Value investing in flat world

Life is short - apply for MCX ipo

noreply@blogger.com (Ravi Aranke) — Thu, 23 Feb 2012 06:00:00 +0000

Life is short and hence we develop a number of rules of thumb as shortcuts. These rules of thumb help us to navigate the information overload and make reasonable decisions most of the times. (See Daniel Kahneman's Thinking: Fast and Slow)

One of the rules of thumb that value investors use to filter out the noise is to avoid all ipos. As Peter Lynch puts it: IPO = It's Probably Overpriced.

However, there are always exceptions that prove the rule.
And in case of MCX ipo, I am ready to break my own rules.

You can find the detailed financial analysis in any number of brokerage reports all of which are heavily recommending the ipo. You can find the details such as MCX having EBITDA margins of >60%, RoE of >60%, a negative working capital and a debt free balance sheet, etc. etc. At the upper band of price offered, it will trade at 18x forward PE which is significant discount to global peers such as ICE ... yada, yada ...

To me, all of this is a sanity check to ensure you are not paying an insane price.

The real reason to buy is Network Effects.

Think Ebay. Buyers go there because sellers are there and sellers go there because buyers are there. Once a network achieves an overwhelming majority of users, it is very difficult for a competing network to come up. It becomes a winner takes all market.

Think NSE Vs BSE. Once NSE achieved the dominant position in equity derivatives trading, however hard BSE tried, it has not made even a dent in the market share of NSE.

Think Facebook Vs Google+

...

The rule of thumb that I would apply in this case is:
Dominant market share + Network effects = Game over!

The really important piece of information in the offer document is that MCX has over 80% share of commodities trading in India.

So, life is short, this post is short - go for MCX ipo.

Oh, and by the way, go for Facebook ipo too if you can get some shares below 100 B market cap :)

Free online courses on valuation by Ashwath Damodaran

noreply@blogger.com (Ravi Aranke) — Thu, 26 Jan 2012 06:33:00 +0000

I taught myself accounting primarily by going through Ashwath Damodaran's books and websites. Needless to say, I am a huge fan.

I am thrilled to see that he is offering his corporate finance course and valuation course online. Free. For anybody and everybody. This is fantastic. See here

Coming on heels of stanford AI course, the world of education is indeed changing for the better.
For the motivated self learner, there couldn't have been a better time.

Think like a hedge fund: Putting simple timing strategies in practice

noreply@blogger.com (Ravi Aranke) — Tue, 17 Jan 2012 16:21:00 +0000

What is the big difference between a typical hedge fund and a typical mutual fund?

At the risk of sounding trite, hedge funds hedge i.e. if the hedge fund manager thinks market will drop, they will either a) step out of market and go to cash or b) find something to short to protect against the drop.

Contrast this with a typical mutual fund manager. Mutual funds do not try to time the market and are pretty much fully invested throughout the market cycles.

As i have posted on my other blog, simple technical timing strategies have worked for last several years. Even if you cannot directly invest in hedge funds, you can implement some of the strategies that hedge funds use.

The biggest hurdle is not in understanding the strategy but to systematically implement it e.g. with a 100 day simple moving average strategy, you would need to step in and out of markets 6 times a year.

This is not advisable for a retail investor. There are costs involved in terms of exit loads if you are invested through mutual funds. If you are invested in straight equities, not only the costs will be prohibitive thanks to bid/ask spreads, but also the sheer hassle of churning your entire portfolio every 2 months is mind numbing.

Is there a simple way, you ask. Yes, there is - if you are willing to go through a bit of learning curve.

Here is what you could do. Keep invested through your mutual funds or carefully selected individual securities portfolio. There is no need to touch your long term portfolio at all.

When the market falls below 100 day SMA, you take out an insurance policy by shorting the nifty futures. As soon as market goes above 100 day SMA, close your short - you no longer need that insurance.

Shorting the Nifty futures is one simple trade which you can do in a minute or less. All you need is a brokerage account with F&O facilities.

Of course, you need to understand the mechanics of the trade and the margin requirements. So it is not something you want to engage in without going through the learning curve. First start small and gain some experience. I have posted the strategy here so that you can educate yourself if you are interested.

All the best.

My current portfolio

noreply@blogger.com (Ravi Aranke) — Thu, 12 Jan 2012 06:51:00 +0000

Since i consult with hedge funds, some of the people (some of the time!) think that i might know a thing or two. Unfortunately, most of the strategies that i research (currency trading, long/short derivatives) fall under 'don't try this at home without supervision' category.

In fact, I don't do these strategies in my personal portfolio in a big way either. Just in case, you are interested in such stuff, please follow my other blog here.

I am sharing what i actually do in my personal portfolio in the hope that it might offer you some pointers. Please apply all the standard disclaimers: what works for me might not work for you. Also, this is a snapshot in time and i am not committing to updating this blog as situations and my thinking evolves.

I am trying to _time_ the market (yes, i have heard that it can't be done) as i have come to believe that Indian markets are driven by hot money chasing past performance. If i am right, emerging markets will continue to behave like commodities and i want the trend to be my friend. I am waiting for Nifty to move above its 50 day moving average.

In the meantime, the money will stay on sidelines in liquid mutual funds. I have opportunistically allocated a whole bunch to NHAI, PFC bonds. At 8.3% tax-free rate (Note: not tax saving, tax-free as in completely free of income tax whatsoever) in a Govt of India enterprise, which you can lock for 15 years, this deal is hard to beat. These instruments will be exchange traded and if there is enough liquidity past the listing, i will allocate more here and make it a default placeholder. Manshu's onemint blog has good analysis on many of the fixed income products and i like his way of thinking.

Long term, i am bullish on wealth creation opportunities in India and the current valuations as i write this are 17x trailing earnings on Nifty. Though not ultra cheap, the market is not expensive either. I don't want to wait too much on the sidelines. As soon as the market gets into uptrend (> 50 day Moving Average), i will very quickly get fully invested in equities.

If you do not believe in technical analysis at all (this was my thinking 2 years back and i might revert there again :), this is good time to get into equities as valuations are reasonable and you can place bulk of your money in index funds or index ETFs till you find something better.

