Value Investing and Indian Equities

The Milgram Experiments

noreply@blogger.com (Shankar Nath) — Thu, 27 May 2010 13:44:00 +0000

In 1961, Stanley Milgram conducted a series of social psychology experiments to measure the willingness of ordinary people to obey an authority figure who has instructed them to perform acts that conflicted with their personal conscience.

The experiment

Three people took part in these experiments - the teacher (participant), the learner (victim) and the experimenter (authority figure). Only the teacher was the real participant in the experiment. The role of experimenter was that of stern, impassive doctor with a white beard & wearing a long white overcoat. The learner was an actor who didn't have a major role in the experiment.

The experimenter would tell the teacher that this experiment was being conducted to study memory and its impact on learning in different situations. Per the rules of the experiment, the teacher would ask a question to the learner and if the answer is incorrect, then a small electric shock would be administered on the learner. These shock increased at a 15-volt increment, starting from 30 volts and going all the way upto 450 volts. After these instructions the teacher and the learner are separated and moved to different rooms. They cant see, but can listen to one another. The experimenter is in the same room as the teacher.

As the experiment continues and the teacher administers these shocks to the learner - it becomes apparent that the learner is in considerable pain. He shouts back at the teacher to stop and even bangs the wall. At around 135-150 volts, most teachers start questioning the experimenter on the purpose of the experiment after listening to the learner experiencing pain. The experimenter would normally say "Please continue" or "The experiment requires you to continue" or "These shocks will not have any long-term damages on the learner". The teacher would then continue and keep addressing his concern to the experimenter who would blankly request the teacher to continue the experiment.

The results

Now ask yourself these questions :

At what point (volts) will you stop when you know that the person on the other room is in excruciating pain? Will you go on and deliver 450 volts of lethal electric shock?

When this question was asked of a fairly large sample of people, only 1.2% were prepared to inflict the lethal 450-volt shock. And although there is no record on the voltage point of stopping the activity, I assume this would be pretty low as most people know how lethal even a 220 volt shock can be. (220 volts is the standard voltage in UK and India)

However when Milgram conducted his experiments - 65% of the participants pressed the 450-volt button. Most of them ever very uncomfortable doing so and at some point, every participant paused and questioned the experimenter. But 24 out of the 40 participants continued and delivered the lethal 450 volts. Of the remaining 35% (who stopped participating mid-way), only 1 person stopped before reaching the 300-volt mark.

The learnings

The experiment shows that ordinary people will go against their conscience and morality to even inflict pain on others, when ordered by an authority figure. Very few people have the resources to resist authority and these are the frightening implications of human nature.

Professor Milgram elaborated two theories explaining his results -
1. The theory of conformism which says, a subject who has neither ability nor expertise to make decisions, especially in a crisis, will leave decision making to the group and its hierarchy.
2. The agentic state theory wherein under an environment of obedience, a person comes to view himself as the instrument for carrying out another person's wishes, and he therefore no longer sees himself as responsible for his actions.

BBC re-enacted the Milgram experiments under a series "How violent are you?". The videos can be viewed here (Part 1 - 6 mins) (Part 2 - 6 mins) (Part 3 - 4 mins). These are worth watching.

Questions for you :
1. How many times do you get swayed by and invest based on recommendations by brokers, day traders and friends?
2. How often do you follow the mob especially in crisis situations? (although they are excellent opportunities for sane investors)

Extra : The Asch experiments also give proof of social conformity. There is a lot of literature on the subject but can be best described in this video (here - 2 mins)

Asian Electronics and Ben Graham's principles of investing

noreply@blogger.com (Shankar Nath) — Wed, 26 May 2010 13:49:00 +0000

Asian Electronics is not my ideal value stock. The company has earned net profits of 71 lacs, 52 lacs and 14 lacs in the last 3 quarters. To its credit, the company has over 220 crores of annual sales but seems to be in dire straits at a CMP of 25.30 rupees. This wasnt the case always; in early 2008, the share price of Asian Electronics was a respectable 515 rupees per share but has faced investor apathy since then.

Is there any value?

While the DCF model will not work any magic here, the NCAV is a different story. One of Ben Graham's potent evaluation tools - the NCAV, throws some interesting numbers when I see the company's Mar-09 numbers.
Net Current Assets = Rs. 355.2 crs
Total debt = Rs. 238.8 crs
Shares outstanding = 2.98 crs
Hence, NCAV (net of all debt) per share = Rs. 39.06

At CMP of 25.30, Asian Electronics is valued at 64% of it's NCA (net of debt) per share.

This corresponds to one of Ben Graham's strict criteria - CMP at 66% of it's NCAV per share. Graham's reasoning was very simple - assuming there is no drastic reduction in the quality of the firm's current assets, there are high chances of getting a sumptuous deal when the firm goes into liquidation. This is a classical situation where the company is better dead than alive.

The NCAV is conservative in approach (which is good). It assumes that the firm will potentially get nothing for it's plant and machinery and investments - not even the salvage value. Asian Electronics seems Grahamian in this respect.

Discount-to-NCAV stocks are normally the ones that have been out of favour with most retailer investors and traders. They are the ones bordering around the no-profit-no-loss mark, have been big previously but have not been able to change to the times. Finding such stocks is not easy but not difficult aswell. Over the last 5 years, I have invested in 9-10 such companies but have had mixed success. I would advice the use the NCAV strategy with caution. Remember, the greater-fool theory is not at work when you are value investing.

The perils of emotional overinvestment

noreply@blogger.com (Shankar Nath) — Tue, 25 May 2010 14:05:00 +0000

Emotional overinvestment is a state where one leans towards doing irrational things under the weight of the time and effort invested in supporting that same irrational act.

EI is most commonly seen in negotiations, where one party relents due to mental weariness. It becomes too difficult for the person to comprehend a no-result after having invested so much of time and effort. In the process he takes decisions which are detrimental to the company. I recently saw one where the buyer quoted 50 rupees and the seller quoted 150 rupees for a shawl. After 5 minutes, the buyer relented to 80 rupees while the seller was stuck on 150 rupees. Then 110-150 and then 130-150 .. and finally the deal closed on 150 rupees. The buyer had overinvested over 30 minutes of his time to come out the deal drawing a blank.

