing the stock further.
Glaxo Consumer – I hold this stock. See analysis here
Castrol – The company has great brands, a good distribution network, very high ROE and great fundamentals. The valuation seems to be a bit on the higher side for me to pull the trigger. My key concerns are management quality and impact of oil pricing on the company’s profits. A few years back, I think the management tried to buy out the domestic shareholders at a low price. As a result I am not too comfortable with the management. In addition need to see if their margins will be impacted drastically by the oil price changes.
Hindustan Sanitaryware – Fundamentals look good, although the 2007 debt is a bit on the higher side. The valuations are quite attractive. I think the company is worth a closer look.
Tuesday, July 01, 2008
Wish I sold off my entire portfolio in Jan !!
No, I have not been wishing that or whining about it. I have heard several of my friends wish that they had done that. Short of knowing the future, it would have been impossible to time the market that well.
I too have losses due to the market drop. However I am not dissapointed or wishing otherwise. It has nothing to do with being brave and more to do with being rational based on my approach.
This is how I construct my portfolio. I typically start buying at or below prices, which are 50% of conservatively calculated intrinsic value. Ofcourse at the peak in Jan, most my holdings had gone up (in some cases too fast) . However they were still trading at a discount to their intrinsic value. Hence I saw no reason to sell my stocks. However as they were above 50% discount levels, I was not doing any major buying too. As a result, after creating a small position in some stocks, I was doing nothing and just twidling thumbs.
Now with the market crash several of my holdings are below the 50% discount mark. There are quite a few new opportunities coming up too. So I have now started accumulating stocks which I had analysed in the past, but the price was not attractive enough.
So the point is this – If you felt the stocks in your portfolio in jan were not overvalued enough to be sold then, they should even more attractive now. If you did not sell then, thinking that they were not overpriced, you should buying more now. Ofcourse this assumes that the fundamentals have not deterioated suddenly.
If however you are pessimistic about the stock after a 30-40% drop, then you need to do some honest thinking. Either your analysis was wrong or the current pessimism is getting to you.
I too have losses due to the market drop. However I am not dissapointed or wishing otherwise. It has nothing to do with being brave and more to do with being rational based on my approach.
This is how I construct my portfolio. I typically start buying at or below prices, which are 50% of conservatively calculated intrinsic value. Ofcourse at the peak in Jan, most my holdings had gone up (in some cases too fast) . However they were still trading at a discount to their intrinsic value. Hence I saw no reason to sell my stocks. However as they were above 50% discount levels, I was not doing any major buying too. As a result, after creating a small position in some stocks, I was doing nothing and just twidling thumbs.
Now with the market crash several of my holdings are below the 50% discount mark. There are quite a few new opportunities coming up too. So I have now started accumulating stocks which I had analysed in the past, but the price was not attractive enough.
So the point is this – If you felt the stocks in your portfolio in jan were not overvalued enough to be sold then, they should even more attractive now. If you did not sell then, thinking that they were not overpriced, you should buying more now. Ofcourse this assumes that the fundamentals have not deterioated suddenly.
If however you are pessimistic about the stock after a 30-40% drop, then you need to do some honest thinking. Either your analysis was wrong or the current pessimism is getting to you.
Wish I sold off my entire portfolio in Jan !!
No, I have not been wishing that or whining about it. I have heard several of my friends wish that they had done that. Short of knowing the future, it would have been impossible to time the market that well.
I too have losses due to the market drop. However I am not dissapointed or wishing otherwise. It has nothing to do with being brave and more to do with being rational based on my approach.
This is how I construct my portfolio. I typically start buying at or below prices, which are 50% of conservatively calculated intrinsic value. Ofcourse at the peak in Jan, most my holdings had gone up (in some cases too fast) . However they were still trading at a discount to their intrinsic value. Hence I saw no reason to sell my stocks. However as they were above 50% discount levels, I was not doing any major buying too. As a result, after creating a small position in some stocks, I was doing nothing and just twidling thumbs.
Now with the market crash several of my holdings are below the 50% discount mark. There are quite a few new opportunities coming up too. So I have now started accumulating stocks which I had analysed in the past, but the price was not attractive enough.
So the point is this – If you felt the stocks in your portfolio in jan were not overvalued enough to be sold then, they should even more attractive now. If you did not sell then, thinking that they were not overpriced, you should buying more now. Ofcourse this assumes that the fundamentals have not deterioated suddenly.
If however you are pessimistic about the stock after a 30-40% drop, then you need to do some honest thinking. Either your analysis was wrong or the current pessimism is getting to you.
I too have losses due to the market drop. However I am not dissapointed or wishing otherwise. It has nothing to do with being brave and more to do with being rational based on my approach.
This is how I construct my portfolio. I typically start buying at or below prices, which are 50% of conservatively calculated intrinsic value. Ofcourse at the peak in Jan, most my holdings had gone up (in some cases too fast) . However they were still trading at a discount to their intrinsic value. Hence I saw no reason to sell my stocks. However as they were above 50% discount levels, I was not doing any major buying too. As a result, after creating a small position in some stocks, I was doing nothing and just twidling thumbs.
Now with the market crash several of my holdings are below the 50% discount mark. There are quite a few new opportunities coming up too. So I have now started accumulating stocks which I had analysed in the past, but the price was not attractive enough.
So the point is this – If you felt the stocks in your portfolio in jan were not overvalued enough to be sold then, they should even more attractive now. If you did not sell then, thinking that they were not overpriced, you should buying more now. Ofcourse this assumes that the fundamentals have not deterioated suddenly.
If however you are pessimistic about the stock after a 30-40% drop, then you need to do some honest thinking. Either your analysis was wrong or the current pessimism is getting to you.
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