Friday, December 31, 2010

Alembic Ltd - Demerger

New year 'celebrations' are nothing but another excuse to drink. So wish you all a very very happy new year. :-)
Now that we have the 'happy new year' and all out of the way, lemme come to the point. Alembic Ltd is executing a demerger scheme. Let us see if there is any money to be made here.

Alembic Ltd is basically a pharma company, into API and formulations. The company can be divided into two parts; one which contains the entire pharma business, except the PenG business. This is a profitable business with 12-13% operating margins and 6-7% PBT margins. The other part contains PenG business, land and power assets. The PenG business is a loss making business, as detailed later.

The scheme:

  • Under the scheme of demerger, the first part of the business (the good part) will be transferred to Alembic Pharma Ltd. (Alembic Pharma (APL) is currently a wholly owned subsidiary of Alembic Ltd.) 
  • Alembic will retain the second part (PenG business, land, power assets).
  • The total debt of Alembic will be split into 85%(APL) and 15%(Alembic)
  • Shareholders of Alembic holding 1 share will get 1 share in Alembic Pharma.

The shareholding:

Public holding in APL would be lesser, since Alembic already holds some shares in APL.

The facts:
  • Currently, the market is valuing Alembic at Rs.900 cr mkt cap and EV of about Rs.1280 cr. On a PE basis, the stock is currently quoting at about 20x.
  • The pre-demerger numbers of Alembic also include those of PenG division. This is a loss making division of the company, with Rs.115 cr revenues and Rs.24 cr loss before tax for FY10.
  • If the FY10 numbers are split to reflect the demerger effect, it would be as follows: 

The opportunity:

Let us try and value the two businesses separately:

Alembic Pharma Ltd:
  • This company would contain the API and formulations business (domestic as well as export). FY10 revenue attributable for this company was Rs.1030 cr, with operating profit margins of around 12.7% and PBT margin of 6.8%. EBITDA of Rs.130 cr and EBT of Rs.74 cr.
  • The business is profitable and growing at 10-12%. APL also has recognized brands such as Althrocin, Roxid and Azithral in its portfolio.
  • Post demerger, APL would have no further need of expansion. Consequently, the free cash generated by the business would be utilized for repayment of debt. (APL debt Rs.350 cr. Alembic total cash from operations for FY10 Rs.127 cr). Consequently, in the EV, the debt should be replaced by market-cap going forward next couple of years.
  • Alembic’s peers and companies in the sector quote at premium valuations, as much as 12x EV/EBITDA and 24x TTM EPS.
  • Valuing Alembic at lower multiples of 10x EV/EBITDA(FY10) and 15x FY10 PAT, market cap comes to around Rs.950 cr. Value per share = 950/18.84 = Rs.50/- (to be used as a reference only).

Alembic Ltd:
  • Post demerger, Alembic will be left with the loss making PenG business, land and power assets. Also, it will have 29.5% stake in APL. Residual assets of Alembic would be Rs.250 crores, which is 35% of gross block.
  • On a conservative basis, I would value the PenG business at ZERO (although it certainly should be accorded some value).
  • Alembic will hold 29.5% of APL, which is worth Rs.280 cr. I am giving a 90% haircut to this and taking only 10% of the value, Rs.30 cr. (Pessimistic calculations help provide some MOS)
  • The power assets consist of 3 cogen plants, total 11 MW and 4 windmills of total 5 MW. Since they are used for captive consumption, I would accord them ZERO value.
  • Alembic would also have land of 115 acres at Vadodara. Out of this, the manufacturing facilities occupy about 45 acres. So what should be valued is only 70 acres. As per information obtained, the land rate in the area is Rs.600-700 per sq.ft. I would value the land at Rs.500/sq.ft. Valuation works out to Rs.140 cr.So, the residual business of Alembic may be valued at Rs.30 cr + Rs.140 cr = Rs.170 cr, or Rs.13 per share.

Total valuation comes to Rs.63 per share. (Rs.50 for APL and Rs.13 for Alembic)

To sum up:
  • Dilution in APL is killing off possible arbitrage in the deal.
  • To get some margin of safety, stock can be bought below Rs.55 per share.
  • There is a probability that BOTH the companies may get delisted for some period of time. (Got to get clarification from the CS on this).
  • regarding the time involved in this deal happening, the management had this to say in a recent TV interview: "The demerger is in process right now. We are awaiting some final approvals which we should hopefully get by the end of December and if all the timelines go well then hopefully by about March we will look at listing a separate company."

At CMP of 67 bucks, I do not think there is much money to be made. Lets hope that the stock drifts down. Position should be taken only if the stock comes at a price where there is comfort.

Cheers and happy investing!

Friday, November 26, 2010

Dai-ichi Karkaria - A value investor's delight?

The reason why I am calling it a 'value investor's delight' is as follows:

* The debt of Rs.1 cr is a deferred sales tax loan.
* Additionally, Dai-ichi holds 8100 shares of Bank of India (market value Rs.37 lakhs) and 57000 shares of Clariant Chemicals (market value Rs.4 cr).

At present market cap, the company is quoting just at its cash and cash equivalents. Plus, there are additional investments in shares, as detailed above. The operating business is available free! Indeed, a value investor's delight.
Sounds good? Well lets get some more dope on it...

  • The company has some real estate asset on which it receives yearly lease rent of Rs.1.5 cr. This asset (which could be a property in some posh area) would be very valuable. No details of the same are available. But this value provides some more MOS to the buyer of the business.
  • The business of the company is cash flow positive and has been generating cash from operating activity.
  • In April 2010, the company completed buyback of 1.55 lakh shares at an average price of Rs.35.74 per share. (Equity pre-buyback was 76 lakh shares)
So the next logical thing to do would be to see performance of the operating business:
  • Dai-ichi is essentially a specialty chemicals company. More details of the products can be obtained here.
  • The company has 2 subsidiaries, Basic Oil Treating India Ltd (no longer a subsidiary) and Dai-ichi Gosei Chemicals India Ltd.
  • The operating performance of the company for the past few years has not been very encouraging, as follows:

  • As can be seen, over the last 5 years, the operating business of the company has not gone anywhere in terms of topline growth. 
  • However, a slow change is seen in the efficiency of operations, with the business becoming profitable at the operating level. This is a positive sign.
  • The company has recently entered into an agreement with CTI Chemical Asia Pacific, a subsidiary of a US specialty chemicals MNC. Due to this agreement, Basic Oil Treating India Ltd, which was Dai-ichi's wholly owned subsidiary will become a 50-50 joint venture of with CTI. Details of the agreement can be found here. Essentially, this deal values Dai-ichi's stake in the JV at Rs.3.7 cr.
So should one buy shares of Dai-Ichi? I, for one, would not be buying the shares for the following reasons:

  • Though this is a great opportunity for someone who wants to buy the entire business, its not so for a small minority shareholder. I, being in the later camp wont be buying.
  • The company is not strong on the operating front. Some cases launched against it by clients like ONGC don't speak too well about the core business.
  • Financially too, the operating business is not making money. The company's profitability has sustained only due to the income it receives on its investments.
  • The cash, which is presently on the books, has come on the balance sheet just last year. Now, whether it will stay there is a big question. Typically, in small companies like these, cash moves around as per the wishes of the promoters! So, I wouldn't want to take that risk.

In case of Dai-Ichi, the value might not be valued! I would prefer to stay away from it.

Cheers and happy investing!!

Binani Cement - Delisting

A big hello after a long time folks. And my apologies for not being able to post often. However, past performance (or lack of it) may not be sustained in future! :-) So, unlike the recent past, I aim to be more proactive now.

Coming to the point, the post is to discuss the Binani Cement delisting play and a possible opportunity to earn some dough here.

Some basics:

As can be seen, at present EV, Binani Cement is not very expensive. However, given the present scenario in the Cement sector, it is not very cheap either!