The same behavior is seen in auctions where bidders, inspite of having a maximum price for themselves, keep up with the increments. They too feel the the sapping effects of EI.

Investing is no different. As a student of value investing, I too have been a victim of it. Researching every stock, however good or bad, takes time and effort. To make matters worse, it also has an element of opportunity cost attached to it. In a bid to find that one hidden gem, I run the danger of picking a weak stock just because of the 'emotional investment' I put into the research of it.

Today, as the market touches 16,000 points on the BSE, we might see some value buys. Every value investor must be vary of the perils of emotional overinvestment as they runs their numbers in annual reports, moneycontrol and tomes of articles on the Internet. Its easy to make a mistake, almost impossible to rectify it.

In conclusion, I am reminded of a line in the movie "Syriana" where one of the attorney says - "When they write the GAAP like abstract art ... you look at a liability long enough and it'll start looking like an asset".

Good luck.

How to spot deep value stocks

noreply@blogger.com (Shankar Nath) — Thu, 15 May 2008 18:54:00 +0000

This article (here) was published in The Economic Times on 4th May 2008. (nah! I didnt write it).

"Manish Sonthalia of Motilal Oswal Securities believes that PSU banks like Oriental Bank of Commerce, which is trading at a PE of 5.6 with book value of Rs 240 for FY09, is a perfect example of a deep value stock." (unfortunately this was the only stock discussed in the entire article)

Recently, OBC declared it's Q4 results and showed a net loss of Rs. 99 crs as against a profit of Rs. 54 crs last year. Additionally, on a full year basis, OBC closed the year on a profit of Rs. 353 crs as against Rs. 580 crs last year. The primary reason for the lowering of profits was the writing-off of the entire unabsorbed losses of Global Trust Bank (GTB) amounting to Rs. 487 crore, including the Rs 242 crore earlier slated for 2008-09, in the financial statements for 2007-08 itself. This means OBC starts of FY08-09 on a clean slate.

To put some quick numbers around this - OBC will save on about Rs. 242 crores this year (apportioned as GTB write-off) this year. So reconstructing FY2007-08 numbers (without the OBC w/off) comes to -
Operating income : Rs. 5,800 crores
Other income : Rs. 615 crores
Operating expenses : Rs. 5,155 crores
Hence, profit before taxes : Rs. 1,260
Less: Taxes @ 35% : Rs. 441 crores
Net profit : Rs. 819 crores

At the current price of Rs.207 and a market cap of Rs 5,186 crores .. the stock is priced at a price-earning of 6.33. I am not assuming any increase in income here (or being a pessimist - am not apportioning additional provisions in the P&L for dubious asset quality). At 6.33, the stock is a bit undervalued. How deep the value is ... anyones guess !

Tough times are actually a good time for

noreply@blogger.com (Shankar Nath) — Tue, 13 May 2008 19:25:00 +0000

Thomas Schoewe loves to say the phrase, "Tough times are actually a good time for Wal-Mart". This outlandish statement is infact coming. Consumers in the United States are riddled with rising food prices and huge cost of gas. This has made it difficult for most households to run their home and a number of them are living off credit. Consequently this year, Wal-Mart slashed grocery prices by as much as 30 percent to lure customers stung by high food costs. This brilliant strategy was promoted with enticing advertisements that read (and asked consumers) - "What will you do with your savings?"

In the last six months, Wal-Mart's stock price has risen $15 a share, or about 33 percent. During that time, Macy's shares dropped by 16 percent, Target's by 6 percent and JC Penney's by 5 percent. As their CFO says, "Wal-Mart customers value our price leadership more than ever, especially as they try to stretch their money even further".

Now, this is a brilliant "economic moat". A business that has the muscle to change potential problems into opportunities. Wal-Mart used it's efficiencies to actually display an advantage to it's customers .. this not only increases sales at stores but also builds loyalty. I am assuming that the stores donot make a loss on the sale of groceries, but are at a no profit-no loss situation. An average Wal-Mart customer doesnt earn his shopping dollars just on groceries. Groceries (i presume) are only 20% of all purchases (value) made by a customer at the stores. So, my 100 dollars at the shop will be split as 80 for other goods and 20 for groceries. I am further assuming that I would make a margin of 10% on groceries (on an average; since they are perishable, everyday commodities) and 15% on other goods. So spliting the spends on an 80:20 ratio, I find -
Case 1 : (80 * 15%) + (20 * 10%) = 14.0%
Case 2 : (80 * 15%) + (20 * 0%) = 12.0% (a small increase in sale is enough to off-set this reduction in profit margin which can be easily done by innovative pricing changes)

This also takes me back to my principles of micro-economics which reads - "In case of essential commodities like food, the demand curve is inelastic such that any increase in price will only induce just a small reduction in demand". This is true from an individual's point of view. However, from a firm's poin of view (Wal-Mart) ... this principle doesn't hold good. In this case, by virtue of lowering the price of food .. Wal-Mart has been able to post very high increase in traffic at their stores which has resulted in greater sales of other goods aswell. I'm wondering how soon will be see a similar campaign from an Indian retail firm (Subhiksha, Reliance, More, EasyDay, Food Bazaar) given the increasing food prices here.

On the subject of inelastic demand ... I'll leave you with a thought :

In March 2002, Ireland enacted a nationwide tax of nine pence (15 cents) on the use of plastic grocery bags, to be collected by retailers. Predictably, in just five months the tax cut plastic bag use by 90 percent.

What is the Price Elasticity of Demand for Plastic Grocery Bags?

PS: If you have an interest in economic policies then read more about this tax (here). Don't miss the comments section.