I have some equity allocation which can be categorised under long term buy-and-hold small cap opportunities. I do not look to time the market here. I have found Rohit Chauhan's rcfunds newsletter service an excellent resource for these ideas. Please go through his blog and if you like his way of thinking, please do subscribe.

I do not like mutual funds and i think structured products are a total scam. More on that later.

New year, new blog idea

noreply@blogger.com (Ravi Aranke) — Tue, 10 Jan 2012 17:23:00 +0000

To be successful in markets, you need to have a well defined edge.

I believe my edge is in combining quant (broadly defined to include statistics, machine learning, computer programming, data analysis) with investing / trading.

Toward that, I have started a new blog

Please follow me over there if you are interested in data driven investing.

Thanks!

Back to life

noreply@blogger.com (Ravi Aranke) — Mon, 04 Oct 2010 07:15:00 +0000

Watch this space ...

Silence will be continued ...

noreply@blogger.com (Ravi Aranke) — Sun, 02 Dec 2007 09:09:00 +0000

I hope some of you missed my postings. I know it ain't true but please don't break my heart.

Since I list my occupation as IT consultant, it is an occupational hazard that one gets drawn into consulting assignments from time to time. Actually, it is nice to be back at work in a predictable environment where your efforts directly contribute to results in real time. Cause and effect rules; bugs can be found and fixed. Bliss!

The consulting stint will continue. So posts on investing will have to take back seat for a while. Maybe, I will figure out a work-post balance in 2008. Maybe there will be a self help book out soon on this topic and a blog to go with the book.

In the meanwhile, I hope you enjoy this Investor Mind graphic.

Cheers,
Ravi

A Sale Decision

noreply@blogger.com (Ravi Aranke) — Mon, 15 Oct 2007 05:13:00 +0000

Many gurus have mentioned that selling is much harder than buying. Here is what Warren Buffett says in his 1974 shareholder letter:
"Never count on making a good sale. Have the purchase price be so attractive that even a mediocre sale gives good results."

The various Good Reasons to sell cited by successful value investors are:
- Sell when new facts reveal that you made a mistake and your original valuation was wrong
- Sell when the original reason for purchase is no longer valid
- Sell when there is a better opportunity for your money

Notice that there is no 'Sell because market looks overvalued' in the above list. This is because of the difficulty involved in precisely defining what is meant by overvalued. Also, you will need a corresponding definition for 'undervalued' which tells you to get in the market when the time is right.

Think about it for a moment. If you could define such a rule with sufficient precision, you won't need to worry about stock picking. You can just play the indexes based on your overvalued/undervalued criterion and make oodles of money.

There is not a single documented case of an investor who has made fortunes this way - though I suspect there will be many examples of people who have lost fortune this way; sometimes many times over. For the curious, read Victor Niederhoffer's recent blow up in this New Yorker Article.

So, why am I selling right now? Though I must admit that there is a 'market is overvalued' voice getting louder and louder at the back of my mind, I am trying hard not to listen to him and liquidate all my positions. Instead, I am trying to systematically evaluate my stocks and see if there are any candidates which match my 'Good Reasons to Sell' list.

Fortunately there are a few cases when the sale decision is just easier. Here is what Joel Greenblatt has to say on the selling dilemma.

This is probably as good a time as any to discuss the other half of the investment equation - when to sell. The bad news is that selling actually makes buying look easy - buying when it is relatively cheap, buying when there's limited downside, buying when it's undiscovered, buying when insiders are incentivized, buying when you have an edge, buying when no one else wants it - buying kind of makes sense. But selling - that's a tough one. When do you sell? The short answer is - I don't know. I do, however, have a few tips.

One tip is that figuring out when to sell a stock that has been involved in some sort of extraordinary transaction is a lot easier than knowing when to sell the average stock. That's because the buying opportunity has a well-defined time frame. Whether you own a spinoff, a merger security, or a stock fresh out of bankruptcy there was a special event that created the buying opportunity. Hopefully, at some point after the event has transpired, the market will recognize the value that was unmasked by the extraordinary change. ...

This process can take a few weeks to a few years. The trigger to sell may be a substantial increase in the stock price ...

When I mentioned on July 31 blog that HTMT global was attractive, the stock price was 390 and the company was selling for less than reproduction cost of assets. There was 400 Cr+ of cash on balance sheet out of 800 Cr Mcap.

There was an even better opportunity for a brief period of couple of days in August when the price went to 290. I was happy to add to my position at the much reduced price.

Now that the price has crossed 520 and the market cap is reaching 1100 Cr, the original reason for purchase has been fulfilled. I am not claiming this is due to market recognizing the value. It might just be the rising tide lifting all the boats. Whatever the reason, the stock has moved out of my bottom tier of value. To continue holding the stock would require valuing the stock on 'earning purchase power' or 'growth of value within franchise' i.e. valuing it in Greenwald's tier 2 and 3. In my opinion, there is simply not enough history behind HTMT global, and for that matter, BPO business to value them as franchises.

So it is prudent for me to exit out of HTMT global and be happy with the satisfactory results obtained.

Exit price: 520

Note to self: The returns were substantially juiced up by averaging down when the price went below 300. A strong confidence in valuation is required to average down. I am not averaging down on Manugraph.

Value in bottom tier - Cheviot

noreply@blogger.com (Ravi Aranke) — Wed, 26 Sep 2007 06:01:00 +0000

In earlier post, I talked about Greenwald's 3 tiers of value and promised to share my best picks in each tier.

Here is the best pick from bottom tier i.e. Asset Value play.

This pick comes courtesy Rohit (Understanding and Applying value Investing Principles) who has written about it a few times. Please read his blog and discussion there to understand the background. Search for 'Cheviot' on the blog.

Cheviot Company (Information from FY07 Annual Report):

Enterprise Value = Mcap + Debt = 109 + 11 = 120 Cr

Net realizable assets = Investments + Net current assets* = 87 + 34 = 121 Cr

*Investments are in liquid MFs and stocks of high quality large caps, thus the realizable value might be slightly higher in the current bull market. Most of the current assets are inventory which is Jute - I think it is fair to assume that a bulk of it will be realised.

Bingo, a net-net bargain if there ever was one. How and when the value will be appreciated by market? I have not a clue and I wouldn't worry about it in this part of portfolio. The idea is to put a bunch of them together with the confidence that downside risk is extremely low.