Let us now look at the shareholding pattern:

The promoters need 20.1% to delist. J P Morgan Special Situations Mauritius Ltd. and Ganesha Prime Holdings Mauritius Ltd (a subsidiary of Stansen Holdings Singapore) together hold 21.4%. So the delisting would require the co-operation of only these two parties.

So let us check out the history of what these big guys have done:

  • J P Morgan had acquired 25% stake in Binani Cement @ Rs.24 in 2005. Out of this, they disposed 10% @ Rs.75 through an offer for sale in 2006-07 IPO. They further sold 3.4% more in the 2010 buyback @ Rs.90. They hold remaining 11.6%.
  • Ganesha had also acquired its 10% stake pre-IPO. They haven't sold anything yet.

Now to the key question; what would be the delisting price?
The floor price has been set at Rs.82.  The company had recently done a buyback @ Rs.90, in which JP Morgan had participated. So logically, they would not tender shares at a price less than Rs.90. Being the majority non-promoter shareholder, they can surely influence the price. In my view, the minimum delisting price would be Rs.90.

Let us also do a risk analysis:

Valuation risk:
I have not participated in a lot of delisting cases, because valuations did not make sense. However, in the present case, the valuations are not very expensive. This risk is low in my opinion.

Event risk:
This is the risk of the event not happening at all and the delisting getting cancelled. However, the promoters have already taken all the steps to go for delisting. They have increased their stake through buyback. The shareholding is also not scattered, making delisting relatively easy. The promoter who is delisting (Binani Industries) has about Rs.500 cr cash on its balance sheet. The financing for delisting is also not a problem. The event risk is therefore low in my opinion.

Promoter risk:
This is the risk of the quality of the promoters. The Binani Group has not been minority shareholder-friendly in the past. Their actions in Binani Metals in the past speak for themselves. In my opinion, the promoter risk is high. I wouldn't trust them 100%.

Time risk:
This is the risk of the delisting getting delayed. However, I think that the time is ripe for them to delist, considering the depressed market conditions and negatives associated with the sector. The postal ballot for going ahead with the delisting has already been sent. In my opinion, it will take 40-45 days for the reverse book-building process to start. The time risk is therefore low, in my opinion.

To conclude:
With a floor price of Rs.82, Binani offers an opportunity with relatively less downside. A minimum 10% upside is visible, with a holding period of about 2 months. Delisting can be very much successful, due to the concentrated shareholding. However, given my discomfort with the promoter quality, I would not take a huge position in this situation.

Cheers and happy investing!

Thursday, September 2, 2010

Where will the 'market' go now?

Answer: No-one knows!

Well, sorry! If you thought this was a post which will give you details as to where the market (index) will go from the present level, you are going to be disappointed. Because, I honestly do not know. (No-one does!)

The reason for writing on this topic is as under:
Me and some investor friends were recently having a discussion on this topic, as to 'market kahaa jayega'. Some poeple presented logical and valid arguments, along with supporting data, as to why the index should fall. Others presented a counter-view which was equally logical and supported with data. This got me thinking and the result is that you people have to read another post of mine!

Where will the index go next? Well, each person will have his own view and logic on this topic, depending upon one factor; how much is that person invested!

For those who are heavily invested and are sitting on little cash: This camp will always say that the market will go up. Reason? Well, its because they are already invested to a great extent. People belonging to this camp will read up on and pay most attention to all positive factors, macro and micro. (This happens sub-consciously and not deliberately.) They will gather and collect data which supports their argument that the market has to go up. They will sub-consciously disregard or give little importance to negative facts or find justifications against them. They will always reach a conclusion that the market has to go up. And the sad part is, they think that they have done this 'logically', without any bias.

For those who are on huge cash and are not heavily invested: This camp will obviously say that the market has to go down. (That is why they are on cash, right?!) The people belonging to this camp will do the exact opposite of the people belonging to the first camp. They will gather information and data which shows an extremely grim and negative picture which is conclusive 'proof', supporting their hypothesis. Again, the sad part is that they will sincerely think that they have arrived at the most logical conclusion. They too will sub-consciously ignore all the positive factors and fixate upon the negative ones.

So what can we learn from this?

  • Our mind is extremely well designed to JUSTIFY. By hook or crook, the mind will find out reasons to justify an action. In the present case, the action is of being invested, or being on cash. In any case, the mind will work in a way to accurately find out reasons to justify this action.
  • Ideally, these reasons should be found first, then the action should follow. However, here, it will inevitably happen that the reasons follow the action. Is there anyone who is fully invested, willing to say that the 'market' has to fall?? Nooo! That person will obviously say that the market will rise! It happens all the time.
  • So, what should be done about this? The answer is pretty simple; DON'T TRY TO GUESS WHERE THE MARKET IS GOING! It is a waste of time and energy. We invest in individual stocks. So doesn't it make sense to concentrate our attention and energy on those stocks and companies, instead of trying to time the market? 
  • Stocks should be bought and sold on their own merit, irrespective of the market conditions. Personally, I think that is the best way of doing things!
I agree that saying all this is much more simple than actually doing it! Not many will have the courage to buy, when everyone around is saying 'the market will fall'. Very few can do it. But then, very few earn extra-ordinary returns in the market, right?

Cheers and happy investing!

Friday, July 30, 2010

Bring out the animal in you!!

If one looks hard enough, one can see 'investing' all around. One can learn something or the other about investing from virtually all aspects of life.
A good investor needs to possess some qualities. A lot of these are 'in-built', others can be learnt.
In this post, an effort has been made to compare certain qualities of a good investor with those possessed by various members of the animal kingdom!! (If you think I am going bonkers, I wouldn't blame you! But still, do read on.)

Please note that:
  • All investors may not possess all the qualities mentioned and honestly, its not necessary too.
  • What is most important is that the investor displays the right quality at the right time. (not all the time)
  • Some of the qualities mentioned are mutually exclusive.
  • Please don't take everything in this post 'literally'.

Sloth - Inactivity

The first one on our list is the Sloth. This tropical rain-forest mammal is an amazing creature. It moves at a top speed of 0.15 mph! 'Sloth' also happens to be one of the seven deadly sins, denoting extreme apathy and inactivity.
In today's 'investing' world, where one is constantly pounded with information, where the need to do something all the time is all-pervasive, where inactivity is unheard of, investors can surely take a cue from the good old Sloth. A lot of times, the best thing to do is to do nothing at all! 
As Warren Buffett quotes "Lethargy, bordering on sloth, should remain the cornerstone of an investment style."
Of course, one should not be a sloth all the time. Inactivity is most called for when one can see frenzied activity all around. In short, be a Sloth selectively. :-)

Honey Badger - Fearlessness

Just a few months ago, the indices were at record lows. Valuations in a lot of companies were tempting, to say the least. There were even some well established companies with market cap less than cash on books! But how many of us bought big? Very few. Why? Afraid that the overall stock prices will tank further? 
Well in that case, one can learn a lot from this mean little guy, the Honey Badger. The Honey Badger has been entered in the Guinness Book of World Record as being the world's most fearless animal. About the size of a house-cat, a Honey Badger in a bad mood will attack almost anything that moves. One can find youtube videos of Honey Badgers attacking leopards and lions!
Again, if done inappropriately, this attitude is plain stupid. But one should certainly be fearless specially at times when everyone around is afraid.

Mama Turtle - Emotional Detachment

The female turtle is probably one of the most emotionally detached dudette ever. She comes ashore, lays its eggs and just leaves. She neither cares for the eggs nor for the new-born. They are left to fend for themselves!!
Now i agree this is totally extreme! The only thing we should take from this is emotional detachment.. in this case, towards stocks, not children! A lot of times, for a variety of illogical reasons, investors become emotionally attached to stocks and don't sell them even at ridiculous valuations. Other way round, investors don't buy 'sitters' due to certain mind-blocks or biases. (happens with me too) Emotions often cloud logic and reason. One should not be emotional while investing. So, while emotions may play the central part in other walks of life, in investing, the lesser their involvement, the better.