Cash is King !

noreply@blogger.com (Shankar Nath) — Mon, 12 May 2008 19:15:00 +0000

The term "Cash is King" has a wikipedia entry. It reads, "Cash is king is an expression sometimes used in analyzing businesses; it refers to the importance of cash flow in the overall fiscal health of the business ... A company could have a large amount of accounts receivables on its balance sheet which would also increase equity, but the company could still be short on cash with which to make purchases, including paying wages to workers for labor. Unless it was able to convert its accounts receivable and other current assets to cash quickly, it could be technically bankrupt despite a positive net worth."

An interesting article appeared on the importance of cash on CNBC-TV18 (here), which claims that about 70% of companies reported a drop in net cash flows from operating activities. This is crucial because a strong operating cash flow pays for all capex requirements of the organisation and dividend to shareholders. If cash from operations declines for a company, then it might have to borrow from the market to finance it's growth plans. Given the current rate of interest, this is a double whammy - and needs to be factored into every stock evaluation.

Largest Build up in Cash Flows :

Biggest Drop in Cash Flows :

Note: I checked Pfizer (here). The net cash from operations is 17 crs and not 23 crs as stated in the article. There has been some extraordinary earnings for Pfizer which may change some variables in calculation of cash flow (i think, but not certain) .. so I'll not delve into it for now. To illustrate an example outside this list, Hero Honda's net cash from operations slipped from 936 crs in FY06 to 625 crs in FY07. In the same period, profits dropped mildly from 971 crs to 857 crs.

Net net, the importance of cash from operations cannot be ignored. This is the lifeline of most businesses and any decline in these numbers should be looked with the minutest precision before allocating your capital for these stocks.

Star-struck !

noreply@blogger.com (Shankar Nath) — Sun, 11 May 2008 18:57:00 +0000

Look what I found !

Dharmesh Joshi from The Ganeshaspeaks Team had posted this on their blog (here). The title of the post read "Golden Period for Bank of Baroda from December 2008 to May 2009".

Here's what the post says -
"According to the Sun Horoscope of BOB's establishment date, Saturn and Ketu's presence in the wealth house might create some hindrances in its economic growth. However, as Mercury, Venus and Rahu are transiting through its Birth Chart, Jupiter will provide gains to the bank.

According to BOB,s nationalized date (19th July, 1969)'s Sun Horoscope, Saturn will transit through its Sun and Rahu will transit through its Birth Rahu taking a U turn between July 2006 and March 2007. However, after this period slow and steady growth is indicated for BOB.

The period starting from 10th December 2008 till 21st May 2009 can be considered as the golden period for BOB. It will create new history in the sector of banking.

May Lord Ganesha bless this bank with more and more depositors in the years to come!"

Allahabad Bank

noreply@blogger.com (Shankar Nath) — Sun, 11 May 2008 09:40:00 +0000

Relatively Allahabad Bank is very cheap .. it's available at a PE of 4 and a dividend yield of 3.40%. Recently (May 2008), Emkay Research gave a buy call on Allahabad with a buy target of Rs. 170 per share. (here)

When I started to run the numbers on Allahabad Bank, the first thing I was interested in .. were the provisions numbers. Lately I went through a bank's quarterly report where the bank had drastically reduced the provisions for that quarter, and was hence able to show a higher net profit for the quarter. Given the increase in interest rates and rise in food prices of essential commodities, there is a higher probability of people defaulting on their loans than say, 12 months back. I'm glad to say that Allahabad Bank has infact, increased it's provisions for the quarter and year.

However this doesnt mean that all numbers deck up well. Some observations -
a) The net profit has declined sharply from last quarter. Q4 has delivered the lowest profits of all quarters, this year.
b) The Opex has risen sharply which will worry the bank. From just 281 crs (on a base of 1440 crs) - the expenses has risen to 508 crs (on a base of 1720 crs).
c) The administration of taxes seems a bit doubtful. The bank pays about 145 crs of taxes on a PBT of 1120 crs - which is about 12.9%. This seems a bit low .. but when I compare it with FY07 (7.6%), FY06 (4.7%) and FY05 (5.1%) .. this number seems pretty satisfactory.

The Emkay report rightly points out, "We like the continuance of the strategy of slower balance sheet growth as the advances have grown by 21% y-on-y compared to a 42% growth in FY07". I would still like to maintain a conservative picture around this because, in case of loans, the impact of intrepidness in lending is seen in about 12 months of the lending. (on a similar note, banks like Barclays and Reliance have gone crazy with lending activity. I received a call from Reliance Capital, about 3 months back where they were offering loans at 10%. The problem today faced by the banks & NBFCs is : while on a standalone your calculations will show that the loan applicant has sufficient income to take care of his expenses and pay off the loan ... the FIs just dont know the number of loans the person holds. If the applicant holds 2-3 loans, then no calculations will be useful as the chances of him/her defaulting is much higher than envisaged by our risk tools. I would blame the credit infrastructure in the country for this menace)

Since I am not good at evaluating banking stocks (the only stock I have ever bought or recommended in this space was Bank of Baroda), I compared Allahabad Bank's performance with Bank of Baroda (didnt include Kotak or ICICI Bank - they trade at very high PEs). Some notes -
a) The opex of BOB has historically been much higher than Allahabad Bank. But given Q4 results, both are pretty much equal.
b) The disappointing part of Allahabad's results were the NII which have been declining. This doesnt seem to be the case with BOB which still delivers rising NII.
c) Taxes paid by BOB are around the 35% mark (of PBT). Allahabad is still about 13% only, which is strange.

Note: the Dec quarter of BOB is nothing short of brilliant. The incomes have really risen but the lingering credit market fear has pushed the price of the stock down. You might want to look at Bank of Baroda aswell. Karvy had recommended a buy on BOB on 29th April 2008 (here)

It seems a number of banking stocks are undervalued. If we factor the 2009 RBI-opening-up-banking-regulations scenario, we can expect some M&A activity in banking which'll pick up the entire industry valuations too .. or I think it will.