It does not hurt that Cheviot has been consistently profitable and has earnings power of about 23 Cr per annum. But let's leave that aside as that will mean getting into the next tier of value.

Greenwald's 3 tier cake of values

noreply@blogger.com (Ravi Aranke) — Wed, 26 Sep 2007 05:15:00 +0000

Bruce Greenwald conducts THE value investing course at Columbia Graduate school. His summer seminars ($2,900 for 2 days) are extremely popular. Of course, that is not the reason I have put him into the list of Gurus I admire and try to follow. The reason is : I try to pay close attention to people whose names start with Green - Greenwald, Greenblatt, Greenspan, ... Green being the color of the money, how can you go wrong?

Greenwald has written an outstanding book titled 'Value Investing: From Graham to Buffett and Beyond'. He takes 3 tiered approach to value investing.

Bottom tier: Asset values
==========================
Think about reproduction cost of assets.

This is the realm of deep value investors like Graham. You find companies selling below their net realizable asset values and/or reproduction cost value. Put together a diversified portfolio of these and wait. No need to dig deep into quality of management or the competitive positioning.

Middle tier: Earnings power value
==================================
Think about franchise value from current competitive advantage.

You find companies with simple, understandable businesses which are available at very attractive prices. These are typically small businesses which occupy a local niche. The niche is small enough to support only one or two players. The businesses that Buffett likes to own as independent subsidiaries of Berkshire Hathaway fall in this category: Newspapers, See's Candy etc.

Top tier: Value of Growth
==========================
Think about profitable growth within the established franchise. This is where companies consistently enjoy above average ROIC thanks to their competitive positioning.

In my opinion, this is the most difficult tier for Value investors. You need to gauge how long the competitive advantage will last and there is a real risk of overpaying. The famous names here are Peter Lynch, Buffett, Bill Miller. Note that they hold multi-billion dollar portfolios. With those big portfolios, you need to hunt for elephants to move the needle on performance and these big sized beasts are simply not be found in the bottom or middle tier in sufficient quantities.

=================================================================================
This 3 tiered approach is a very good way to think about the investing choices and helps me to articulate the rationale behind a particular investment.

In the next few posts I would like to share my best ideas in each tier. I would love to hear from you on your best ideas.

Cranes - A Capital Intensive Software Products Business

noreply@blogger.com (Ravi Aranke) — Fri, 07 Sep 2007 05:57:00 +0000

Software products business is legendary for high returns on capital - ergo, 'Capital intensive software products business' is an oxymoron.

However, when you pursue growth for the sake of growth - without paying too much attention to whether this is profitable growth - you end up with a situation where more and more capital is required to support the top line growth.

Such seems to be the case of Cranes software, a software products company I otherwise like. It has niche focus on scientific and engineering software; the products (Sigma, Systat etc.) enjoy a worldwide reputation; are already in use by thousands of scientists and engineers and have high switching costs thanks to the learning curve involved.

Unfortunately, Cranes seems to be on an acquisition overdrive. There are 2 red flags that emerge after going through annual reports (posted on the Cranes Software web site).

(small red flag) Sales are growing mainly through acquisitions. There doesn't seem to be any organic growth.

	FY05	FY06	FY07
Sales (Cr)	163	210	284
Growth in Sales (Cr)	50	47	74
Amt Paid for Acquisitions(Cr)	86	56	125

The amount spent for acquisitions is hardly giving rise to commensurate growth in top line. Maybe it will pay off in the long run as Cranes claims. But if the acquisitions made in FY05 and FY06 are not paying off yet, I have my doubts.

(BIG RED FLAG) Software development expenses are being Capitalized. Search for 'Capitalizing software development expenses' in Google and you will be presented with a bunch of results and case studies.

On page 21 of FY07 annual report, Cranes says:

During the year, the Company invested Rs. 3,117.23 million (net of Income), the main components of which were Rs. 1,610.55 million towards product development investments for upcoming versions of the range of proprietary products ...

Note that this 161 Cr was spent for creating new versions of existing products. This is separate from the 125 Cr that is spent on acquisitions (shown in the table above).

In the software products business, releasing new versions of your software is the equivalent of keeping your shop tidy and clean. It is the requirement of staying in business and can hardly be classified under creating a new asset that is above and beyond the asset you already have.

The depreciation charged for FY07 is only 44 Cr - not even within the ballpark of 161 Cr that was required to just stay in the place. If the entire 161 Cr were expensed, Cranes would have shown a big loss for FY07 instead of the 86 Cr of PAT that it has shown.

So where did this 161 Cr go? You have to stuff it some place under the carpet and that place happens to be Capital WIP (work-in-progress) entry on the balance sheet. This is 161 Cr for FY07. Add to that last year's similar entry of 67 Cr and there is a monstrous 230 Cr of capital WIP sitting on the balance sheet.

Of course, you can't keep shoving stuff under the carpet. It has to come out some time. Either it will be coming off as big depreciation charges in the future (unlikely, as that will make Cranes unprofitable for years) or as one time big bath write-off.

Indeed, it is more appropriate to call Capital WIP as Capital Write-off-in-progress or Capital Wreck-in-progress.

Well, I guess, time to move on and turn other rocks to see what is hiding under them.

Obfuscation and the art of reading annual reports

noreply@blogger.com (Ravi Aranke) — Mon, 27 Aug 2007 07:32:00 +0000

ob·fus·cate [ob-fuh-skeyt, ob-fuhs-keyt] Pronunciation Key - Show IPA Pronunciation –verb (used with object), -cat·ed, -cat·ing.

1.	to confuse, bewilder, or stupefy.

2.	to make obscure or unclear: to obfuscate a problem with extraneous information.

3.	to darken.

I love this word. I can't pronounce it without obfuscating both my listener and myself.

Since Manugraph is in my portfolio as part of magic formula pick (Good ROCE, Cheap price, small stake), it was interesting to read the annual report when it arrived in mail.

Typically it takes me few hours spent over couple of days to get bored with the content and move on. In the case of Manugraph, there were so many riddles that it took me a better part of the week.

In this FY, Manugraph acquired a company in the US which is almost similar in size to itself (in terms of revenue). I was expecting the management to comment on the acquisition at some length and answer questions such as:
- How are they going to pay for the acquisition?
- What impact does it have on balance sheet and income statement? What are the goals going forward?

etc.