House Lizard - Cut Your Loss!

The common house-lizard (chipkali) will cause most of the female readers to scream with disgust. But there is something to be learnt from this velvety creature too. :-) When faced with danger, the lizard detaches its tail, which keeps on wriggling on its own. As the predator gets distracted by the wriggling tail, the tail-less lizard makes good its escape. Better to lose a tail, than to lose its life, right? The tail will grow back.
In investing too, sometimes, we need to lose our tail. (not literally of course!). E.g. When we realise that buying a particular stock was a wrong decision and its now quoting at a small loss, we should sell it off immediately without waiting for it to come 'cost-to-cost'. A small loss due to an incorrect decision is perfectly acceptable than losing a big chunk and peace of mind.

Hyena - Opportunistic

This rather repulsive looking creature is a super opportunist! Hyenas are opportunistic feeders and have a keen sense of judgement and risk. They typically trail the bigger cats and feed off the leftovers of their kill.
Similarly, in investing, one should be on the prowl for opportunities where the risk-reward ratio is in one's favour. Special situations (mergers, demergers, acquisitions, takeovers, slump-sale, etc), rights issues and warrants are prime opportunities available for opportunistic investors and decent money can be intelligently made in them. One needs to keep one's eyes and ears open for such opportunities always.

Cat - Curiosity

"Curiosity killed the cat" goes an idiom. Well, we aren't planning to do any killing here, don't worry. Cats, by nature are extremely curious. You can play with a cat for hours and it will still want more. They like to explore, try new stuff and often get into trouble.
I believe that an investor also should be just as curious. Curious with regard to companies, their products, the nitty-gritties involved. Curious with regard to learning new stuff, appreciating new techniques and always wanting more. The day one's curiosity ends is the day learning stops. And in investing, one should continue to learn all the time. So a big MEOW to all..

Sheep - Humility

I also do not know why, but sheep look so very humble, don't they? Well, at least to me, they do! (dunno if they are really so) The stock market is a place where humility is rare. People often claim to be far more than they are or something they are not! Successes are trumpeted and failures are quietly swept under the carpet. A lot of people think they are the best, much better than everyone else! In such scenario, a healthy dose of humility is an absolute must. One should never think of oneself as the greatest investor on planet earth. The market shows such people their rightful place soon enough.

Crab Spider - Patience

This cute looking fella is the Crab Spider. The most curious feature of the Crab Spider is that it does not weave webs. It does not go hunting after insects too. It sits still patiently, allowing the prey to come within striking range. It can sit still for long periods of time waiting patiently for the next yummy meal.
Now thats patience. Waiting and waiting for the right opportunity to come by. Today, patience is totally lacking in the overall investment community. The definition of 'long term' has become very flexible. In such a scenario, one cannot help but admire the Spider Crab! :-)

Black Panther - Solitude

This fabulous looking creature, the black panther (leopard) lives alone its entire adult life, except during mating. (Hmmmm)
Anyways, relating this to investing, as my good friend Dnyanesh says 'investing is a lonely profession'. I completely agree (although loneliness and solitude are vastly different concepts). As individuals, we are different in all respects. Our investment ideas and processes are equally different. Our decisions are also, in a way, unique. Getting together in groups and discussing investments will only lead to confirmatory biases taking over. Buffett has also strongly advocated the limited use of committee-style investing for getting extra-ordinary returns. Taking cue from the black panther, one should 'hunt' alone. (Also, the idea of the lone hunter/lone ranger sounds so Hollywoodishly cool!)

Dolphin - Have Fun

Dolphins are synonymous with fun. Have you ever seen a sad dolphin?! Even when they are working (a.k.a hunting), they jump around and seem to have a good time.
Similarly, if one is not having fun in one's work, that work is not worth doing, imho. Investing is tremendous fun. (at least I think so) So enjoy, have a good time and make good money. If your investing activity is synonymous with ulcers, blood pressure, tension and sleepless nights, believe me, its just not worth it. Having fun will make you a better investor and a better human. :-)

Well, there you have it. Some of the key qualities of good investors that one can observe in nature. (I am not at all claiming that the above list is exhaustive).
I love to co-relate multiple disciplines and different streams of study and knowledge with investing. It gives one a fresh approach and perspective. If you also liked what you just read (hope you are still awake), then do read this book. Its mind-blowing and a trillion times better than what you just read.
Would love to hear your comments..

Cheers and happy hunting!!!

Monday, July 26, 2010

Some good books worth reading...

"A man who does not read good books has no advantage over the man who cant read!" So says Mark Twain.. And it is so very true. There is a world of knowledge out there. And its yours if you choose to.
Personally, I love to read. Due to time limitations, I read books about investing and psychology only. These books have taught me a lot. They have awed me, humbled me and I have communicated with the greatest minds on earth through these books! Here is a list of good books you also can read and learn from. For simplicity sake, I have categorized them based on various criteria. The order in which the books are mentioned has no significance whatsoever.

The Buffett/Graham/Munger category:

1) Security Analysis - Graham & Dodd
The original text of value investing, first published in 1934. The book is currently in its sixth edition and it is still on the best-sellers list. It is proof that investing is indeed timeless. The book is extremely technical in nature. Readers who are not serious will find it daunting. (To be frank, boring!)

2) The Intelligent Investor - Graham
The follow-up to the Security Analysis book, The Intelligent Investor is yet another classic. Much more simplistically written, I believe it is a must-read for any budding investor.

3) Buffettology/The New Buffettology - Mary Buffett
An excellent book to read about Warren Buffett. Written in simple language.

4) The Snowball - Alice Schroeder
Size-wise, this is the biggest book on Buffett! :-) Personally, it was not big on value addition, for me. After reading this book, one's respect for Buffett as a human being and family man (not as an investor) would surely come down.

5) Poor Charlie's Almanack - Munger
Reading this book has been quite an experience. It takes a huge amount of mental effort to understand and absorb this book. Munger is amazingly smart, equally funny and kinda whimsical.

6) How to pick stocks like Warren Buffett - Timothy Vick
Gives a step-by-step and simplified analysis of Warren Buffett's stock picking approach. But, do remember that understanding Buffett is comparatively easy, implementing Buffett is damn difficult.

There are countless books written on Buffett. Be careful about choosing which one to read. Most of them contain the 'Buffett' name just to sell the book.

The Value Investing/Investing category:

1) Common Stocks & Uncommon Profits - Phil Fisher
One of the best books on investing, imho. Fisher should be called as the Father of Simplicity! Reading this book will change your whole outlook towards investing and how you look at companies.

2) Value Investing: From Graham to Buffett and beyond - Bruce Greenwald
Another amazing book. I have been fortunate enough to attend a seminar by Prof. Greenwald and hear him talk. It was a great experience. Definitely a book worth reading.

3) Value Investing - James Montier
For me, Montier is a rockstar! He is one of the world's leading authorities on Behavioural Finance, a subject close to my heart. Montier's work on value investing is also very much worth reading.

4) The Little Book of Value Investing - Christopher Browne
An amazing book. Simplifies the 'investing in a business' approach to a great extent.

5) The Focus Investor - Rockwood
Though not strictly a book on value investing, this book provides an altogether different approach to investing by combining varied investing philosophies. Surely worth reading.

6) The Dhando Investor - Pabrai
For me, this is a coffee table kinda book. Imho, the book is over-rated.

7) Margin of Safety - Klarman
This has to be on your must-read list. An amazingly written book on the concept of margin of safety, which is central to the value investing philosophy.

8) One up on Wall Street - Peter Lynch
9) Beating the Street - Peter Lynch
Both are good books by a very street-smart investor. Lynch was not at all in the value-investing camp, but he earned phenomenal returns (the best ever) as a mutual fund manager.