Notes from 2008 Wesco Shareholder Meeting

noreply@blogger.com (Shankar Nath) — Sat, 10 May 2008 14:17:00 +0000

The complete notes are available at seekingalpha.com (here). I have picked a few interesting points delivered by Charlie Munger at the meeting. (My commentary in blue)

One of my favorite stories is boy in Texas, when the teacher asked the class the following question. There are nine sheep in pen, and one jumps out, how many are left? Everyone got it right, and said eight are left. The boy said none are left. The teacher said you don't understand arithmetic, and he said 'no you don't understand sheep'.

Charlie Munger here, refers to the domino effect where companies tend to imitate others (for quick gain) without an after-thought of the possible effects. This is especially true on account of the recent shakeout of financial companies across the world. In the US & UK, the sub-prime mortgage crisis (owing to mortgage-backed securities) have spelled down for Bear Sterns, Citigroup and Northern Rock (UK). In India, NBFCs like Citifinancial, GE Money (and banks like ICICI Bank) are facing peril at the hands of rising delinquencies in the small ticket segments.

If you are an investment bank and had to be rescued, there should be limits on leverage and the complications of your business. There should be qualitative limits too. By and large banks behaved well when it worked this way. When I was young, Bank of America – would not have done things they do now. Derivative trading, no good clearance, no rules, excess and craziness feeding on itself. The plain vanilla products got priced down to no profits. They wanted to do complicated stuff. Not sure if it cleared, or other side would be good for it. It didn't bother anyone since they wanted the profits .... People talk about marvels of system and risk transfer – but some of our troubles COME from having so much risk transfer.

Regulation has it's place in capitalism. To trust the market to correct by itself and letting ill-run companies die on their own is no longer an option (without jeopardizing the entire financial economy of the country). Munger also makes a point for simplicity and understanding of their actions. When financial corporations issued CDS, they assumed that the risk of default never existed. Firstly, their equity base was too small to bear this risk and secondly, unlike insurance, the risk of default on financial instruments is never random & can bankrupt companies in an instant. Munger also trackbacks to the art of value investing which is much more simpler than most of these alternate investments and often gives more value to the investor.

The only duty of corporate executives is to widen the moat. We must make it wider. Every day is to widen the moat. We gave you a competitive advantage, and you must leave us the moat. There are times when it is too tough. But duty should be to widen the moat. I can see instance after instance where that isn't what people do in business. One must keep their eye on ball of widening the moat, to be a steward of the competitive advantage that came to you. A General in England said, 'Get you the sons your fathers got, and God will save the Queen.'

Munger again captures the essence of value investing - "the art of finding an economic moat and widening it." From Berkshire's point of view, this is what their investments in Coca-Cola, Gillette, Disney, GEICO and NetJet have been - proof of which has been captured in the company's shareholder value.

The choices we make

noreply@blogger.com (Shankar Nath) — Fri, 09 May 2008 18:39:00 +0000

A senior member of my company narrated this joke today. Thought I'll share it with all.

"In Calcutta, my home town, there once lived a professor of mathematics. People appreciated his humility and also his vast experience in the field. He was a man of many skills and was also awarded with a medal from the chief minister.

Every year, somewhere around September, he would take a week off from college; go all the way to the hills of Darjeeling to a small cottage of his in the woods. In peace and surrounding tranquility, he would pray to lord Shiva for hours. A strict schedule of just 1 meal a day (comprising vegetable and soup), waking up at 5:00 in the morning and meditation for 8 hours - was enough to break anyone, but the professor. True to his faith, the professor spent 6 such days in the cabin.

On the 7th and final day, the lord appeared before the professor. The lord's smiling face was greeted by the professor's ecstatic amazement.

The lord said, "Thank you professor, for in these modern times too .. you have prayed for me. You are indeed a wonderful human being. And in return, I would like to grant you a wish. You can choose anyone of the following :
a) Wealth (you & your generations will never have to earn .. ever)
b) Beauty (you will have the most beautiful woman in the world as a wife)
c) Knowledge (you will be bestowed all the knowledge in the world)

The professor being a humble man, thanked the god and didn't want any of those wishes. But lord Shiva insisted. The professor had a choice to make. He said, "Hmm ... god, I am a professor and Saraswati is the most important thing to me ... I choose option c) - knowledge"

To which God said, "Granted". God was just about to leave for his heavenly abode, when suddenly the professor shouted, "Oh lord .. wait lord .. wait". The lord reappeared and asked, "What is the matter, professor?" ... and the professor meekly said, "I am sorry lord, can I have wealth please?"

Insurance agent plans airline

noreply@blogger.com (Shankar Nath) — Thu, 08 May 2008 05:52:00 +0000

Truly inspiring article in Business Standard (here) !

Radhakrishna Shetty didn't let his humble beginnings come in the way of his dreams.

Radhakrishna Shetty, 44, is an agent of the state-owned Life Insurance Corporation as well as a financial advisor operating out of Mumbai, the financial capital of India. Don't expect this one to be lurching in corridors waiting to pounce on you with a new policy offer. Shetty is a millionaire agent, driving around in an expensive car, something many of his clients cannot afford.

More than that, Shetty has plans to start an airline. He has placed the order for a 180-seater Boeing aircraft and has asked a consultant to draw up a business plan for him. Meanwhile, his personal helicopter is on the way, making him, perhaps, the country's first life insurance agent to own one.

His plan is to start a budget airline that will fly on domestic routes. His hopes are pinned on an upcoming airport in Shimoga, 60 km from his hometown Chickmangalur. He is not too worried about the clutter in the low-cost aviation business and is confident of pulling it off.

For now, the project has been handed over to a consultant who will chart the routes and business model for him, which will be finalised only by March 2009. What he is sure about, however, is that he wants to fly and will stop at nothing.

Had someone met Shetty when he was a child, nobody would have believed that one day he would join the ranks of Vijay Mallya and Naresh Goyal.

Shetty's parents were labourers in a coffee plantation in his hometown. Despite the struggle to put enough food on the plate, his father would go to great lengths to educate his two sons, Shetty being the younger. He recollects growing up with just a bowl of Ragi porridge as the day's solitary meal. "It used to pain me that my family had to sacrifice food for our education," Shetty recollects.

He was on the verge of quitting studies, when he heard of the night school in Mumbai. Working through the day to support his family and studying in the nights appealed to young Shetty.