No such luck - this important matter has been dealt within a couple of sentences. They did not even welcome the new team on-board and introduce them to shareholders. Sheesh!

That's where things get interesting. With calculator in hand, flipping back and forth between the balance sheets and income statements of Manugraph (standalone), DGM (acquired company) and Manugraph (consolidated), I could put together some of the pieces. Exactly my idea of a fun afternoon - Not!

-I think Manugraph has made the acquisition at a really good price - getting 250 Cr of topline for about 90 Cr.

- The debt has increased by about 100 Cr. Since there is 75 Cr of liquid investments on the balance sheet, this is not worrisome.

Most of the bad news is contained within the US operations:

- The rise in inventory is entirely due to US operations.
- The US operations is barely profitable.

If Manugraph manages to wring out some costs from the US operations and bring it somewhat in line with India operations, things could change.

Market today is not even remotely considering this possibility and has driven the price of Manugraph down to 52 week low. In fact, price is so low that today you can get in at half the price of insiders.

Did I say insiders? Yes, I did.

The annual report says that "9 Foreign nationals were alloted 3.98 Lakh shares at premium of 246 each on 20th December 2006". That is 10 Cr worth of investment.

Naturally, the identity of these foreign nationals is left as an exercise for the reader of the annual report. A quick visit to BSE site resolves this riddle. The knowledgeable foreigners are none other than Mr. Chris Lunt and others who were erstwhile directors of the US operations.
Looks like there is some motivation in place for US managers to fix their operation and turn it around.

There are many riddles like this throughout the report.
Is this obfuscation intentional? That riddle is solved if you look at the center spread. It has one of the silliest graphic I have seen in years - world map distorted by scaling it horizontally (only!) and superimposed on top are 3 planes going in different directions.

Instead of trying to scratch my head any further on what those planes mean, I think I will change my verdict:
Don't ascribe to malice what can be ascribed to stupidity.

A good buy at current price.
Manugraph CMP: 120, Current Market cap: 364 Cr Trailing PE: 7.8

Wait and Watch turns into Action! HTMT global is attractive

noreply@blogger.com (Ravi Aranke) — Tue, 31 Jul 2007 16:35:00 +0000

HTMT global announced results today.

Here is comparison with FirstSource which announced its results a few days ago. (HTMT results are in brackets). In Cr of Rupees

Income from Operations: 253 (143)
Operating profit: 68 (27)
PAT: 44 (18)

QUiZ: Given these numbers, what should HTMT fetch in comparison with Firstsource?
Your options are:
A) 56% of Firstsource: Based on revenue numbers. After all, the acquisitions in such a rapidly moving area as BPO/ITeS happen on top line numbers.
B) 40% of Firstsource: I prefer Operating profit or PAT
C) Much less than this - say 30%: After all, Firstsource is bigger and has first mover advantage.

Today's answer given by Mr. Market is: 24% of Firstsource.
Market Cap: 3359 (813)

This is a huge difference in valuation even without considering the cash of about 500 Cr that HTMT global is supposedly sitting on as war chest. I cannot really confirm this as HTMT global has not provided a recent balance sheet or capital deployed statement.

In earlier post few days ago, I compared HTMT with EXL and found it cheap.

Since I don't like comparative valuations very much, it is always better to arrive at value by using some other methods which are on firmer footings. A quick back of the envelope calculation shows that HTMT is valued at 11x this quarter's annualised earning. That is cheap.

The depreciation and amortization is 6.5 Cr which means cash flow should be much higher than PAT of 18 Cr. That is nice.

All in all, HTMT global is a definite buy. CMP: 395, Current Market cap: 813 Cr

UPDATE 02/AUG:
In a press release, HTMT confirms that it indeed has 100 M$ surplus cash (Above 400 Cr). That certainly builds in a great deal of 'margin of safety'.
From the press release:
"The company has over $100 million of surplus cash to fund acquisitions. Its M&A team is actively scouting for acquisitions in the BPO/KPO space. Currently, about 4 targets are in active consideration."

Quarterly results and looking for needles

noreply@blogger.com (Ravi Aranke) — Tue, 31 Jul 2007 15:45:00 +0000

The results season keeps one busy. Companies with good results (or promotional management) will have half page ad's in papers with Big Up Arrows around numbers. I have not seen an ad with down arrows - actually I saw few - but they were NPA numbers for banks.

As always, it is the change in the behavior that offers more clue than the behavior itself. If the company you are following put ads in the papers last Q and not this Q, that might be worth investigating. If there is no press release this time and the announcement of results is wrapped up by just a filing with NSE/BSE, that might be worth investigating.

Case in Point: Zicom security solutions. No press release on the web site. Thankfully, results are posted under Investor section. PAT is shown as 2.23 Cr and all looks OK till you read the notes.
Note 3 is produced verbatim below:

"

3. The Board of Directors of the Company in its meeting held on July 2, 2007 has approved the Scheme of Arrangement whereby with effect from April 1, 2007, Consumer Service (Retail) Group Business ["CSG (Retail) Business"] would be transferred into Company's wholly owned subsidiary. The said arrangement is subject to the approval of Honorable High court and other authorities. Pending the approvals, the results shown above do not include results of CSG (Retail) business.

The results of the Company without giving effect to the above Scheme of Arrangement would have been as under:

Net Sales – Rs. 4516.70 Lakhs
Profit Before Tax – Rs. (417.32) Lakhs

Profit After Tax – Rs. (417.32) Lakhs

Let's see. The company would have lost significant money if it had not separated the results of one business unit. Moreover, this business unit , even after separation, will be fully owned subsidiary - so, consolidated results should include it anyway. Such things make me go Hmm...

Here is what the next note says:
"

4. The above results are prepared on stand alone basis and do not include results of subsidiary viz. Zicom Manufacturing Co. (HK) Ltd and Joint Venture Company viz. Unisafe Fire Protection Specialists LLC, Dubai.

"

My interpretation: We won't tell you what the results would have been on consolidated basis because picture won't be pretty.

The company had come on my radar as a possible Peter Lynch type retail expansion play. It is investing into consumer brand building (that's where the losses possibly come from) and is going to have outlets in various malls.

Unfortunately, with this kind of accounting, I have to say Pass!