10) Reminiscences of a Stock Operator - Edwin Leferve
This is not a book on investing as such, its written by a hard-core trader. But its an amazing and wonderful read. One can learn a great deal about the psychology of the markets from this book.

11) Its when you sell that counts - Cassidy
One of the very few books written on the art of selling! Contains a lot of stuff on behavioural finance too.

The Behavioural Finance/Psychology category

1) Predictably Irrational - Dan Ariely
A superb book for anyone interested in psychology. Full of examples and experiments.

2) SWAY - The irresistible pull of Irrational Behaviour - Braffman
Well, the title says it all, doesn't it?

3) Panic - Michael Lewis
A history of how markets panic. Will help you to be ready next time!

4) Behavioural Investing - Montier
Another excellent book on the application of behavioural finance in investing.

5) Seeking wisdom: From Darwin to Munger - Peter Bevelin
Another fascinating book, written in an interesting way.

6) Chaos - James Gleick
A very very complicated book imho. Not directly related to investing, but covers multiple fields and aspects.

7) The (mis)behaviour of markets - Mandelbrot
This book takes a look at the classical financial and valuation models and theories and then takes them apart!

The Entertaining Category

1) Liar's Poker - Michael Lewis
A hilarious look at what happens in a typical investment bank. Amazing book.

2) Where are the Customers' Yachts - Fred Schwed
Another excellent and entertaining take on how Wall Street operates. A must-read.

3) Fooled by Randomness - Taleb
4) The Black Swan - Taleb
Taleb's books take time to understand and digest. But are very absorbing. These two books always help me remain within my aukaad! :-)

5) Damn Right - Janet Lowe
This shouldn't really be in the entertaining category, but I personally found it amazingly entertaining. Anyways, anything on Munger has to be witty and entertaining! Do take a look.

These are few of the books I have read and I would recommend that you also take them up. It would be a life-altering experience. I am in the process of reading more books and would update any good books I come across.. Currently, after going through a Montier phase, I am taking up The Art of Strategy which was sent by my good friend Carlos. Btw, Carlos, if you are reading this, I expect a huge number of comments (a.k.a. brickbats) from you, since 'books' is a matter close to your heart. :-)

Cheers and happy reading!!

P.S. I do not have a soft copy of any of the books, so kindly do not ask me to email soft copies n stuff..

Tuesday, July 6, 2010

Investing in Holding Companies

One of the more popular 'theme' in the 'theme-based-investing' categories is investing in Holding Companies.
For the un-initiated, let me first explain in brief what this theme is all about...

  • There are some listed companies, whose main 'business' is to own and hold equity shares of other companies, most of which are listed group companies, run by the same management. 
  • Basically, instead of the individual promoters owning shares of all their group companies, all these holdings are held in a single company. This is called as the 'holding company'. (May or may not be a 'holding company' from accounting point of view.)
  • E.g. Bajaj Holdings and Investments Ltd. is the holding company of the Bajaj Group. It holds 31% stake in Bajaj Auto, 35% stake in Bajaj Finserv and 24% stake in Maharashtra Scooters, among its other investments.
So what is the 'accepted' logic for going about investing in such companies? Well, it goes like this...
  • Such companies hold shares of other listed companies. The market value of these investments (since they are also listed) will normally be higher than the value of investments shown in the books of the holding company.
  • In many cases, the market value of the holding company's investments (net of debt) is much higher then even its own market-cap.
  • So, investors argue that the holding company is undervalued, since it has 'assets' whose market value is greater than its own market-cap.

An example will clear this further;
Nalwa Sons Investments Ltd. (NSIL) is the holding company of the O.P. Jindal Group. It holds shares of Jindal Saw, Jindal Southwest, JSW Holdings and JSW Steel.
If one were to buy NSIL at current market-cap of Rs.500 cr, one would get investments worth Rs.2200 cr. Seems like 'buying a dollar for fifty cents' huh? 
This, precisely, is the investment argument that the believers in this theme of investing put forth. Further, while calculating the 'fair value' of the holding company, investors in general 'give' a discount to the market value of its investments. (The usual norm in the market is to accord a 50%-60% discount.) Thereby, fair value of NSIL should be about Rs.1300 cr (60% of market value of investments). Hence, at the present market-cap of Rs.500 cr, NSIL is a 'screaming buy'.

Now, while this logic seems reasonable, let me ruin your day by putting forth my thoughts on the same...
  • Strategic stake v/s financial stake: There are some investments which are financial in nature (to be sold later, preferably at a profit and make money.) There are other investments which are strategic in nature (never meant to be sold, but are meant to be held on and on, as part of some strategy.) Holding companies are created from the strategy point of view and their investments are necessarily strategic in nature. Holding companies stake in other group companies is in the nature of the 'promoter holding'. If this stake is sold, the group will lose control of the company. (In effect, it will never be sold)
  • Does market value matter??? Sooo, since the investments made by holding companies are strategic in nature, these will never be sold, but held on till eternity! So, if the market value is never going to be realised (by selling off the investments), should it matter? Should one even bother calculating the market value of the holding company's investments?
Please keep in mind that I am talking about only holding companies. If a company holds shares of an un-related listed company, the market value of these shares should be given due consideration, imho.

Well then how can these holding companies be valued?
  • In my view, these companies should be valued like any other business. Its revenue is the income it receives on its investments (dividend). Usually, expenses are limited and most of the revenue is reflected as the profit.
  • One can multiply this profit by a PE ratio accorded to a zero-growth company (e.g.Graham suggests 8.5 PE ratio) to arrive at the fair value of the holding company.
  • This is merely a suggestion and cannot be the only way to value a holding company. To each his own!
  • Further, investments other than those in group companies should be given their fair market value.
Of course, when one values holding companies like this, the resulting 'fair value' will be far farr farrrrr lower then the prevailing market cap, meaning that these companies should not be bought. Well, this happens to me all the time and till date, i have ended up buying only one holding company...

I am well aware that not everyone will agree with me. (In fact, i think most investors wont!). Valuation is an art and is very relative. The way I look at holding companies will not be the way you do!
But isn't that the beauty of investing? Well can all agree to disagree on certain fundas and still, all of us can earn money!! E.g. My good friend Ayush is a firm believer in the holding company investing theme (and I am not!) And i know it for a fact that he has earned a lot of money in this theme (and I have not!) Ayush, party-time dude!

As usual, the purpose of this post is to start off discussions on the topic. I do not claim that my views are right and others' are wrong...

Do pitch in your views on this theme..

Cheers and happy investing!!

Wednesday, June 23, 2010

Phillips Carbon Black Ltd - In a Sweet Spot!

There will be some people who will surely run away after seeing that Phillips Carbon Black Ltd (PCBL) is a RPG group company, hence the warning! :-) Also, please read my disclosure at the end of this post.

PCBL is India's largest manufacturer of Carbon Black. It is also the largest exporter of carbon black in India, deriving around 20% of its revenues from exports. The company has three manufacturing units with an installed capacity of 2.7 lakh MT, as shown in Fig. 1.