In Mumbai, he found himself a day job in a canteen at a fish market. His job entailed cleaning tables and vessels and also help in the kitchen, earning Rs 300 a month with the day's meals on the house and a small shack to sleep in. "My day would start at five in the morning with work in the canteen till 9 am.

From 9.30 am to 5 pm, I worked in a chartered account's firm. The rest of the day would be spent at college," he says. The day would end only after 11 pm, when he would finish cleaning the canteen.

"I hardly got four to five hours to study and to sleep. Those were very tough days for me," he says.

A chance meeting with a development officer in LIC changed his life for ever. The first four years as an LIC agent did not make any difference to his life. He managed to maintain his agency by meeting the minimum norms. In 1990, his income was less than Rs 10,000 a month — a decent sum but not enough to set up a sizeable business.

Things started changing after he met Logan Naidu, a motivational speaker in Bangalore in 1995. He learned about the trade association Million Dollar Round Table (MDRT) from Naidu, which became a source of inspiration. In the same year, he qualified for MDRT by earning Rs 2.88 lakh as commission. After that, there was no looking back for Shetty. His insurance commission alone for the year 2007-08 was around Rs 1.3 crore.

"Your need can be the best driving force for the customer as well as for yourself," he says. Shetty never wants to be financially comfortable so that he can keep running the race.

Ansal Properties and Construction Limited

noreply@blogger.com (Shankar Nath) — Tue, 06 May 2008 18:35:00 +0000

There was a mass exodus on this stock in the month of April by Indian mutual funds. From 3.96 million shares held by mutual funds in March 2008 ... the MF holding of the stock fell to a little over 72,000 shares in April 2008. And yet, when you look at the stock ... it is currently sitting pretty at a price-earning of 11.33. The NCAV of the stock is 78 rupees per share which is not bad at all (2.25 of CMP). While LY profits were 131 crs, this year's profits (FY08) are expected to close at 180 crs.

The stock price has been beaten down from a high of Rs. 500+ to about 176 rupees per share now. I found a couple of negative reports on the stock ...

a) In Feb 2008, Goldman Sachs in their report had removed Ansal Properties from the Conviction Buy list. The reasons sited was : "We have limited visibility on when option value on its Hi-Tech City project in Greater Noida is likely to be realised. The stock could remain on the sidelines until the market gets greater confidence on the group’s execution capability. We still rate the stock Buy and our revised 12-month potential RNAV based target price of Rs367 (from Rs410), implies 48% potential upside" (here)

b) This other one by ICICI Direct is even more interesting. I couldnt find too many details on the expected dip in profits (from 216 crs in FY07 to 50 crs in FY09) but I would assume that the lack of profits is due to some really long-term projects that the company has taken over such as the SEZ development in Punjab. (here)

I am a bit confused. At Rs. 174, the stock is very tempting and unless there is an event which I have missed out, the stock's a buy. Ansals' is a known name in the construction industry (although I have heard a number of stories in the press of the company bending rules in the past, I would like to believe that the outfit has improved in time by being more professional and transparent in dealings) and a PE of 11 is quite an anomaly.

However, I am still perplexed on why would mutual funds suddenly move away from a stock in herds. 4 million to 72,000 shares in MF ... there has to be an explanation !

Investing in dreams

noreply@blogger.com (Shankar Nath) — Mon, 05 May 2008 18:47:00 +0000

This article (here) in CNN Money Fortune is worth a read. Authored by Andy Serwer, the article comprises of excerpts to an interview with Larry Page on "how to change the world". Page talks extensively about breakthrough ideas that are round the corner but people fails to take a chance on them. Sighting his own example, he says, "Even when we started Google, we thought, "Oh, we might fail," and we almost didn't do it. The reason we started is that Stanford said, "You guys can come back and finish your Ph.D.s if you don't succeed."

Some thoughts Larry Page left behind in the interview :

1. Over 40,000 people a year are killed in the U.S. in auto accidents. Is there a chance of making this number zero or a very very small number. People are working on it - on making cars automated like the car by Infiniti which will kick you back when you change lanes (a large source of accidents). Using technology to save lives is not costly .. but there are very very few people working on it.

2. People think Moore's Law is a description of what happened. But Moore's Law actually caused people to do the right thing. Everyone was organized about it - making things better quickly.

3. Solar thermal is an area Google has been working on; the numbers there are just astounding. In Southern California or Nevada, on a day with an average amount of sun, you can generate 800 megawatts on one square mile. And 800 megawatts is actually a lot. A nuclear plant is about 2,000 megawatts.

4. Back in time .. everyone said Sam Walton was crazy to build big stores in small towns. But this turned out to be a breakthrough idea and Walmart is today the world's largest retailer. Almost everyone who has had an idea that's somewhat revolutionary or wildly successful was first told they're insane.

So who kills innovation? In the investment community, analysts are the first people who put the sword on any breakthrough innovation drive. The uncertain nature of the investment and the capital required to pursue the innovation activity deals a death knell for the stock price of the company. With most CEO compensation (and tenure in a company) linked to increase in shareholder value (read: price of share), it's evident that executives will work towards short term goals ranging from one quarter to the other .. to keep analysts happy and a uniform rise in price.

Investing in companies which can give a breakthrough idea is defined by high risks. Probably a value investor will not tread this path - as he cant see into the future as much as he can see a mismatch in the price and value of a stock. So a value investor might not invest in an Apple, Google, Starbucks, Zara, Pixar, IBM, Bionade, Iridium, P&G, Intel etc. because the PE ratio would never add up.