Another demerger, Another wait-and-watch

noreply@blogger.com (Ravi Aranke) — Tue, 24 Jul 2007 06:06:00 +0000

Request: If somebody could point me to where all the special situations (demerger, spin-off's, split-off's etc.) in Indian markets are listed in chronological order, that would be much appreciated. Thank you.
-
The 52 week low list brought to my attention another de-merger: Hinduja TMT. Hindujas spun off BPO business, keeping the cable business in the original company. The relisting happened in June. Since then, the shares of cable business (Hinduja TMT) and the BPO business (HTMT global) have promptly started their downward journey.

The interesting thing about both these businesses is what they have received as parting gifts from the parent. When Vodafone started a bidding war for Hutch, a lot of people benefited besides Ruia's of Essar. Hinduja's, too, received approx 2000 Cr from sale of their stake in Hutch. Out of this booty, they have endowed both the BPO and cable business with about 500 Cr each. The cable business has also got 47 acres of land in Bangalore. All of this information is listed in detail in the 24th April BSE announcement

Now, if BPO or cable business could be obtained below 500 Cr, it would be a classic Graham Net-Net bargain. Unfortunately, the market cap today for each business is about 900 Cr ( no debt) and hence we need to dig deeper.

For a comparative valuation of BPO business, one could look at EXL. From Nasscom's FY06-FY07 ranking of ITES/BPO companies, EXL ranks at no. 10 and HTMT global is at No. 13. EXL trades on Nasdaq at 12x latest Q revenue. For HTMT, taking the Dec. quarter number and putting a 10x revenue multiple, values it at 800 Cr. So, if one believes that EXL is trading fairly (hint: I don't think so), HTMT Global could be obtained at 50% discount viz. obtained at 400 Cr (900 Cr market cap - 500 Cr cash).

I would personally wait as I think the impact of rupee appreciation is going to be harder on BPO companies compared to IT companies. Sans any moat, EXL at 3x forward annual revenue is expensive and I would be wary of applying similar valuation to HTMT.

HTMT announces its results on 30th July. If the results are not good, market might overreact and drive HTMT globals' market cap below 500 Cr. That would be the time to swoop in and capture this net-net.

Moving on to cable business, this is much harder to understand - partly because Hinduja TMT owns only 63% of the cable business and there are a bunch of other business clubbed together. There is no clarity of CAS rollout and the competitive positioning of the cable companies. For more background, see my earlier post on Zee demerger.

In summary, wait for any of these businesses to be available at 500 Cr and/or watch for insider actions. Wait and Watch!

Rising Rupee, what should I ask of thee?

noreply@blogger.com (Ravi Aranke) — Mon, 16 Jul 2007 10:12:00 +0000

A friend asked about my views on the rising rupee and how it would impact IT services companies.

That's a great question to ask because the changes in environment cause biggest rifts and thereby create biggest investment opportunities. Unfortunately, the way the question is generally asked (at least on TV) is about the impact on profit margins and stock prices for next quarter or two. In this form, it is not a very profitable question to ask. One of the basic tenets of efficient market theory is that you can't profit from public information. All the information about rupee and its impact on services companies is public information. It is discussed to death and I would be very surprised if it were not already reflected in the price. So, for an investor, this is a question which is past its 'use by' date.

Then what are good questions to ask? Before we look at good questions, let's look at FABQ - Frequently Asked Bad Question: Where rupee would end and when?
I could do hardly do better than quote turn-of-the-century financier J.P. Morgan. Asked "What will the stock market do?" he replied: "It will fluctuate."

Asking about where rupee will trade is a bad question because nobody can predict macro-economic events like the rise of rupee and especially the time frame in which it would happen. TV commentators can't do that. If they could, currency markets provide a much more lucrative career option than being on TV. RBI can't do that - however valiantly it tires. Billion dollar hedge funds advised by Nobel prize winners can't do that. Otherwise, Long Term Capital Management would still be around.

In Ken Fisher's recent book 'The only 3 questions that count', Ken outlines the line of profitable questioning. Let's put on the skeptic's hat as Ken advises and devise some potentially profitable questions.

Profitable question 1: How do you know rupee will continue to appreciate?

Past behavior means nothing. From here on, rupee is as likely to appreciate as depreciate. If everybody is assuming that rupee will continue to appreciate, there might be a chance to benefit from this group think.

It is a common value investing tactic to look at sectors where the recent bad news and the group think that bad news will continue has distressed the prices. Unfortunately, last time I looked, there was some correction but no fire-sale in IT services companies stocks.

Profitable question 2: How do you know a strong rupee is necessarily bad for Indian IT services companies?

Actually, a subquestion of this is already being asked. For example, today's Economic times list IT companies which derive a substantial portion of their revenue from domestic market - such as 3i Infotech and Rolta. If there are such babies being dumped with bathwater then that could provide interesting opportunities.

Moving back to the original question: Is strong rupee necessarily bad for IT services companies? In the short run, yes. But value investing is not about short run so let's discard that answer and think a bit more.

We know from competitive theory that companies will try to do whatever it takes to survive.
Some of the companies might become very motivated to relocate chunks of work to cheaper locations. Bigger companies like TCS and Infosys already have delivery bases in China and the Phillipines and Mexico and they might emerge stronger as their smaller, India-only, competitors fall prey to rising rupee. Smaller companies will probably have to specialize and dominate a niche and move up the value chain.

In short, rising rupee is just one of the variables in the ever changing competitive landscape and no definite long term conclusion can be drawn that would apply to all companies. Like most things in investing and life - it depends :) :

Profitable question no. 3: How will rising rupee help IT services companies?

Again, a subquestion is already being asked. Will rising rupee help some Indian companies? Obviously, companies which have a lot of import bills to pay in dollars will benefit. If this is not already priced in the market, it might be worth investigating.

Back to original question: How can strong rupee benefit IT services companies?
For one, acquisitions suddenly become more possible. I am not talking about Infosys - Cap Gemini types which, in my opinion, are too difficult to succeed. I am talking more about TCS acquiring Australia's FNS and thereby gaining a core banking product. Maybe this is how good services companies will morph into product companies - by using strong currency for M&A.
Serial acquirers like Cranes Software might benefit even more given their small base effect.