Carbon black is basically a black powder, used as a reinforcing agent in rubber. The tyre sector accounts for more than 60% of the carbon black consumption in India. The principal raw material for carbon black is carbon black feedstock (CBFS), which is a crude derivative. Hence, its price is always pegged to the price of crude. (Fig. 2)

Consider the following points about the carbon black industry in India:

  • Only 2 players, PCBL and Hi-tech, a unit of Aditya Birla Nuvo, control over 80% of the country's carbon black market. It is a virtual duopoly. (Total size of the market is approx 6.2 lakh MT) 
  • However, the duopoly does not result into any pricing power for the pair. The risk of cheap imports (a.k.a. dumping) always ensures that the carbon black prices are benchmarked with international prices. Carbon black is a commodity business, with operating margins between 13-15%.
  • Currently, the industry is protected by an anti-dumping duty which is in force.
  • Tyre manufacturers are on a massive expansion spree in India, which will inevitably result into improving demand for carbon black, which is expected to grow at a CAGR of around 8% over the next three years.
Sounds cool? So what is PCBL doing to take advantage of this situation?
  • Of course, PCBL is expanding capacity from the present 2.7 lakh MT to 4.1 lakh MT (0.9 lakh MT Greenfield at Mundra and 0.5 lakh MT Brownfield at Kochi). These capacities are expected to be operational towards the end of this calender year. Considering the customer-industry growth, this expansion seems to be well-placed.
  • PCBL has also made its maiden international foray by forming a 80:20 JV with Vinachem, a Vietnam based company for manufacturing 1 lakh MT of carbon black in Vietnam.
  • During the manufacture of carbon black, a combustible waste gas is released, which has to be flamed up. PCBL has established co-gen power plants, where this waste gas is used as fuel to generate power. The company is targeting expansion in this segment too, from the present 44.5 MW to about 70 MW. This move augurs well for the company, since there is virtually no feedstock cost (no coal/gas required). The per unit cost of generation is below 40 paise/unit, while the power can be sold on merchant basis at above Rs.4/unit. This segment wont add much to the top-line, but will add tremendously to the bottom-line.
  • For re-using this waste gas, instead of flaming it up, PCBL is also eligible for carbon-credits. (Not clear exactly how much)
  • Additionally, PCBL also has investments in listed group companies, with market value of investments of about Rs.100 cr. (Since i do not believe in the 'holding company valuations' theme, this is totally meaningless for me.)
PCBL is currently valued by the market as given. One can check the detailed financials of the company here. The trailing valuations surely look cheap. With the expansion expected to be operational by the end of this calender year, the carbon black business can do close to Rs.190 cr operating profit for FY11. (Assuming 2.8 lakh MT sale @ Rs.50000/MT and operating margin @ 13%). All the figures have been taken on a bit lower side, to be conservative.
The power business, on the other hand, is an even better story. By the end of next year, PCBL will have operational power capacity of 70 MW against 44.5 MW currently. Out of this, about 30 MW would be used by PCBL and the remaining 40 MW would be sold to SEBs. When the company starts generating power at full capacity, the operating profit from the same could easily be more than Rs.100 cr.

Surely sounds like a steal? Well there is some stuff I am afraid of:

  • This RPG group company may do something RPG-ish and screw up returns for shareholders of PCBL.
  • Volatility in crude prices as well as forex could distort future numbers.
  • Like PCBL, Hi-tech also has aggressive expansion plans. If tyre demand were to taper off or is not as high as expected in future, both these players will sit on their expanded capacities, looking at each other! This is typically what happens in a lot of commodities and is exactly why investing in commodity companies should not be one's first choice.
To sum-up, PCBL is currently in a sweet spot, with decent visibility of revenues as well as profits over the next two years. The EPS growth could also be accompanied by a PE re-rating, once the 'power story' of PCBL gets marketed well! ;-) On the basis of current as well as forward valuations, the 'bright future' does not seem to be priced-in at the present market-cap..

Cheers and happy investing!!

P.S. : Investing in commodity companies is risky. Investing in a RPG group commodity company is, therefore, risky-raised-to-two. So, considering the illustrious history of the RPG group, I have yet not had the guts to invest in this company. I do not have any position in PCBL.

Tuesday, June 8, 2010

An interesting (and profitable) experiment..

As I had mentioned in my introductory post, as a hobby, I teach in 3 B-Schools in Pune as a visiting faculty. Besides the regular syllabus, I discuss lots about psychology, investor behaviour etc in class. Sometimes, I also conduct certain experiments where my poor students become the guinea-pigs! (evil smile)
I recently conducted an experiment in Behavioural Finance which i had adapted from one of the many books i read on the subject. The results were pretty interesting!

I started by telling the students that I am going to sell them a Rs.50 note. The concept of 'buying money' itself was a bit hard to digest for some, but what the hell. I also told them that this note was signed by a very famous personality and they could get at least Rs.1000 if they sold that autograph. (This was a mere distraction; the note was signed by just me, but I refused to tell them whose sign it was!!) Almost everyone started fixating on whose signature it might be.
Then I asked them how much would they pay for it. Most of the students quoted an amount up to Rs.50. Some dare-devils also quoted beyond 50. I asked them if they would be ready to buy this Rs.50 note for Rs.5. Everyone said yes. So I said lets have an auction. The auction had the following rules;
  1. The bids would start at Rs.5 and in multiples of Rs.5 thereafter.
  2. A person can talk only to place the bid during the auction and for no other reason. (So that no-one influences others)
  3. The highest bidder wins the auction and gets the Rs.50 note.
  4. The second highest bidder (runner-up) has to pay me an amount equivalent to his bid. (This was the critical condition which no-one really understood. They were all busy thinking about the signature!)
Well, the auction started at Rs.5 and rapidly went up to Rs.45. Almost everyone was interested in bidding. I now told them that the signature was mine and the Rs.50 note was worth Rs.50 only! Then the fun started. (Evil smile again)
  • One chap bid Rs.50 for the note. (After all, it was Rs.50 for a Rs.50 right?)
  • Then i told the Rs.45 bidder that if he loses, he needs to pay me Rs.45 as per the rules. So, in order to avoid the loss, he needed to win. Naturally he bid Rs.55.
  • Then I came back to the Rs.50 bidder and told him the same thing. He too placed a higher bid at Rs.60 in order to avoid loss. 
  • None of them could afford to be a runner-up, otherwise they would have to pay me the amount of their bid. The bidding frenzy continued unabated.
  • In a matter of minutes, the bidding had reached Rs.210!!! It was then that I had to decide to stop the auction. 
  • Well, the chap who had bid Rs.210 won the Rs.50 note. And the runner-up who had bid Rs.205 had to give me Rs.205. In effect, I sold a Rs.50 note for Rs.(210+205) = Rs.415! Sweeeet!
We all have observed similar things happening to us during investing in the stock market. So what are the lessons we can learn from this exercise;
  • One should become a teacher and swindle unsuspecting students. Its quite profitable. (Ok ok, thats not a lesson to be learnt. In fact, I gave them all chocolates out of the money I collected from them!!)
  • We all fixate and concentrate on un-important stuff and become blind to the obvious. Just like everyone fixated on the signature on the note so much that they failed to carefully consider the trick condition of the auction! While investing, we must give due importance to all parameters and conditions and not get excited or influenced by some single attractive parameter. We wouldn't want to miss out on something important, would we? 
  • We are extremely loss-averse: Our brains are wired in such a fashion that we will do anything to avoid losses. Its a natural human tendency. In the experiment, everyone started with the objective of earning profits, but ended up trying to avoid losses!! The loss aversion of humans plays out well. We have to learn that there is no need to pay more than Rs.50, for something which is worth Rs.50. This was a losers' auction and those who participated were destined to lose. Similarly, in stocks, if one has made a mistake, then one should get out immediately upon recognising it, irrespective of the loss.
Emotions and thought patterns are truly wonderful (or harmful) and it is fascinating to study them. We just had an introduction to some concepts of behavioural finance and i intend to post separately on each topic.
Hope you all enjoyed this one. (Including any students of mine who are reading this!)

Cheers and happy investing!!

Thursday, June 3, 2010

ACGL - Murphy's Law Holds True!

"Anything that can go wrong, will go wrong". So says Murphy's Law. And in case you want a real life example of the same, look no further than Automobile Corporation of Goa Ltd. (ACGL).
ACGL, whose promoters are Tata Motors and the Govt of Goa, is one of India's largest bus-body manufacturers. It also produces sheet metal components. But things just haven't gone ACGL's way. I honestly feel bad for the company's management.