A couple of thoughts I leave here:
1. Is there a method of factoring innovation to our methodology of stock valuation?
2. How many Indian companies are there who have made such breakthrough ideas? (I can think of Infosys in outsourcing and Bharti Airtel is low cost telecommunication)

Are Railroads a good investment in India?

noreply@blogger.com (Shankar Nath) — Sun, 04 May 2008 18:50:00 +0000

Charlie Munger in the 2007 Wesco Annual Meeting spoke about investing in railroads. He delved into how they (Warren Buffett and Charlie Munger) shunned railroads till they identified the competitive advantage they presented. In his words -

Railroads – now that’s an example of changing our minds. Warren and I have hated railroads our entire life. They’re capital-intensive, heavily unionized, with some make-work rules, heavily regulated, and long competed with a comparative disadvantage vs. the trucking industry, which has a very efficient method of propulsion (diesel engines) and uses free public roads. Railroads have long been a terrible business and have been lousy for investors.

We did finally change our minds and invested. We threw out our paradigms, but did it too late. We should have done it two years ago, but we were too stupid to do it at the most ideal time. There’s a German saying: Man is too soon old and too late smart. We were too late smart. We finally realized that railroads now have a huge competitive advantage, with double stacked railcars, guided by computers, moving more and more production from China, etc. They have a big advantage over truckers in huge classes of business.

Bill Gates figured this out years before us – he invested in a Canadian railroad and made eight hundred percent. Maybe Gates should manage Berkshire’s money. [Laughter] This is a good example of how hard it is to change one’s mind and change entrenched thinking, but at last we did change.

The world changed and, way too slowly, we recognized this.

In addition to the competitive advantages stated by Munger, I would add one more to it : Cost of Fuel. At about $120 per barrel, we are way past the $20s of the 1990s or a bearable $50 in Jan 2007. Oil prices have risen 6 times over the last 10 years ! (here)

Trucks are a huge consumer of fuel (diesel) and with the finance minister indicating his inability to hold on to subsidies given for fuel .. it's obvious that industries will start looking at other sources of transportation. The next viable source is railways where coal, diesel or electricity is used as fuel. Sweeping changes are happening around the railways - multiple innovations in cargo carriers, a privatisation drive, rationalisation of charges etc. With increasing freight loads, the railways will soon become a serious challenger to roadways for movement to goods.

From an investors viewpoint, Container Corporation remains the market leader with 15 private entrants trying to churn a niche for themselves. Another related stock in the news is Titagarh Wagons. And then there was another company, Kalindee Rail.

Concor seems really interesting :
a) Increasing profits/sales every quarter
b) Dividend yield of 2.5% (probably increase this year)
c) Cash in company at 9% of m-cap
d) Zero debt
e) EV/EBIT of 10.8
f) Excellent FCF

Sterling Biotech

noreply@blogger.com (Shankar Nath) — Sat, 03 May 2008 19:15:00 +0000

I am reading Sterling Biotech's financials on moneycontrol.com and wondering, why aren't mutual funds looking at this stock? More so, why aren't research houses tracking this stock?

Here's a company that -
a) Has just delivered Rs. 55 crs in net profits for the quarter ending 31st March 2008.
b) Sales has grown every quarter for the last 5 quarters
c) Both, sales and profits have grown at a 3-year CAGR of 32%
d) Operates at an OPM of 44%
e) Has a NPM of 20%
f) Has about 816 crores of cash/bank in it's books (which is 17.6% of m-cap)

The stock is currently at a 52-week high of around 205 rupees !

Value Trap

noreply@blogger.com (Shankar Nath) — Sat, 03 May 2008 18:42:00 +0000

Over time, the most common measure of a stock's value or cheapness has been a low price-to-earnings ratio (P/E). But many investors who follow this trail often find themselves falling into the "value trap." To quote an old Japanese saying, "Yasukarou, warukarou—what is cheap may also be bad."

In an excellent article, (here) Amit Dugar explores the potential pitfalls of value investing and offers some practical guidance on avoiding the value trap.

An excerpt from the article :

The theory goes, with the cheaper share, investors are buying protection and lowering their risk. While investors expect a lot of future growth from a stock with a high double digit or triple-digit P/E, the market will often trash it at the slightest hint of trouble. On the other hand, the market is signaling it has low expectations for a stock trading at a single-digit P/E. Bad news is likely to have nowhere near the same impact on the low-P/E stock that it would have on the high-P/E one. The theory is that since the market has lower expectations, these stocks are more likely to show positive surprises in the future—with a greater likelihood of above-average returns.

In reality - some cheap stocks are dogs. That's where the value trap comes in. There are lots of examples of former high-flying growth stocks now selling for much lower P/E multiples than in the past. This does not necessarily mean that these stocks are now a good value. They may continue to fall, and may never recover. Without knowing their intrinsic values or possible catalysts for turnaround, you can't know whether they offer good value or not.

Notice the author talks of two important things here - 1. intrinsic value and 2. catalyst. I would like to talk a bit more about the catalyst.

A catalyst refers to an internal or external event (foreseeable or non-foreseeable) which dramatically moves the stock upwards or downwards. While we had explore a similar event like Siemen's one-time provision (post), the essence of a constructed catalyst (i.e. internal) is captured in the following items -

1. LBO (leverage buyouts) : When PE groups buy out publicly-traded companies and subsequently own them privately. The catalyst here is that speculation that certain publicly-traded companies might be ripe for picking by these private investors may increase the market price of their stock. An Indian example of LBO : KKR's acquisition of 85% in Flextronics (article in IHT)

2. Leveraged recapitalizations : are similar to LBO's in that such recapitalizations usually retire sizable amounts of the common stock of the publicly-traded companies involved, by buying it in the in the open market and replacing it with newly-issued debt. Unlike companies involved in LBO's, these companies' stock remains publicly-traded--but, again, speculation that XYZ Co. is going to do such a recapitalization will tend to increase the market price of its stock. My favourite case study on leveraged recap is the one on 'Sealed Air Case' (here)

3. Corporate split-ups : When companies divest part of their structure by giving such parts outright to the original companies' shareholders or selling the parts to other parties. Again, speculation of such deals will tend to drive up the stock price of those companies. There have been many split-ups in recent years with Reliance being the prominent example.