-

As value investors, let's ask right questions and pray that TCS, Infosys, Wipro, Satyam all miss their earnings and guidance numbers for a couple of quarters in row. That should allow us to finally tiptoe into investing into IT services area.

If nothing else, I expect rising rupee will make investing in IT services companies a lot more interesting. You can't just take # of heads and multiply by the 40K USD to arrive at annual sales figure any more. You will actually have to study the competitive positioning and strategy.

Sell strategy - 52 week high?

noreply@blogger.com (Ravi Aranke) — Mon, 09 Jul 2007 09:44:00 +0000

In an earlier post, I talked about a search strategy '52-week lows' - looking at the beaten down dogs as potential buy candidates. Unfortunately, in today's market where Sensex and Nifty are hitting all time highs, there are hardly any decent fish left for bottom fishing.

What should a value investor do? If you propose buying at 52 week lows, it sounds logical that you should be selling at 52 week highs. (Charlie Munger: Invert, always invert!) Move out of the way of the train and wait for Mr. Market to offer better prices.

Well, not so fast. Value investing does not mean buying only the beaten down dogs and ugly ducklings. Modern masters of value investing have adapted the art to the changing times. You have Warren Buffett buying and holding blue chips like Coca Cola and Amex over the years because he believed that the growth in underlying business would take care of the price he was paying. This is allowed in value investing.

Buying Google and Amazon.com and calling yourself a value investor is allowed too. Surprised? Exhibit: Bill Miller, whose Legg Mason Value fund had a 15 year streak of outperforming S&P 500. Bill Miller rightly says that if you had avoided the all time high stocks, you would have avoided Wall*Mart and Microsoft and Dell throughout the 1990s. Without these stocks in your PF, it would have been extremely difficult to match the index leave alone beating it.

So, how would one use a 52 week high list? Curiously enough, just like 52 week low list. If a stock you already have or like appears on the 52 week high list, it is a trigger to run re-valuation. Is the margin of safety still there? If yes, continue holding it or even buy more - 52 week this or that be damned.

I recently ran re-valuation on Kirloskar Oil after it hit 52 week high. The Kirloskar Oil passed in flying colors. I am buying more.

I am not so sure about CRISIL but I will continue to hold till it doubles again :)

I need to run revaluations on 3i Infotech (I already have) and Geodesic, KLG systel, Zicom (Look interesting).

Towers of Hanoi, Russian dolls and Kirloskar

noreply@blogger.com (Ravi Aranke) — Mon, 02 Jul 2007 12:04:00 +0000

What is common among Towers of Hanoi, Russian Dolls and Kirloskar group of companies?

Those among you who did computer programming probably can guess the answer. Hint: Recursion.

A set of matryoshkas (Russian dolls) consists of a wooden figure which can be pulled apart to reveal another figure of the same sort inside. It has in turn another figure inside, and so on.

The Tower of Hanoi or Towers of Hanoi is a mathematical game or puzzle. It consists of three pegs, and a number of disks of different sizes which can slide onto any peg. The puzzle starts with the disks neatly stacked in order of size on one peg, smallest at the top, thus making a conical shape.

Look at Share holding of Kirloskar Brothers (KBL) and Kirloskar Oil Engines (KOEL).

A) KOEL market cap is 3145 Cr. Now watch carefully at Russian Doll No. 1.
KBL owns 38 % of KOEL.

B) KBL market caps is 4548 Cr. Now for the Russian doll no. 2. KOEL owns 10% of KBL.
But as we have seen above, KBL owns 38% of KOEL. So, in effect, KOEL owns 38% * 10% = 3.8 % of itself.

Let me illustrate with a concrete example:
Suppose KOEL market cap increases by 1000 Cr, then KBL market cap should increase by 380 Cr. This follows from A as KBL owns 38% of KOEL.

When KBL market cap increases by 380 Cr, KOEL market cap should increase by 38 Cr. This follows from B.

Now, since KOEL market cap increases by 38 Cr, the KBL market cap should increase by 14 Cr.
Since KBL market cap increases by 14 Cr, KOEL market cap should increase by 1.4 Cr.

If KOEL market cap increases by 1.4 Cr, ..., so on, ad infinitum.(I can hear you, Enough, ENOUGH!)

Fortunately, all recursion cases have a terminal case which ultimately resolves the recursion. As the numbers get smaller, it is less and less meaningful to keep up with the recursion. Let's leave the elegance of recursion to programming classes and get down to the valuation of Kirloskar Oil Engines (KOEL).

The balance sheet of KOEL is as conservative as you could ask for.

The quoted investments are treated at cost (example: KOEL stake of KBL is on the books at 9 Cr. The market value at today's prices is 474 Cr. Stake in Kirolskar Ferrous is on books at 27 Cr. Current Market value: 108 Cr).

The investments which have gone bad are promptly written off (example: investments in Mysore Kirloskar and Ghatage Patil).

Result: Balance sheet significantly understates the investments. The book value of investments is 500 Cr where as, in my opinion, the current market value is at least 1000 Cr.
Subtract this 1000 Cr from KOEL market cap of 3145 Cr and you are getting a business which is growing by 25% per annum at PE of around 10.

Pictures Courtesy Wikipedia.

Do baby Zee's provide investing opportunity?

noreply@blogger.com (Ravi Aranke) — Sat, 23 Jun 2007 16:41:00 +0000

One of the key takeaways from 'You can be a stock market genius' by Joel Greenblatt is to look for de-merger/spin-off transactions. These are fertile areas of investigation and can offer lucrative opportunities for individual investor.

Fortified with my pleasant experience of GE shipping de-merger, I spent few days looking at Zee Entertainment de-merger which happened around January. A quick look at two smaller parts - Dish TV, which is direct-to-home satellite TV business and Wire and Wireless, which is the cable business - encouraged me to dig deeper. The initial signs were all according to text book. Specifically:

- The price of de-merged parts has fallen significantly since the de-merger.
Dish TV price has ranged from 143 to 97 and currently trades at 109.
Wire and Wireless price has ranged from 140 to 66 and currently trades at 67.

- Insiders are aligning themselves to profit from market mispricings. For example, wire and wireless was to issue 131 Cr. worth of warrants to promoters (Zee's promoters including Mr. Subash Chandra) convertible @122 Rs. a share. If promoters are willing to buy shares @122, how wrong can one go buying @67?