  • In 2007, the company raised money through a rights issue to double capacity. And then the global economic crisis hit. Talk about perfect timing! Bus exports fell and ACGL, with its expanded capacity and lesser demand, suffered a lot.
  • The company had decided to move its sheet metal business to Pune, to make Goa a dedicated bus-body manufacturing operation, since the scale had increased. Of course, then the global economic crisis hit and this plan had to be shelved. The company has now bought a plot at Dharwad for this purpose.
  • Well, things improved gradually and the company seemed to be limping back to normal. But then, Murphy's Law!! The labour union declared a strike and also prevented any workers from entering the premises. The seriousness of the strike can be judged from this article.
Well, feeling bad for the management and all is fine, but the critical question is, does the company have any value? Now since the company is going through a really bad phase, lets try and find out the bare minimum valuation that can be given to the company;
ACGL is being valued by the market as given. It is important to remember that the cash on books is because of the company's rights issue and is not fully internally generated.

Anyway, the company has two divisions, Sheet Metal Components and Bus Body Building. 
The Sheet Metal Component Division is smaller in size and is profitable. This division's performance was hit in 2009 because of closure, for shifting to another location.
So what kind of valuation should one give to this division? Since we are trying to calculate the minimum value of the business, let us value it at 4x FY08 PBIT of Rs.7 crores. This division may be valued at Rs.28 crores.

Moving on, to the bigger and more important Bus Body Division;

  • This division has not performed efficiently. In 2009, the PBIT per bus body was down to a record level of Rs.35307/-. This was essentially because the company got more orders for smaller buses, in which margins are lesser. 
  • The current capacity of the division is 4800 bus bodies. The only thing lacking is orders!!! As and when the operations become normalised, the company should be able to sell at least 4500 bus bodies a year, generating PBIT of at least Rs.18 crores at Rs.40000 PBIT/bus body. Both these numbers have been deliberately taken on the lower side. (In fact, all requirements for hiking this capacity to 10000 bus bodies are complete).
Ok, let's day-dream here a bit. Let's suppose that the scenario improves drastically and the company manages to get large orders on the domestic as well as foreign front. It is able to operate at full capacity of 10000 buses! What would happen then? Even if we consider PBIT/bus body of Rs.40000/-, the potential for PBIT of at least Rs.40 crores exists!
Those numbers felt nice huh? Good, now back to reality! :-) 
One can surely give this business a value of 8x PBIT, resulting into a 'normalised' valuation of Rs.144 crores. (Rs.18 crores x 8 times)
So let us see what can the fair value of the business be;
I have assumed that cash Rs.25 crores has been eroded during FY10.  Hence, in the adjoining valuation, cash has been taken as only Rs.40 cr. The valuation works out to Rs.212 cr against present market cap of Rs.147 cr!! Sweeeeeeet!!!

Well, before you place the 'buy' order with your broker, please read The Good, The Bad and The Ugly of the company!!

The Good
  • ACGL has strong promoters in the form of Tata Motors. TaMo has been supporting the company throughout its times of distress. TaMo has also increased its stake in ACGL over the last 2 years.
  • The conservative valuation of ACGL works out to much more than the market cap.
  • The business potential is huge. With rapid urbanisation and transportation requirements, large demand for buses is expected.
The Bad
  • Due of one reason or the other, historically, ACGL has failed to deliver and live up to its potential.
  • Our valuation is at 'normalised' operations. When will the operations normalise? Well, thats anybody's guess. Absolutely no visibility is there.
The Ugly
  • ACGL's promoters (Tata Motors) have a JV in India with one of the world's largest bus body manufacturers, Marcopolo. Details can be read here. In my view, this is a huge conflict of interest. The promoter has a JV, which competes directly with its subsidiary! So how does TaMo divide its business between its JV and its subsidiary? Not really clear. Big risk here..

Well, to conclude, one can say that ACGL definitely has value. The key question is, when will the company get back on track so that this value gets unraveled? Or will Murphy's Law continue to wreck havoc with ACGL? Time will tell...


Saturday, May 29, 2010

Ashiana Housing - An Interesting Case

I know, I know.. The first question that you would pop is; what is a dude, who claims to be 'value-based', doing with a real-estate company! That’s a very fair question, considering the way most builders/real estate players around us operate. But Ashiana Housing is different! Also, it is important for a good investor not to have mind-blocks against companies or sectors. So let us study this company and decide whether there is any value in it.

Consider these facts:
  • Unlike most other real estate players, Ashiana does not go bonkers over land bank. It keeps on maintaining land bank which would give it project visibility for the next 5-6 years, at any point of time. Further, it enters into agreements with existing land owners, thereby reducing initial capital requirement. As a result, the company is debt-free and yet has excellent revenue visibility.
  • Ashiana commences a project only after detailed study and after getting visibility of customer advances. The management states that "we won't start a project where we feel we won't get customer advances". This reduces the working capital requirement too.
  • Ashiana concentrates on Tier 2 and 3 towns. It enters any area only after proper study and also by establishing partnerships with local developers. As a result, it has built up excellent reputation and goodwill in towns like Bhiwadi, Jaipur and Jamshedpur, where it mainly operates. Better to be a biggish fish in a small pond huh?
  • Ashiana has created a niche in the form of developing 'old age retirement homes' under the brand name 'Utsav'. It currently has two such schemes, one at Jaipur and the other one at Lavasa, Pune.
  • Ashiana also maintains the projects that it develops, through its subsidiary Vatika Marketing. This ensures that the quality of its projects stays high even after completion/handing over.
  • Ashiana's accounting policy also appears to be very conservative. The company accounts for sales on a percentage of completion method. (For more details, please refer to the annual report.)
The company appears to be good huh? Well a good company can become a good investment only at a good price and valuation! So now that we have seen some qualitative aspects about Ashiana, lets study the numbers:

Market cap is Rs.225 crores at CMP of Rs.125/-. (Just FYI, the stock had gone down below Rs.30 in Jan 09. And the price has gone up more than 3 times in the past 1 year. :-)  I am sure many of you will now be like "its gone up too much, let's wait for it to come down". As is commonly observed, this wait increases, as the stock falls, only to repent after it probably goes up again! Same old, same old!)
The company's financials are in good shape. In order to keep this post shorter, I am not providing a table of the financials. One can check out the financials of the company here.

Ashiana's ongoing projects:

The company has ongoing projects involving saleable area of about 68 lakh sq ft. The company has about 50 lakh sq ft additional land bank. Of the projects detailed above, Utsav - Jaipur and Pune are retirement resorts, Village Centre is a Hotel (100 rooms) cum retail centre owned by Ashiana while others are regular group housing schemes. Except Rangoli Garden, which was launched recently, the company is expected to complete all the other projects by the end of FY13. If we adjust the above total saleable areas as per Ashiana's share as well as a haircut for already constructed area, its about 30 lakh sq ft to be completed upto FY13. This gives excellent revenue visibility.
In one of its investor presentations, the management had claimed that they expect to recognise operating profits of Rs.225 crores upto the end of FY13 (Cumulative). That's equal to current market-cap! Let us see if this is possible.

  • Ashiana's average realisation per sq ft for the December 09 quarter was Rs.2084/-, while average cost of construction was between Rs.1000-1100/-. That gives an operating profit margin of Rs.900/sq.ft. Let us take it as Rs.800/- to be conservative.
  • As per Dec 09 management concall, the management's target is constructing 11 lakh sq ft in 2009-10, 13 lakh sq fr in 2010-11, 15 lakh sq.ft in 2011-12 and 18 lakh+ in 2012-13. (Not all this will be booked as sales immediately).
  • Booking of total 30 lakh sq ft sales and consequently, Rs.240 cr (Rs.800x30 lakh) operating profit upto 2012-13 seems quite achievable. Impressive indeed. Like me, you also need to do some basic excel based calculations to arrive at likely profit numbers. Its quite simple.
There are of course, significant risks, but they are more macro in nature. The real estate sector itself could get hit due to:
  1. Possible hike in interest rates, which discourages customer spending on real estate
  2. Implementation of the proposed Direct Tax Code, where tax benefit for housing loans could be removed. This, i think, is a significant risk to the real estate sector.
One needs to keep these risks in mind. Though they are macro in nature (which means we will probably never be able to predict or time them), in my view, they are quite critical.