4. Huge stock buybacks : Many companies have been for years buying back their own publicly-traded shares on the open market. Of course, this buy-back activity tends to increase the market value of the stock by increasing the demand of the companies themselves for it. However, the investment community has grown a bit skeptic of buy-back announcement. Enclosed is a news article where UBS didnt term Dell's $10 bn buyback announcement as a catalyst (here)

5. Spin offs : The spin-off of a segment of the company that was not a good match with the rest of the company--is actually promoting future organic growth of the company. A recent Indian announcement was the proposed spin off of it's tower by Tata Teleservices (here).

These catalyst are instrumental in hiking or shunning the price of a share and value picks are no different. For any value stock to come out of a value trap, a catalyst is a must.

JL Morison (India)

noreply@blogger.com (Shankar Nath) — Sat, 03 May 2008 10:29:00 +0000

JL Morison (India) comes close to a Benjamin Graham pick. The specs of the company are enclosed -
Market cap : Rs. 38.54 crs
NCA : Rs. 81.22 crs
Debt : Rs. 40.16 crs
Share capital : Rs. 1.37 crs
FV : Rs. 10 per share
NCAV : Rs. 299.70 per share

At a CMP of Rs. 282 per share (May 3rd), the stock is available at a small discount to it's NCAV. It is interesting to note that the cash/bank in the company is Rs. 49.80 crores (much higher than the m-cap of the company or 63% of it's EV)

However on the earnings side, the net/operating profits are duh!. The business also holds about 11 crores of investments in it's balance sheet (I dont have the annual report with me to peek). If these investments are marketable securities then we can add that to the NCAV.

The stock seems partly Grahamian .. but we should avoid the value trap. I am following up this analysis with a post on value trap.

Shop and drop

noreply@blogger.com (Shankar Nath) — Fri, 02 May 2008 19:19:00 +0000

An observation.

Stride Arcolab has acquired a 17% stake in Genepharm Australasia (here). The news article in Economic Times says that the shares were issued to Stride at A$0.55 (as against an original price of A$0.60).

How would you read into any situation where the seller reduced the price of a product? The 8% discount in acquisition price was on account of trading results and share performance, says the article. I peeked at the Genepharm Australasia stock chart on the Australian Stock Exchange (here). To my surprise, the stock has been going down from the day the company announced Stride Arcolab's 2.2% stake. The stock was priced at A$0.46 then. Currently, it is priced at A$0.22 (a drop of 52%). The EPS of the stock (trailing 4 qtrs) is A$0.15 .. which puts the stock at a PE of 1.5x.

I am surprised that Genepharm Australasia actually dipped so much inspite of a healthy news like this : Genepharm Australasia Ltd. reported earnings results for half year ended December 2007. For the period, the company reported net profit of AUD 1,343,000 or 0.9 cents per diluted share on net sales of AUD 32,174,000 compared to net loss of AUD 664,000 or 0.5 cents loss per diluted share on net sales of AUD 25,081,000 for the same period a year ago.

How much is the Mona Lisa worth?

noreply@blogger.com (Shankar Nath) — Thu, 01 May 2008 18:50:00 +0000

For a question like this (here), here are some answers that pop out -
a) It's priceless
b) It's worth $500 million
c) Prior to the 1962-63 tour, the painting was assessed for insurance purposes at $100 million. Adjusted for inflation since then -- $100 million in 1962 is approximately $645 million in 2005. So, thats the price of the painting today.

Incidentally there is one man who has "the" answer - Warren E. Buffett

In his letter dated January 18, 1964, Warren Buffett discusses "The Joys of Compounding" with the following insight :

Since the whole subject of compounding has such a crass ring to it, I will attempt to introduce a little class into this discussion by turning to the art world. Francis I of France paid 4,000 ecus in 1540 for Leonardo de Vinci's Mona Lisa. On the off chance that a few of you have not kept track of the fluctuations of the ecu, 4,000 converted out to about $20,000.

If Francis had kept his feet on the ground and he (and his trustees) had been able to find a 6% after-tax investment, the estate now would be worth something over $1,000,000,000,000,000 - That's $1 quadrillion or over 3,000 times the present national debt, all from 6%.

I trust this will end all discussion in our household about any purchase of paintings qualifying as an investment.

Asian Electronics

noreply@blogger.com (Shankar Nath) — Thu, 01 May 2008 18:43:00 +0000

My stock screener threw 'Asian Electronics' this week. Here's why -

a) From an asset perspective :
At an NCA (Mar-07) was Rs. 431 crores and total debt of Rs. 165 crores, Asian Electronic's NCAV is at 95.5 rupees per share. At a CMP of 196 rupees per share (May 1, 2008) ... the CMP/NCAV is 205% (I have started to move away from Grahamian's 66% rule .. it's too tough)

b) From an earnings perspective :
The business operates at an NPM of 25%. Barring the quarter of Dec '07, the business does over 100 crs of sales, yielding 25 crores of net profits on an average. Excluding the Dec quarter, the annual EPS is around Rs. 80. At a CMP of Rs. 196, we are looking at a normal PE of 2.45

Since the 400-500 levels the stock was in - about 4-5 months back - the stock has been beaten down to the sub-200 levels. This is owing to a disastrous Dec '07 quarter and general fall in the markets. This may be a special situation in the making ... if Asian Electronics can bounce back with it's usual 20 crores of profits for the next quarter then we have a story in our hands. (The research house, Prabhudas Lilladher, expects AEL to deliver 87 crs next quarter at a PAT of Rs. 13 crs (here)).

I have not invested in the stock yet .. wont mind a second opinion though.

Power Grid Corporation of India

noreply@blogger.com (Shankar Nath) — Wed, 30 Apr 2008 19:04:00 +0000

The Business Standard features an excellent article on Power Grid (here). The article talks about some businesses which Power Grid has, which can turn out to be hidden gems and a strong profit-centre 3-4 years from now. The report says -

1. The company owns and operates a fibre-optic cable network of 20,000 km, which connects over 100 Indian cities. This bandwidth is leased to more than 60 customers, including major telecom operators such as BSNL, Tata Teleservices, Reliance Communications and Bharti Airtel. The revenue from this segment has grown about ten-fold from Rs 7.4 crore in FY04 to Rs 77.3 crore in FY07 and stands at Rs 93.4 crore in the nine month ended FY08. These are estimated at about Rs 130 crore for FY08 and expected to grow at 25-30 per cent annually over the next few years. The net profit margin from this business is about 28-30%.