Well, as I studied the situation more, it appears that my initial enthusiasm was unwarranted.
Cable and Dish are simple business to value. The valuations are entirely dependent on two factors: # of subscribers and ARPU (average revenue per user). Multiply the two and you get sales figure. Slap a suitable multiple (more on this in a moment) and you arrive at valuation.

Conversely, one can start at the valuations and determine the no. of subscribers needed to support that valuation.

Let's reverse engineer the numbers for Dish TV first. The current valuation is 4800 Cr. The investor presentation on the Dish TV site says that they will need to raise another 1000 Cr in next 2 years. So, EV = 5800 Cr. The current # of subscribers is 1.9 M and according to Dish TV's own projections, they will hit 8 M subscribers in 2011. Let's say management projection on this is correct. Management also projects ARPU of 450 INR/month/subscriber. In my opinion, this is very optimistic. The competition with Tata sky and potentially other new entrants (Bharati and Reliance are rumored to get into the act), will keep ARPUs down. Let's assume that they stay steady at the current level of about INR 250.

So, you get 8 M * 250 * 12 = 2400 Cr of sales in Year 2011.
The comparable businesses in US, Direct TV and Dish TV USA, trade at price/sales multiples of 2 and 1.5 respectively. Dish TV (India) is already selling at P/S multiple of > 2 of its projected 2011 sales. In other words, hardly a bargain.

Situation is much better at cable business - Wire and wireless. Its current valuation is 1500 Cr and it needs about 1000 Cr of new investment making its EV 2500 Cr. Wire and Wireless is projecting almost similar subscriber numbers as of DishTV through 2011 - so valuations will work out similar to Dish TV viz. sales of around 2500 Cr in 2011. Comparable business - in this case, comcast US - trades at slightly higher valuations of P/S of about 3.

So, if one were to choose between Dish TV or Wire and Wireless, definitely W&W offers some margin of safety.

Neverthless, I don't think the opportunity is compelling enough because W&W needs to ramp up and prove itself. They have less than million subscribers now. Though digital cable has some tailwind behind it in terms of CAS regulation and better picture quality, its pricing is regulated - supreme court has dictated 5 Rs/channel pricing. It is doubtful whether W&W will have any pricing power. Also, buying up each cable-wallah and stitching together their coalition will probably prove time consuming and costly. You also have to bet that between now and then (when the business turns cash flow positive), new technology won't confuse this picture further.

Search strategy: 52 week lows

noreply@blogger.com (Ravi Aranke) — Fri, 11 May 2007 17:08:00 +0000

Many value investors look at 52 week lows for ideas. I, too, have started taking a look at such a list appearing in economic times everyday - except I don't go and look at these companies if I don't know about them already

If I have already identified a company as having sustainable advantages and decent business model, then, when such a stock appears on 52 week lows I am definitely interested.

Recently Mr. Market was kind enough to throw two such bones.
1) Manugraph: Good ROCE. From what I have read and from the website, the company seems to have a dominant market position in newspaper printing machines _worldwide_. Recently acquired a company in the US for very good price. The newspaper industry in the developing world is a growing industry.

Available at PE of less than 10 for current market price of 140.

2) MacMillan India:
The company site is investor friendly. They break out segment revenues. Take a look at investor presentation.
MPS is a pure play BPO/KPO and is the most interesting business hiding inside the traditional publising business. Offshoring of publishing business is set to grow in next few years.

At price of 280, the business is available at PE of around 12.

These are decent value plays and probably worth a good look. However, what makes their purchase difficult is I am too spoilt for choice. In the current market, some other more interesting plays are available with around same PEs, similar ROIC and much better growth. Examples: Kirloskar Oil Engines and Sintex.

More on these later.

Sometimes cursory analysis is sufficient (ICRA ipo)

noreply@blogger.com (Ravi Aranke) — Sat, 31 Mar 2007 07:49:00 +0000

Since CRISIL was on my watchlist ICRA IPO was on watchlist too. Till date, I hadn't applied for any IPOs and had read that chances of getting your shares is slim - which means opportunity cost in tying up your capital. Anyway, I decided to take a closer look and apply.

By various analysts (such as published in Economic Times), ICRA IPO was valued at 18-20 times trailings earnings. That sounded reasonable vis-a-vis CRISIL's 25 times forward earnings at 2200.

What about fundamental analysis? I didn't need much.
1) ICRA mentioned that they don't need IPO money for expansion or anything like that. Their business is already generating oodles of cash. IPO was to enable the exit of early investors.
When business does not need new outside money to grow, that is very good business.

2) ICRA is substantially owned by Moody's. Moody's is substantially owned by Warren Buffett for a number of years.

A business Buffett loves, available at attractive price.
Do you really need more analysis than that?

BTW, I don't think I got any shares though. There is no way to tell. The IPO was oversubscribed something like 50 times. My money is tied up in the meanwhile.

Watching for insider buys

noreply@blogger.com (Ravi Aranke) — Wed, 28 Mar 2007 06:27:00 +0000

This is from Peter Lynch 'Beating the street'.
Peter's Principle #15:
When insiders are buying, it's a good sign ...

Insiders selling might have a number of reasons: They need money to pay for the new yatch or they want to diversify like you and me. However, the buying is done for only one reason viz. they think the stock is cheap.

I started looking for places where I could find the insider trades posted in India. SEBI has various disclosure norms but unfortunately, they don't seem to have the disclosures themselves archived on SEBI site. These are available on BSE and NSE sites and also reported in various newspapers such as Hindu BusinessLine.

Let's see what insiders are up to in my portfolio companies.

GE shipping:
Wow. Insiders are buying and buying - quite significant amount too. Bharat Seth (MD) has taken his holdings from under 7 percent to 8.16 percent since December 2006. Other people are buying too. Very, very, interesting!

Shriram Transport Finance:
Goldman Sachs is buying some shares but no significant insider activity.

3i infotech and Hero Honda:
No significant insider activity recently.

ITC and CRISIL.
Small time sales by directors. Possibly ESOP's. Nothing significant.
Anyway, ITC and CRISIL are not family/single owner companies.

So, all in all, one green flag (GE shipping) and no red flags.