Ashiana Housing is expected to declare its FY10 results tomorrow (May 29, 2010). Although, in my view, this company's performance should not be seen on a quarterly basis since quarterly numbers could be quite lumpy. To sum up, I think Ashiana is a wonderful company, with ethical and conservative management which has expanded judiciously. The projects in hand as well as future plans of the company appear good and one should surely keep tabs on Ashiana Housing Ltd.

Cheers and happy investing!

Friday, May 14, 2010

Hindsight Bias - Don't Watch Your Behind Too Much!

Things are so obvious. Its obvious that valuations in late 2007 were crazy. It was a bubble for sure and one just had to sell at that point. 
Its also obvious that valuations in early 2009 were equally crazy. One just had to buy at that point. 
These market tops and bottoms are so obvious. One really wonders why most of the market participants didn't act on it...
Well!! If investing was so easy, there would be no other profession! :-) All these facts I mentioned above are obvious today. They were not so obvious at that time. In fact, everything that has happened in the past (not just in investing) seems pretty much obvious when we think of it at present. We sometimes lament at obvious mistakes made in the past, or sometimes justify them, so that we don't have to lament! Think about it, isn't that right? This is the basic funda of the concept of 'hindsight bias'.
Wikipedia defines hindsight bias as 'inclination to see events that have occurred as more predictable than they in fact were before they took place.' Boy, thats one big sentence. In essence hindsight bias is the phenomenon where we look at events in the past, and  convince ourselves that we knew they were going to happen and were prepared for it. While in fact, we just weren't. 

I like parties. Parties are fun and can be useful too. If I get surrounded by people talking about stocks and offering me tips, its probably time to sell, whereas if everyone is avoiding me, its probably time to buy. (Well, to be honest, I go to parties for the booze, not to take buy/sell decisions!). Anyway, the following is a very common conversation, which happened last year. We all must have heard such stuff at parties and social gatherings.

Mr.A: Boss, bazaar dekha? Its gone real bad man..Sensex below 10000!
Mr.B: Of course, what did you expect yaar? You really believed in the 'India shining story' and all? It was so obvious that the crash was going to happen. In fact, I had told my friend Mr.C in December 2007 itself, that dude, sell off. We can't sustain these crazy levels. And see what happened..
Sounds familiar? Such dialogues like 'maine bola tha', 'I had told you that time only', etc are extremely common, specially in equity investing. 
Unfortunately, since I am also part of the conversation, I ask Mr.B: Sirjee, since you knew of the crash so confidently before it happened, did you sell your stocks? Or better still, did you go short on the index? I am sure you must have earned a truck-load of money. 2008 must have been the best year of your life!
Mr.B: Umm, wellll actually I did not sell my stocks. Umm, you see I am a long term investor. The losses at present are just 'paper losses' and i am sure that the prices of my stocks will rise a lot again. So its quite ok since I think long term.
Me: Well, to quote Keynes; 'in the long run, we are all dead!'
Mr.B laughs awkwardly and drifts away. Thank god!
This is a great example of how we think about past events at present. About how we justify our past actions to convince ourselves that we were right.
Another good example is that of technical analysts on TV. Now i do not have any disrespect towards any person. Neither am i saying that technical analysis does not work. It may work for some people. I am not one of those. 
This is what is typically said in the morning, before the market opens:
Nifty closed at 5155 yesterday. We remain cautiously optimistic (my favourite market term) on the market. On the higher side, nifty would face resistance at 5182. If that resistance is overcome, nifty could shoot up to 5200, which would be a major resistance. Beyond 5200, nifty would face resistance at 5215 and at 5032. On the lower side, support is seen at 5140. If this support is broken, a very strong support is seen at 5120, below which nifty has a support at 5100. In case 5100 is broken, nifty could free-fall to 5075. We would see strong support coming in at 5060.’


Anyway, in the evening, after the market is over, the following is said:
As expected, nifty made an upmove to reach 5182 levels. Overcoming this resistance, it shot up to 5210, beyond which profit-booking set in. Nifty fell to 5150, which acted as a major support, but in the end-of-the-day’s trade, the bears took the nifty down to the support of 5120, to close at 5125.
Perfect post-event analysis, which is essentially not value-adding. Technical analysts are a great example of hindsight bias. (Again, no disrespect meant, these are just the facts)
In the market, everyone has an opinion and everyone is expert at analysing things beautifully after they happen. And everyone has that goody goody mushy mushy feeling that we knew it all along. Well it ain't so!
Now that we know that, maybe unknowingly, we can get exposed to hindsight bias, lets see what damage it can do to an investor;

  1. We don't learn from our mistakes: One of the biggest aspects of investing is learning from mistakes, so that they are not repeated. But those affected by hindsight bias think that they never make a mistake! So the learning gets stunted. Not a good position to be in..
  2. Gives a false sense of security: Investors affected with hindsight bias think that they have successfully predicted and knew all the happenings in the market. Hence, they remain blissfully confident that they will be able to do this in future too. In reality, this might not happen and can lead to significant losses.
So now that we know about this phenomenon, maybe next time, we'll all introspect before we claim to have predicted something that has already happened before it had happened. 
To avoid being affected by hindsight bias, we must all be honest, introspect, acknowledge our mistakes sportingly and let bygones be bygones.

Cheers and happy investing!

P.S. My apologies for the cheesy title.. :-)

Wednesday, May 5, 2010

God..the market is falling...what next??

I think this is the most-asked and discussed question these days. And it sure is a million dollar question. (Although 'million' seems small these has to talk in trillions to get noticed!)
Well I have been asked this question a lot in different forms lately. The same question comes disguised in forms like 'market kya lag raha hai?' or 'teji ya mandi' or better still 'where do u see the market 2 months from now?'
Arey! If i 'saw' the 'market' 2 months from now, i wouldn't bother with all the research and analysis, would I? ;-)
Anyways, just thought that this is a good time to post on this topic. And I thought it better to post in a question-answer form, to be concise and to-the-point.

Que: Where do you think the market will go from here?
Ans: Well, i think it will either go up or it will go down. Theoretically, it can remain unchanged!!!
Frustrating answer? Well, in my defense, it was a frustrating question! To frustrate you even more, let me answer the question with more questions..
How does it matter? 'Market' as everyone refers to, is the broader index, which is a sweat-inducer for many people. So the 'market' consists of only 30 (sensex) or 50 (nifty) stocks. Now, are these stocks our investment universe? Do we trade in Nifty derivatives? If the answer to both is 'no', then one really should not care about where the 'market' will go. We invest in individual companies, so why not try and focus our attention on that, instead of trying to second-guess the index movements? How does the index movement matter, if we are neither investing in the index nor solely in its constituents?
Have you ever been successful at predicting index movements? I don't think anyone can say 'yes' to that. Predicting index movement correctly and consistently is impossible, as per me. The index is a hotchpotch of many companies, whose individual prices move due to a variety of factors. All these movements together move the index. So, in my view, predicting these individual movements and the overall movement is not possible. (You might have guessed by now that technical analysis does not work for me and I don't even try to do it.) So, all-in-all, predicting index movements is an exercise in futility. So I have made my peace with the fact that I am incapable of predicting where the sensex/nifty will go and that I will never ever be able to 'time' the 'market' properly.