2. The company also plans to lease space on existing towers to mobile service providers. The company currently has about 200,000 transmission towers spread across the country. Even assuming that 15-20 per cent or 30,000-40,000 of these are available for leasing, the company is estimated to earn revenues in the range of Rs 600-700 crore annually by FY11 (considering prevailing tower rentals of Rs 35,000-40,000 per month). For FY09, leasing revenues are estimated at Rs 146 crore (7% of the total net profit) and at Rs 298 crore for FY10 (11.5% of the total net profit).

3. These apart, the company is also leveraging its vast experience in transmission related services, by providing consultancy services to various government funded projects such as implementation of projects under APDRP & RGGVY. Consultancy business, which is about 5.7 per cent of the total income, has grown from mere Rs 37 crore in FY04 to Rs 226.4 crore and is expected to grow fast on account of increasing allocation of funds for various projects.

The authors opine that Power Grid is available at a great valuation and it's buy time !

What's a poof IPO?

noreply@blogger.com (Shankar Nath) — Wed, 30 Apr 2008 19:03:00 +0000

A poof IPO is an unusual and innovative method of bringing groups of small companies in similar businesses, typically with tens of million dollars in revenues, to the public market. Using the funds from the initial public offering, the entrepreneurs are able to buy additional companies through a strategy known as a ''roll-up.''

Here's how it works : A venture capitalist will approach several private companies in the same industry, such as bus companies or air conditioning contractors. They then arrange an IPO to buy the companies and combine them into a single operating unit. The owners receive a combination of equity and cash. Some investors describe the maneuver as a ''poof IPO,'' a kind of magic act where several companies are transformed, poof, into one company.

Surprisingly, its a strategy that has attracted a lot of other players. Those who play the roll-up game, often known as consolidators, tend to seek fragmented markets with no clear market leader. The idea is to buy up lots of companies to boost revenues and earnings while saving money through economies of scale. Given the nature of the deal, it's evident that most such poof IPO deals happen when the stock market is at an unusual high.

It's a bit difficult to identify companies in the Indian context who can be identified as 'poof' IPOs. On 'roll ups', a company like Teledata Informatics seems close as it shows an insatiable appetite for lapping up companies in India, Singapore, UK, Thailand, Indonesia and US. (here).

However : the concept is innovative and can be very rewarding if operations can be perfectly consolidated, a strong management can be seated and a proper focus laid down for the business. Some areas, I can think of, that allow for such opportunities include medical centres (a chain of clinics), gymnasiums (a nation-wide branded health centre) etc. The reason why tuition centres might not fit the bill as they are uniquely service oriented & getting consistency in service and methodology might be difficult. So, the next time the stock market goes high and you can organise 10 similar business (of revenues of say, 1 crore each) ... do your math (10 businesses of 1 crore each at a multiple of 15 = Rs. 150 crore IPO) !

Ports on the rise

noreply@blogger.com (Shankar Nath) — Mon, 28 Apr 2008 19:02:00 +0000

A news item in the Business-Standard (here) referred to an Ernst & Young study, where the consulting firm are seeing an increased interest among investors in ports. The study found that ports are in favour as they provide a steady source of income. Ports, the study says, generate steady cash flows and operate on high margins.

Mundra Port has risen by 40% in the last 1 month. Running on a mammoth rupees 29,516 crores of market capitalisation, the Mundra Port management is quite upbeat about their projections for the company in the next few years. (here). I further read an ICICI Securities report (here) published when the scrip was priced at Rs. 580. The analyst awarded an upside of 44% (Rs. 835) from those levels. At a CMP of Rs. 736 today, there is still way for the stock to move.

Not too many ports in India are listed in the stock exchanges. However, I agree that ports will more important in the future as supplies move more frequently from port to port. This is quite the economic moat that Ben Graham often talks about. A port is a bit like the immigration desk at your airport ... without that stamp you cannot legally leave the country. With ports looking towards giving a unified, self-sustained ecosystem for industries and export units to flourish - their importance cannot be ruled out. My take on the sector is strong. However this doesnt mean that Mundra Port is a good buy (or a bad one). I just dont have an opinion as I have too little information to work on.

Bharat Electronics

noreply@blogger.com (Shankar Nath) — Mon, 28 Apr 2008 14:52:00 +0000

Cash and abundance are two words that dont go together for most companies. But not Bharat Electronics. Priced at Rs. 1207 (April 25th), the cash in the company (as on 31-Mar-07) was a heavy 260 rupees a share (2080 crores). This is about 21% of the m-cap.

Kotak and Indiabulls have given a BUY rating to the stock from it's current levels with a 25-30% upside. This is on account of -
a) Trading at 60% discount to BHEL in P/E terms (fwd PE estimates)
b) Expected rise in defence expenditure (rising at 15% p.a.)
c) Excellent free cash flows

BEL is an excellent business to be in. With a huge order book, it would be sometime before competitors can make a dent in BEL's market share and established markets. I was particularly impressed with the huge cash generator, the firm is. In one of the reports (i think it was Kotak), the research house expects the cash per share of BEL to close at Rs. 337 per share.

I have picked up some 10 shares today morning at 1234 rupees. The stock is upto 1296 rupees.

Bond insurance

noreply@blogger.com (Shankar Nath) — Sun, 27 Apr 2008 08:27:00 +0000

Weekend Reading : I read a couple of excellent articles on Berkshire Hathaway's participation as a bond insurer. An article in the NY Times (here) tracks how a phone conversation between Eric Dinallo and Berkshire's Ajit Jain paved the way for Berkshire to insure NY municipal bonds.

Ajit Jain, in a finely worded text (here), talks about how bond insurance helps bring stability to the price of bonds, offer protection to the investor in these bonds and keeps the interest rate low for bond issuers (as the bond is backed up by a AAA rated insurer).