My portfolio and 1-minute pitch on each stock

noreply@blogger.com (Ravi Aranke) — Wed, 07 Mar 2007 04:55:00 +0000

Here is top 5 from my portfolio and one-minute pitch on each. Peter Lynch has said that if you can't explain the core thesis of your investment idea in a couple of minutes, in language simple enough that a child could understand, then probably you don't have a good investment idea to begin with.

So here it goes - my attempt to explain my top 5 as of today. I will write a detailed writeup on each one when I get time. My plan is to take a look after one year and see how these picks have fared.

Shriram Truck finance
Growth of over 30% y-o-y, available at forward PE in teens (my calculation). Much better NIM than banks. Focused business dominating its niche. With the growth of economy and building out of inter-city roads infrastructure, transportation via trucks should grow. Everybody from Citi to Chryscapital is eagerly lending money to them and grabbing pieces of business. Today's price: 125

Great Easter Ship
PE is 4. I think this is because shipping is supposed to be a cyclical business but I have looked at past 10 years results (as published in their annual report and on the web site) and it doesn't look bad at all. Has consistently made money and paid dividends. Also, great ROCE (> 30) . Hmm, and shipping was supposed to be capital intensive business. These guys certainly know how to run a shipping company. Very shareholder friendly. Spun off Great Offshore to unlock value. Today's price: 199.

3i Infotech
A rare software company in India where Product and services both contribute around 50% to revenue. Niche player focused on financial services markets (after all, it was part of ICICI group), growing significantly in terms of revenue and customer wins. Available at trailing PE of 13.
Today's price: 225

ITC
Phillip Morris (MO) has been the best performing stock in US markets for last 50 year. Check out Jeremy Siegel's article here
ITC is India's MO. Very similar characteristics. Tobacco business throws off a lot of free cash which gets deployed in business such as processed food and hotels. Available at trailing PE of 24 for a greater than 25% y-o-y growth. It is probably as close to buy-it-and-forget-it-for-decades stock as you can get.
Today's price: 163

Hero Honda
This is a classic value pick. Bajaj is eating their lunch. However, with a great ROCE (> 50) and lowest price in 2 years (PE 14) , one can bet on reversion to mean. Maybe Bajaj would stumble once-in-a -while and Hero Honda would have a better product. Maybe not. As I see it, downside risk at this price is limited.
Today's price: 665

On the watch-list, waiting for right price
CRISIL
Finance minister, in his budget speech, has hinted SMEs to go for ratings to enjoy better rates on borrowings. (Source: BusinessWorld, 12 March 2007 issue article 'Rush for Rating').
...
CRISIL has so far rated 750 SMEs and has plans to rate 10,000 (yes, 10K!) SMEs in next two years. This is a lucrative, fee-based, low capital business. And that is just new icing on the cake. The existing cake of rating all sorts of stuffs (from bonds to IPOs to mutual funds) is delicious too.

CRISIL might also benefit from KPO work done for S&P (S&P owns a portion of CRISIL). I will wait for price to drop below 2200 or so (so that PE gets below 20) before nibbling.

Today's price: 2300

Goals, Investing philosophy and other Big stuff

noreply@blogger.com (Ravi Aranke) — Wed, 21 Feb 2007 10:31:00 +0000

Warren Buffett says that a review tells you more about the reviewer than the reviewed object. So my blog is probably going to reveal a lot about my goals and investing philosophies in any case.

Still, I think it is worthwhile to put it in writing. This is important for me to trace my evolution (hopefully!) toward a better investing philosophy. Also, it might be useful for anybody reading the blog to put the posts in better context.

My goals:

+ Net returns (net of trading costs, taxes and other frictional costs) of at least 5 percent above the index returns. If I cannot get above 5 percent, it is hardly worth the effort.
Over the years, US markets have returned _on average_ 10 percent and Indian markets about 15 percent. That means, I am happy to achieve _on average_ 15 percent in global markets and 20 percent in Indian markets.

+ Sleep well at night. This means only a small portion of portfolio will be invested in individual stocks. I believe that market is mostly efficient and hence bulk of my portfolio is indexed.

+ Learn about the businesses. For a value investor, stocks are partial ownership of the underlying businesses.

+ Spend time commensurate with hobby (more on that below). It is a hobby and not a full time job. So, most of the time will be spent on learning and not trading.

+ Most importantly, have fun!

My Heroes:

Joel Greenblatt (Little book that beats the market)
Ben Graham
And of course, Warren Buffett and Charlie Munger

Investing philosophy:

Primarily derived from Joel Greenblatt's 'Little Book that beats the market'.
In that book, Greenblatt advises individual investors to put together a portfolio of stocks screened mechanically using 2 criteria:
a) Good- defined as High ROIC (Return on Invested Capital) and
b) Cheap - defined as Low P/E

I don't have time to do a detailed fundamental analysis of each stock in the portfolio. Of course, I will do some analysis to confirm whether the numbers going into a) and b) above are realistic. e.g. that they are not inflated by one time events, that they make sense over the years and quarters etc.

I will also apply the sanity check to make me feel comfortable that I am not getting into a lemon.

- Do I understand the business and financial statements? (Avoid Enron)
- Trustworthiness of management (as seen from annual reports and press interviews)
- Competitive analysis (Where is that high ROIC coming from and is it sustainable?)
- Is the price reasonable? (Where is that low P/E coming from?)

Why should it work?

Because Greenblatt says it can be done :)
Seriously! I believe that if one puts together a portfolio of stocks chosen according to the criteria (cheap and good), it should work out. The edge I have is that I am managing my own money and only answerable to myself or, rather, to my wife. Hence I can be patient and can take long term view. Mutual funds don't have this luxury and therein lies my edge.

What's in a name?

noreply@blogger.com (Ravi Aranke) — Mon, 19 Feb 2007 06:52:00 +0000

Investing is a hobby for me. I dabble in it when I have some free time on my hands. I enjoy testing my theories of the world in the stock market. I make money or I learn humility. Either way, I gain.

This blog is about taking the best of the ideas in Value investing from around the world and
1) Applying them to stocks of companies incorporated in India
2) Applying them to MNCs whose products are available in India

The title 'Value investing in Flat world' is motivated by Thomas Friedman's book on globalization 'The world is Flat' BTW, I am not a huge fan of the book. I just like the title :)
I have posted my review on Amazon.com for those interested.