Que: O really? So you mean to say that the index movement has no impact on overall stock prices? Boss, when it rains, everything gets wet. The index is a representation of the macro scenario. You just cannot afford to ignore the index.
Ans: Well, although i do agree partly about it, I would ask one more question. Have you been able to predict the 'macro' picture properly and consistently? You foresaw in 2007 that the world economy would be going through a tough time? Or that it would plateau and rebound quite fast a short time later? Trying to predict the macro (one has to study the world-wide scenario these days!) picture is like trying to put handcuffs on an octopus! Just like an octopus has too many arms, here too, there are just too many variables/factors and one will surely miss some. (if not many). So, while studying/reading up on the broader economic picture does add to knowledge and has made me more alert recently, I have been unable to incorporate the same successfully, while investing in companies. I wonder if your experience has been different.

Que: Bummer! What the hell man? You are negating everything. So what do you think one should do?
Ans: Well, so sorry to be 'the irritating pest who opposes'. But what if we do the following:
1) The absolute golden rule: BUY CHEAP. Now one needs to remember two things here. When I say 'cheap' I am referring to the valuations, not to the price. Second, 'cheap' is a relative concept. What seems cheap to me may look ridiculously expensive to you and vice-versa. So, you should develop your own parameters while looking out for 'cheap' stocks, vis-a-vis their perceived intrinsic value.
2) There should be a decent margin of safety (MOS) too. This would give you the necessary buffer in case things don't go as you plan. One can build good MOS by being pessimistic! If you analyse a stock assuming worst case scenarios going forward, and it still looks cheap, you have a decent MOS. You should, of course, think straight and control your emotions while doing this. Remember, you are doing this to determine whether you can buy, not to justify your decision of buying!
I have been thinking a lot lately on building MOS in volumes! I intend to express my thoughts on this topic in a separate post later.

Que: Well, what if I don't find any cheap stocks?
Ans: The most likely reason for this would be that you are not looking hard enough! Value exists at all times, one just needs to look deeply and dig it out. But still, if you are really not finding any cheap stocks, sit on cash amigo! Unlike mutual funds, we individual investors have the luxury of taking cash calls. There is absolutely no compulsion to be invested all the time in equity. If cash gives you comfort, so be it!

Que: Well what if your so-called cheap stocks also fall?
Ans: Well that would be good news, right? Something cheap has become cheaper! The stock is on sale! If your analysis is strong and you have the conviction, you should buy more. This is where the concept of 'MOS in volumes' can be useful.

Que: Hmm.. Well what should an individual investor do, if he wants to start investing now?
Ans: Well, first, he should introspect as to why he wants to start investing now?!! Is it because he has seen people around him earn a bundle in the market and he has become greedy? If that is the case, its the worst reason to start investing and such an investor needs to think a lot more before entering the equity market.
My humble advice to a new investor would be to be extremely picky and choosy while buying stocks, leave cash on the table and start off by building small positions. You may earn small on the upside but at least you won't lose big on the downside! Build your own conviction as time passes and then graduate to bigger positions. The market is a great teacher, try to learn as much as possible!

Whatever I have written above is from the point of view of 'investing'. Traders and speculators, for whom a company is merely a price quote on a ticker, may think differently and I humbly and readily agree to all their objections and surrender without a fight!
Well, those were my thoughts on the topic. Hope they made some sense. I would eagerly welcome your views and comments. Learning never stops and I would love to learn a lot from you.
Cheers and happy investing!!

Wednesday, April 28, 2010

Funda-mental Shorter Term Positions!

In case you are expecting any intra-day, intra-week or even intra-month calls, please read the following first:

For me, a 6 months time frame would be short term, a time frame upto 2 years would be medium term and beyond 2 years would be longer term time frame for investing.

So for those of you, whose average holding period typically lasts a few hours, this post would be of no interest!

Also, let me clarify that this activity has never been my focus area, nor is it my main objective for being in the market. Hence, under this 'theme', I would advocate taking a small, 2-3% of the portfolio position and take advantage of a 30-35% spike in price, typically over one or two quarters. One should also consciously ensure that one's position size in this activity does not increase with consistent success, if any! ;-)

Let me explain myself with the help of a couple of examples:

LG Balakrishnan & Bros Ltd.

CMP: Rs.265/-
Mkt cap Rs.204 cr (EV Rs.313 cr)
Trailing PE: 11x
Dividend yield (normalised) 1%

Consider these points:

  • LGB is basically a 2 wheeler auto ancillary company. The company manufactures motorcycle transmission chains, sprockets and small parts, using fine blanking process.
  • The company's brand Rolon commands over 50% OEM and replacement market share. Clients include all 2 wheeler manufacturers in India.
  • The balance sheet is in decent shape, specially after the sale of its industrial chains business last year. Valuations are not really cheap, but cannot be called over-the-top expensive either.
  • Bajaj Auto is LGB's biggest customer. Now, upto November 2009, Bajaj Auto's monthly sales were quite sluggish. November onwards, the monthly sales have really taken off, as often discussed in numerous newspaper articles. (Monthly bikes sold 56% up in Oct 09, 137% up in Nov 09, 85% up in Dec 09, 112% up in Jan 10, 80% up in Feb 10 and 85% up in March 10)
  • So will this have a positive spill-over effect on LGB's sales? Will LGB's March 2010 results look really good, specially because of the low base effect? Time will tell..
  • Mr.Market usually rewards good results with a spike in the market price, as there occurs a 'reversion to mean'; since in light of good results, the stock suddenly starts appearing cheap. When this happens, the spike in price can earn an investor a tidy profit.
  • A visible negative: LGB has some optionally convertible bonds, to be converted in 2012. This could lead to dilution in equity. Anyways, under this theme, one would not stick around until that time!
Interesting? Well, here is another example..

Gujarat Alkalies & Chemicals Ltd.

CMP Rs.119/-
Mkt cap Rs.870 cr (EV Rs.1183 cr)
Trailing PE: 8x
Dividend yield 2.5%

Consider these points:
  • GACL is a diversified chemical company, but is primarily a caustic soda manufacturer. It is also the country's largest caustic soda manufacturer.
  • In mid 2009, caustic soda consumption in the US turned sluggish due to overall depressed conditions. (US is the largest producer of caustic soda). A lot of mass scale dumping of the commodity in India took place.
  • Prices of caustic soda crashed in the country. Here is a dated ET article about the same. Prices crashed from Rs.22000-25000 per ton to below Rs.10000 per ton!
  • The industry appealed to the government to levy safeguard duty, which was levied in December 2009. Notification.
  • Post safeguard duty, the prices of caustic soda have started rising again and are now above Rs.20000 per ton. A recent news article..
  • So, with increase in realisations, will GACL report better numbers in March 2010 and June 2010 quarters? Raw material prices (salt) have not increased a lot.
  • Andhra Sugars has a caustic soda division. The March 2010 results of Andhra Sugars show a 90% increase in the caustic soda segmental profits. This could be a pointer to the likely results of companies in this sector.
  • A visible negative: GACL has announced a mega expansion plan, for which it will have to take up significant debt and maybe dilute equity too.
I would re-iterate that putting money under this theme is an extremely risky proposition. Second-guessing near term results should not be an investor's main activity. (Watching good movies can be! :-) ) 
I would never advocate taking a major portfolio position under this theme, but it is an interesting way of looking at things nevertheless! 

Also, if one has taken a position under this theme, a spike in market price is all one looks for. (Something like a 30-35% spike can be aimed for in most cases). Once the spike happens and the 'reversion to mean' takes place, the objective of buying the stock gets fulfilled. One should immediately sell off the stock, once it becomes fairly valued. One should not allow greed to take control and hope for higher market price. (Even if it happens later, fine, let others earn too! :-) )

So, one need not speculate/punt while taking shorter term positions. Such positions can make your portfolio go that extra mile.
Reading newspapers, industry journals and talking with industry people is the best way to get information which will help you take such calls.
If you get any, do let me know! :-)